OPPORTUNITY ZONES- ADVANCING SOCIAL AND FINANCIAL GOALS OF INVESTORS
Passage of the Tax Cut and Jobs Act in December 2017 created significant new opportunities for investors and developers through the existence of Opportunity Zones. There are over 8,760 Opportunity Zones located in all fifty states, the District of Columbia and five US territories. This compares with only 40 empowerment zones and 40 renewal communities which had been established by Congress according to an August 2018 article in Forbes magazine.
Incentives of major tax benefit are subject to clarification as new regulations and clarifications are expected to emerge after the second round of hearings held in July 2019. However they may be clarified the tax incentives are of such a magnitude that they should be understood by investors and developers.
The Opportunity Zones program offers three tax benefits for investing in designated areas as defined by each state as an Opportunity Zone. These incentives for investors include:
- The temporary deferral of taxable income for capital gains that are reinvested in an Opportunity Fund. The deferred gain must be recognized on the earlier of the date on which the opportunity zone investment is disposed of or December 31, 2026.
- A step-up in basis for capital gains reinvested in an Opportunity Fund. The basis is increased by 10% if the investment in the Opportunity Fund is held by the taxpayer for at least 5 years, and by an additional 5% if held for at least 7 years. This thereby excludes up to 15% of the original gain from being taxed.
- A permanent exclusion from taxable income of capital gains from the sale or exchange of an investment in an Opportunity Fund if the investment is held for at least 10 years. It should be noted that this exclusion only applies to gains that accrue after an investment in an Opportunity Fund.
Consider this example: an investor sells stock, art or other asset which she purchased in September 2013 at a cost of $ 100,000. She sells the asset in December 2019 for $ 250,000, thereby realizing a taxable gain of $150,000. Within 180 days of that sale she reinvests the money in a Qualified Investment Trust in an equity investment. That Fund then invests the money in stock of businesses operating within the OZ. The investor plans to holds her interest in the Fund until sometime in 2031. Consequently, this investor receives a step-up in basis of 15% with respect to the sale of the asset, , deferral of capital gains taxes on the sale of the asset until December31, 2026 and elimination of all capital gains taxes on the sale of the properly qualified OZ fund which has been held for at least ten years.
An aspect of the OZ incentives can be seen by comparing to what if familiar to many real estate investors- the 1031 exchange. In addition to enhanced tax benefits the OZ incentives go well beyond the scope of a 1031 exchange since the underlying transaction is not restricted to real estate but applies as well to sale of any other asset triggering a capital gain as far ranging as stock, works of art or other items of personal property.
Applicability of the Opportunity Zone program requires participants to both locate their projects in an Opportunity Zone, or in proximity as defined under the legislation and for their projects to be qualified. The requirements specified in the regulations for realization of OZ benefits differ depending on whether the project is a real estate investment or one involving an operating business. In the former case an investment such as in housing or medical facilities is more likely to benefit the residents of the OZ compared to a business whose employees and services more predominantly benefit those outside the zone and thus subject to more stringent standards.
Understanding of the OZ program allows potential investors to evaluate a new way to advance social and financial goals. For example, the scope of tax benefits also allows the investor to take advantage of a broader range of transactions than is available under a 1031 exchange. The OZ program allows an investor to invest in a way that meets her social goals, provides the incentive to a developer to build or enhance a business in the OZ that may not otherwise meet investment criteria, and provides a vehicle for a Community Fund or other not- for – profit to establish its own project and attract investors.