Treasury, IRS issue proposed regulations on new Opportunity Zone tax incentive
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IR-2018-206, October 19, 2018
Opportunity Zones, created by the 2017 Tax Cuts and Jobs Act, were designed to spur investment in distressed communities throughout the country through tax benefits. Under a nomination process completed in June, 8,761 communities in all 50 states, the District of Columbia and five U.S. territories were designated as qualified Opportunity Zones.
[That is, to provide tax incentives for private investment in low-income communities across the nation.]
Opportunity Zones retain their designation for 10 years.
Investors may defer tax on almost any capital gain up to Dec. 31, 2026 by making an appropriate investment in a zone, making an election after December 21, 2017, and meeting other requirements.
In the case of a capital gain experienced by a partnership, the rules allow either a partnership or its partners to elect deferral.
Similar rules apply to other pass-through entities, such as S corporations and their shareholders, and estates and trusts and their beneficiaries.
Generally, to qualify for deferral, the amount of a capital gain to be deferred must be invested in a Qualified Opportunity Fund (QOF), which must be an entity treated as a partnership or corporation for Federal tax purposes and organized in any of the 50 states, D.C. or five U.S. territories for the purpose of investing in qualified opportunity zone property.
The QOF must hold at least 90 percent of its assets in qualified Opportunity Zone property (investment standard).
Investors who hold their QOF investment for at least 10 years may qualify to increase their basis to the fair market value of the investment on the date it is sold.
The proposed regulations also provide that if at least 70 percent of the tangible business property owned or leased by a trade or business is qualified opportunity zone business property, the requirement that “substantially all” of such tangible business property is qualified opportunity zone business property can be satisfied if other requirements are met. If the tangible property is a building, the proposed regulations provide that “substantial improvement” is measured based only on the basis of the building (not of the underlying land).
In addition to the proposed regulations, Treasury and the IRS issued an additional piece of guidance to aid taxpayers in participating in the qualified Opportunity Zone incentive
Rev. Rul. 2018-29 provides guidance for taxpayers on the “original use” requirement for land purchased after 2017 in qualified opportunity zones.
They also released Form 8996, which investment vehicles will use to self-certify as QOFs.
More information on Opportunity Zones, including answers to frequently-asked questions, is on the Tax Reform page of IRS.gov. The Tax Reform page will also feature updates on the implementation of this and other TCJA provisions.
Click here for complete list of Opportunity Zones.
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October 25, 2018
Treasury Releases Proposed Regulations for Opportunity Zones
Further guidance has been proposed regarding the substantially all requirement in Section 1400Z-2(d)(3)(A)(i) whereas if at least 70 percent of the tangible property owned or leased by a trade or business is qualified opportunity zone property then the trade or business will satisfy the substantially all requirement. While the “substantially all” phrase is used throughout the regulations, the specific guidance only applies to Section 1400Z-2(d)(3)(A)(i). We can hopefully anticipate that the next round of guidance provides a better understanding of the definition around the various meaning of “substantially all” as it is used through the regulations.
In addition, the proposed regulations offer that land will be excluded from the basis when determining if the building has been substantially improved. Omitting this requirement provides some ease to investors who were concerned about repurposing vacant or otherwise unutilized land.
LINK > https://www.pmbusinessadvisors.com/opportunity-zones/
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October 31, 2018
Eagerly Anticipated Opportunity Zone Regulations Released (From Forbes)
On October 19, the Department of the Treasury released taxpayer-friendly proposed regulations (the “Proposed Regulations”) under Section 1400Z of the Tax Code. Due to the lack of administrative guidance, fund managers and other investors have hesitated taking advantage of new tax benefits designed to incentivize private sector investment into economically-distressed “opportunity zones.” The Proposed Regulations have been well received and will cause many investments to move forward.
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NOTE:
How To Generate Tax Savings By Making Impact Investments In Opportunity Zones
The views are those of Adam Strauss as of the date of publication and are subject to the change and to the disclaimers of Appleseed Capital.
Businesses will have a 31-month window to use the capital from an Opportunity Fund. There is no geographic requirement for Opportunity Funds, so Funds can invest in any Opportunity Zone in the country regardless of where the Fund itself is based.
There are already a few funds that focus on real estate, venture capital-type investment in small businesses, and/or particular geographies. In theory, any individual investor could create his or her own Opportunity Fund in which to invest as long as it was certified by the Treasury, but more funds are likely to come from larger institutions. . .
> Once an investor has decided to join an Opportunity Fund, he or she would sell an appreciated asset and then put their capital gains into an Opportunity Fund within 180 days of the sale. Investors would then report their investment to the IRS via the appropriate tax form, which is expected to be released soon.
As of now, investors can roll the gains from multiple sales of assets into one Opportunity Fund and there is no cap on the amount of gain that can be deferred. Short-term and long-term capital gains as well as section 1231 gains are eligible for tax deferral in an Opportunity Fund, but short-term gains will still be taxed at ordinary income rates when they are ultimately recognized.
READ MORE : https://www.forbes.com/sites/adamstrauss/2018/10/31/how-to-generate-tax-savings-by-making-impact-investments-in-opportunity-zones/#4ba09f071e5c
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Opportunity Zone Tax Benefits
As part of the Tax Cuts and Jobs Act enacted into law in December 2017, the Opportunity Zone statute (codified as Section 1400Z of the Tax Code) provides two main tax incentives designed to encourage investment in opportunity zones. First, the legislation allows for the deferral of gain to the extent that corresponding amounts are reinvested into one of more “qualified opportunity funds” (or QOFs).
Second, the legislation excludes from gross income the post-acquisition gains on investments in QOFs that are held for at least 10 years.
The Opportunity Zone legislation left a lot of questions unanswered regarding how to comply with the rules. This lack of guidance meant that taxpayers have been unwilling to make investments for fear that they would not be entitled to receive the favorable tax treatment that the legislation provides. While the Proposed Regulations still leave some questions unanswered, they provide enough certainty to allow for prudent investment.
Proposed Regulations
The Proposed Regulations both describe and clarify the requirements that must be met by a taxpayer in order to defer the recognition of gains by investing in a QOF and provide rules for QOFs relating to self-certification and some of the ongoing requirements imposed on QOFs.
The proposed regulations do not address all questions. The Department of Treasury and the IRS are working on additional published guidance, including a second round of proposed regulations expected to be published in the near future.While not intended to be a complete description of all changes, we note the following:
Rules Relating to Taxpayers Deferring Gain
Clarification of eligible taxpayers. The proposed regulations clarify that taxpayers eligible to elect gain deferral are those that recognize capital gain for Federal income tax purposes. These taxpayers include individuals, C corporations (including RICs and REITs), partnerships, and certain other pass-through entities.
The proposed rules include special rules for partnerships and their partners. Specifically, while there was no question that a partnership could defer gain, the proposed regulations clarify that a partner may elect gain deferral with respect to its allocable share of partnership gain, assuming the partnership fails to do so.Capital Gains Only. The proposed regulations clarify that only capital gains are eligible for deferral. Eligible gains generally include capital gain from an actual, or deemed, sale or exchange, or any other gain that is required to be included in a taxpayer’s computation of gain. (Certain statutory exceptions apply, including gains from a sale or exchange to a person closely related to the taxpayer.) Short or long term capital gains are both eligible.
The proposed regulations provide limitations/exceptions for gains under “Section 1256 contracts” and for gains from positions that are of have been part of an offsetting-position transaction (meaning, a transaction in which the taxpayer has substantially diminished its risk of loss from holding one position with respect to personal property by holding one or more other “offsetting” positions).
Equity Investments Only. To unlock QOF benefits, the taxpayer must make an investment in exchange for an equity interest. An equity interest includes preferred stock or a partnership interest with special allocations. Provided that the taxpayer is the owner of the equity interest for Federal income tax purposes, the taxpayer may use that interest as collateral for a loan (whether a purchase-money borrowing or otherwise) without jeopardizing eligibility.
That said, if the taxpayer instead chooses to structure its investment as a loan to a QOF (as opposed to an equity investment), the taxpayer will not be entitled to defer its prior gains or otherwise enjoy the tax benefits that the Opportunity Zone legislation provides.
Timely Elections. To be able to elect to defer gain, a taxpayer must generally invest in a QOF during the 180-day period beginning on the date of the sale or exchange giving rise to the gain. For a partner (or other person indirectly realizing gain through a pass-through entity), the 180-day period begins on the last day of such entity’s taxable year.
That said, the proposed regulations provide a special rule for partners where the partnership is the entity realizing gain and will not elect to defer the gain: In this scenario, if the partner knows both the date of the partnership’s gain and the partnership’s decision not to elect deferral, the partner may choose to begin its own 180-day period on the same date as the start of the partnership’s 180-day period. Similar rules apply to other pass-through entities (including S corporations, decedents’ estates, and trusts) and to their shareholders and beneficiaries.
Election for Investments Held at Least 10 Years. Under the opportunity zone legislation, a taxpayer that holds a QOF investment for at least ten years may elect to increase the basis of the investment to its fair market value on the date that the investment is sold or exchanged and thus, effectively exclude that gain from income. This basis step-up election is available only for gains realized upon investments that were made in connection with a proper deferral election. The proposed regulations reiterate that it is possible for a taxpayer to invest in a QOF in part with gains for which a deferral election is made and in part with other funds. This results in a “mixed” QOF, where the tax benefits associated with a QOF are available only with respect to that part of the taxpayer’s investment relating to realized gains.
Under the opportunity zone legislation, all qualified opportunity zones will lose their designation on December 31, 2028. This raises issues regarding gain deferral elections that are still in effect when the designation expires. The proposed regulations address these issues by permitting a taxpayer to make a basis step-up election after a qualified opportunity zone designation expires. The ability to make this election is preserved until December 31, 2047, which is 20 ½ years after the latest date that an eligible taxpayer may make an investment that is part of an election to defer gain.
Rules Governing Qualified Opportunity Funds
Certification Process. To facilitate the certification process and minimize the information collection burden placed on taxpayers, the proposed regulations generally permit any taxpayer that is a corporation or a partnership for tax purposes to self-certify as a QOF, assuming the entity is statutorily eligible to do so. It is expected that taxpayers will use IRS Form 8996, Qualified Opportunity Fund, both for initial self-certification and for annual reporting of compliance with the 90-percent asset test.
The proposed regulations allow a QOF both to identify the taxable year in which the entity becomes a QOF and to choose the first month in that year to be treated as a QOF. Any investments made by taxpayers prior to this date will not be eligible for QOF tax benefits.Valuation Method for 90-Percent Asset Test. To avoid penalties, the opportunity zone legislation requires a QOF to hold at least 90 percent of its assets in qualified opportunity zone property, determined by the average of the percentage of qualified opportunity zone property held in the fund (A) on the last day of the first 6 month period of each taxable year and (B) on the last day of such taxable year. The proposed regulations require the QOF to use the asset values reported on the QOF’s applicable financial stated for the taxable year. If the QOF does not have an applicable financial statement, the proposed regulations require the QOF to use the cost of its assets.
Nonqualified Financial Property. With certain limited exceptions, the opportunity zone legislation does not consider cash as qualified opportunity zone property. As such, cash held in the QOF may cause the QOF to fail the 90-percent asset test, even if that cash is held with the intent of investing in qualified opportunity zone property.
The proposed regulations provide a working capital safe harbor for QOF investments in qualified opportunity zone businesses that acquire, construct, or rehabilitate tangible business property. Provided there is both a written plan that identifies the financial property as property held for the acquisition, construction, or substantial improvement of tangible property in the opportunity zone and a written schedule consistent with the ordinary business operations of the business that the property will be used within 31 months, then this safe harbor will apply, assuming the business substantially complies with this schedule.
Substantial Improvements. Among other things, to be considered qualified opportunity zone business property, the original use of such property in the opportunity zone must commence with the QOF or the QOF must substantially improve the property, which is satisfied by the QOF making additions to basis with respect to the property within 30 months of acquisition in an amount which exceeds the acquisition price for the property. In other words, improvements to the property must result in at least doubling the QOF’s basis in the property.
For purposes of this requirement, the proposed regulations provide that the basis attributed to land on which a building sits is not taken into account in determining whether the building has been substantially improved.
Contemporaneous with the issuance of the proposed regulations, the IRS released Revenue Ruling 2018-29, which addresses the application to real property of the “original use” and “substantial improvement” requirements of the legislation.
Qualified Opportunity Zone Businesses. Under the opportunity zone legislation, for a trade or business to qualify as a qualified opportunity zone business, it must (among other requirements) be one in which substantially all of the tangible property owned or leased by the taxpayer is qualified opportunity zone business property.
The proposed regulations provide that if at least 70 percent of the business’s tangible property is qualified opportunity zone property, then the trade or business is treated as satisfying this “substantially all” requirement. The proposed regulations note that the phase “substantially all” is used throughout the opportunity zone legislation, and that the 70 percent threshold is intended only to apply to such term as is used for determining whether the business is a qualified opportunity zone business.
Mixed Funds. If only a portion of a taxpayer’s investment in a QOF is subject to the deferral election, then the opportunity fund legislation requires the investment to be treated as two separate investments, which receive different treatment for Federal income tax purposes. The proposed regulations reiterate that a taxpayer may make an election to step-up basis in an investment in a QOF that was held for 10 years or more only with respect to that portion of such investment for which a proper deferral election was made.
For investments made through partnerships, the proposed regulations clarify that deemed contributions of money under Section 752(a) (i.e., partnership liabilities) do not constitute an investment in a QOF. Therefore, such a deemed contribution does not result in the partner having a separate “mixed fund” investment. Thus a partner’s increase in outside basis is not taken into account in determining what portion of the partner’s interest is subject to the deferral election (or what portion is not subject to the deferral election).
Effective Date: The proposed regulations are effective after a 60-day comment period and once they are later published as final. However, taxpayers and QOFs may rely on the proposed regulations now, provided they apply the proposed rules in their entirety and in a consistent manner.
The full text of the taxpayer-friendly proposed regulations can be accessed here: https://www.irs.gov/pub/irs-drop/reg-115420-18.pdf.
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