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Tax Incentives for Qualified Opportunity Zone Investments

In 2017, the Tax Cuts and Jobs Act was enacted and passed into law. The Act introduced Qualified Opportunity Zones to encourage sustained economic growth and investment in economically distressed areas.

More than 8,700 low income urban and rural census tracts nationwide have been designated as Qualified Opportunity Zones. Examples in Massachusetts include neighborhoods surrounding the train stations in Brockton, Lawrence, and Springfield. Interactive maps are available online.

This program comes with significant tax benefits for investors, including capital gains deferral, tax basis increases, and capital gain exclusions.

During 2019, the Treasury released a second round of the proposed regulations in order to clarify the nuances of the incentives, as well as reiterate the goal of the incentives: to reduce unemployment, relieve poverty, and boost economic activity and growth in the designated communities.  

Opportunity Zone Tax Benefits for Investors

  1. Capital Gains Deferral

This incentive allows for a temporary deferral of the tax on certain capital gains.

The taxpayer can sell qualifying appreciated assets (to an unrelated party) and defer any capital gain taxation by rolling that capital gain into a Qualified Opportunity Fund (QOF) within 180 days. The taxpayer must recognize the deferred capital gain by December 31, 2026, or when the taxpayer exits the fund, whichever comes earlier.

  1. Tax Basis Increase

Initially, the taxpayer’s basis in the QOF is zero, but will increase by 10% of the deferred capital gain after the investment is held for over five years. After holding the investment for seven years, the basis is increased by an additional 5%, giving an overall step-up of 15% over seven years.

  1. Capital Gain Exclusion

Appreciation in a QOF may also be permanently excluded from taxable income. After 10 years, the taxpayer can elect to step up the basis to 100% of fair market value when they sell the QOF investment on or before December 31, 2047. This means the entire gain would be exempt from federal income tax.

What Qualifies as a QOF?

The following constitute the characteristics of a Qualified Opportunity Fund:

  • Investment vehicle that is either a domestic partnership or a domestic corporation
  • Purpose of the fund must be to invest in qualified opportunity zone business property or stock/partnership interests in qualified opportunity zone businesses
  • Hold at least 90% of its assets in qualified opportunity zone business property at two dates each year:
    • Last day of the first 6-month period of the taxable year of the fund (typically 6/30)
    • The last day of the taxable year of the fund (typically 12/31)
  • Penalties are incurred each month it fails to meet the 90% requirement

The following do not qualify:

  • Single member limited liability company investments
  • Tiered or fund of fund investments (a qualified opportunity fund cannot invest in another qualified opportunity fund)
  • Excluded businesses:
    • Suntan facility
    • Race track or other facility used for gambling
    • Golf course
    • Liquor store
    • Country club
    • Massage parlor
    • Hot tub facility

Opportunity Zone Tax Benefit Example

Key Dates

10/19/18: First round of proposed regulations released

4/17/19: Second round of proposed regulations released

12/31/19: Last date to invest in QOF and receive a tax basis increase of 15% of deferred capital gain for holding > 7 years

12/31/26: Deferred capital gain must be recognized

12/31/28: Qualified Opportunity Zones expire

12/31/47: Last date to receive capital gain exclusion on sale of QOF investment

Conclusion

Investing in opportunity zones provides investors with a unique opportunity to bolster sustainable economic growth in disadvantaged communities while achieving significant tax benefits. Should you have any questions or would like to further discuss the impact of Opportunity Zone investing, please contact Michael C. Stravin, CPA, MST, Tax Principal, at 617-428-5404 or mstravin@wolfandco.com; Kristin L. Stone, CPA, MST, Tax Senior Manager, at 617-428-5464 or kstone@wolfandco.com; or Ryan P. Brunell, CPA, MST, Tax Principal, at 617-933-3348 or rbrunell@wolfandco.com.

This content is for information purposes only and should not be considered investment advice.  Specific investing strategies should be discussed with your investment advisor.