New Opportunity Zones: Tax Deferral and Permanent Exclusion of Capital Gains

By Baker Newman Noyes March 27, 2018

Significant – and little discussed – benefits of the Tax Cuts and Jobs Act

Summary

The Tax Cuts and Jobs Act of 2017 (TCJA) created three new tax incentives (summarized below) for investing in low-income communities. New Internal Revenue Code Sections 1400Z-1 and 1400Z-2 provide for the temporary deferral of inclusion in gross income for capital gains reinvested in a Qualified Opportunity Zone through a Qualified Opportunity Fund, and the permanent exclusion of certain capital gains resulting from the sale of an investment in a Qualified Opportunity Fund. These tax incentives are designed to encourage long-term investments in low-income communities, and complement the new markets tax credit.

Definitions

A “Qualified Opportunity Zone” means a population census tract that is a low-income community (a term that has the same meaning as used by the new markets tax credit) that is designated as a Qualified Opportunity Zone by a state. The designation as a Qualified Opportunity Zone will remain in effect for ten years until December 31, 2028.

A “Qualified Opportunity Fund” means any investment vehicle which is organized as a corporation or partnership for the purpose of investing in Qualified Opportunity Zone Property that holds at least 90% of its assets in Qualified Opportunity Zone businesses and/or business property. Qualified Opportunity Funds must be certified by the Treasury Secretary.

Tax benefits

• Temporary Gain Deferral – A taxpayer may elect to exclude from gross income, gain on the sale of any property to an unrelated party in the tax year of the sale if the gain is reinvested in a Qualified Opportunity Fund within 180 days of the sale. 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. No election may be made for any sale after December 31, 2026.
• Step-Up in Basis – For investments held at least five years, the taxpayer’s basis is increased by 10% of the gain originally deferred and an additional 5% if held for at least seven years, thereby excluding up to 15% of the original gain from taxation.
• Permanent Exclusion – For investments in Qualified Opportunity Funds held for at least ten years, taxpayers may elect to exclude from gross income any additional gains beyond that which was previously deferred (and that has already been recognized). There is no exclusion available for investments made after December 31, 2026. In the case of any investment in a Qualified Opportunity Fund where only a portion consists of gain to which a deferral election was made, the permanent exclusion rules only apply to that portion of the investment.

Conclusion

As is often the case with federal tax law changes, it is unclear which states will adopt these new federal benefits. However, for federal tax purposes, those willing to invest in Qualified Opportunity Zones can enjoy significant new tax benefits by deferring and/or legitimately avoiding otherwise taxable gains.

If you have any questions regarding the Tax Cuts and Jobs Act and its impact on your current entity structure, please contact your BNN tax advisor at 800.244.7444.