For over a year we have been tracking the provisions relating to Qualified Opportunity Zones, a new code section added to the IRC through the Tax Cuts and Jobs Act at the end of 2017. Going into 2020, the IRS has issued Final Regulations which answer some of the burning questions that we have carried over the past year. These regulations were released on December 19, 2019, and we have summarized the key elements of these regulations below. Background As many of you are aware, Qualified Opportunity Zones (QOZ) allow taxpayers to invest in a Qualified Opportunity Fund (QOF) as a mechanism for capital gain deferral. Taxpayers are permitted to invest capital gains in QOFs allowing for capital gain deferral until 2026 so long as those gains are invested in a QOF within 180 days of gain recognition and the QOF invests 90 percent of its capital in a QOZ property. Taxpayers who hold investments in a QOF for at least five years may exclude 10 percent of the originally deferred gain, and investments held for more than seven years qualify for an additional five percent exclusion of their originally deferred gain. At this point in time the taxpayer will pay the applicable tax due on the original deferred gain, but as a result, will have full basis in the QOF investment. In what could be the most attractive feature of the new law, after 10 years of holding the investment, post-acquisition appreciation is 100 percent excluded from taxable income for federal tax purposes. This post-appreciation gain exclusion initiative has been incorporated by many state’s own income tax laws, with California and Massachusetts being the only two current notable outliers. December 19, 2020, Final Regulations These final regulations combine the two previously reported rounds of released proposed regulations and provide much needed clarity and additional rules based on public comments provided to the Service. The final regulations are generally effective March 13, 2020, for tax years ending after December 31, 2017. Taxpayers are permitted to choose to rely on these regulations prior to this date if they so choose. The regulations are now split into two distinct sections and included much needed information on the following:

1. Timing of eligible gains
2. Working capital safe harbor
3. Substantial improvement
4. Basis adjustments for QOF held for at least 10 years

  Timing of Eligible Gains Eligible gain that is to be deferred must be invested within a 180-day period. In general, this period begins on the day on which the gain would be recognized for federal income tax purposes but for an election to defer the gain. The 180-day period with respect to net gain from §1256 contracts that were not part of a straddle begins on the last day of the tax year in which the gain would otherwise be recognized. The final regulations, in contrast with the proposed regulations, provide that the 180-day period with respect to qualified capital gain net income from §1231 property begins on the date of the sale or exchange that gives rise to the eligible §1231 gain (that is, on the date the gain would be recognized for federal income tax purposes if the eligible taxpayer did not elect to defer the gain under §1400Z-2(a)). In the context of a partnership or other pass-through entity, the entity itself can make an election to defer capital gain through investment in a QOF, or, if and to the extent that the entity does not make that election, the partners can make the election with respect to their distributive shares of the capital gain. Generally, if a partner’s distributive share includes eligible gains with respect to the partner, then the 180- day period for the partner begins on the last day of the partnership’s taxable year. However, the regulations also provide that if a partner knows (or receives information) regarding both the date of the partnership’s gain and the partnership’s decision not to elect deferral, the partner may elect to begin its own 180-day period on the same date as the start of the partnership’s 180-day period. A 180-day election for partners of a partnership, shareholders of an S corporation, beneficiaries of decedents’ estates, and beneficiaries of non-grantor trusts, with the option to treat the 180-day period as commencing on the due date of the entity’s tax return, not including extensions is provided in the final regulations. However, the final regulations do not provide this election for beneficiaries of grantor trusts, because the grantor(s) are treated as owners of the grantor trust’s property for federal tax purposes. For example, the 180-day period for a partner of a calendar year partnership making this election would begin on March 15 of the subsequent calendar year. To address the treatment of gains from installment sales the final regulations, allow eligible taxpayers with installment sales to choose the 180-day period to begin on either the date a payment under an installment sale is received in a tax year, or on the last day of the tax year in which the taxpayer would first recognize gain on the installment sale. Thus, a taxpayer may elect to treat each installment payment under an installment sale as giving rise to a 180-day period for that installment payment, and a taxpayer may have multiple 180-day periods for gain related to the installment sale. The final regulations provide that the 180-day period for investing gain from an inclusion event begins on the date of the inclusion event. Working Capital Safe Harbor A safe harbor provision is provided in the final regulations with regards to working capital stating that tangible assets can benefit from up to a 62-month safe harbor (through a combination of two 31-month safe harbor provisions the taxpayer may be eligible for). Additionally, the final regulations state that there is a 24-month period that may be granted to taxpayers whose QOZ property is located in a federal disaster area. The final regulations also provide clarity regarding the treatment of in-progress assets and gross income generated by working capital safe harbor assets during the safe harbor period, and confirmed that these assets and income will be treated as used in a trade or business and generated from a trade or business during the safe harbor. With additional clarity provided on these key concepts there likely could be an uptick in capital infusions to multi-asset QOZ Fund investment strategies that include operating entities located in a zone. Substantial Improvement The final regulations elaborated on the aggregation rules, which will replace the asset-by-asset approach for purposes of determining whether the property has been sufficiently improved. The final regulations explain that buildings located entirely within a single parcel of land can be aggregated into a single property. In addition, multiple buildings located within adjoining parcels of land can be treated as a single property if:

• The buildings are operated exclusively by the QOF or the QOZB,
• The buildings share facilities or significant centralized business elements, and
• The buildings are operated in coordination with or reliance upon one or more trades or businesses.

  Tangible property that is purchased, leased or improved by a trade or business that has undergone the required substantial improvements will qualify as QOZ business property for the 30-month substantial improvement period in the final regulations. This property will qualify so long as there is a reasonable expectation that the property will be substantially improved and used in the trade or business in a QOZ by the end of the 30-month period. The previously issued guidance surrounding related party leasing arrangements is still applicable to this type of property. Original Use Qualification and Vacancy Period In addition, there was clarity provided on how periods of vacancy would aid in meeting the definition of the original use of the property. There was a reduction in the required vacancy period outlined in the proposed regulations five years to one year. This would make the property eligible so long as the property was vacant one year before its QOZ designation and it remained vacant through the date it was purchased by a QOZ fund or a QOZ business. The vacancy definition will be met by land or buildings so long as the property is less than 20% utilized. Basis Adjustments for QOF Held for at Least 10 Years The proposed regulations stated that a passthrough QOF that was beyond the 10-year holding period would be permitted to sell property, including investments in a QOZ business and exclude any capital gain resulting from the sale. The final regulations have expanded this provision to allow the exclusion of all gains, not just capital gains, aside from any gains on the sale of inventory in the ordinary course of business. This a substantial taxpayer friendlier determination. The final regulations also provide guidance for calculating the basis step-up for sales of partnership interests, clarifying that a partners stepped up basis in a QOF partnership following this 10-year election is equal to the net FMV of the interest including that partners share of partnership debt in relation to the interest. Conclusion The rules relating to QOZ have been expanding since the TCJA, and the IRS has indicated they will continue to monitor the interaction of QOZ’s and existing credits and incentives at the federal level. Additional guidance is expected in the future including the Internal Revenue Service tax reporting forms. Although taxpayers may rely on these regulations it is not expected that the final regulations will be published in the Federal Register in 2020. We will update you as more information becomes available.

Of the many changes that came from the Tax Cuts and Jobs Act (“The TCJA”), Qualified Opportunity Zones (“QOZ”) have been one of the most talked about provisions as the 2018 tax season progresses. As a recap, through QOZs, taxpayers may elect to temporarily defer the tax to be paid on capital gains until the 2026 tax year that are invested in a Qualified Opportunity Fund (“QOF”) within 180 days of gain recognition, the QOF must invest 90 percent of its capital in QOZ Property. Taxpayers who hold investments in a QOF for at least five years may exclude 10 percent of the original deferred gain, and investments held for more than seven years qualify for an additional five percent exclusion of their original deferred gain. In what could be the most attractive feature of the new law, after 10 years, post-acquisition appreciation is 100 percent excluded from taxable income for federal tax purposes. Many states are still evaluating how they are going to deal with the new QOZ rules.

Click here to read the full update.

The passage of the Tax Cuts and Jobs Act (TCJA) resulted in a complete makeover of the forms used to prepare individual income tax returns. Apparently “filing on a post card” is possible; for some, the new Individual Income Tax Return will indeed be as simple and straightforward as filling out a two-sided post card-sized form. For many others, however, the new form will be accompanied by one or more of six new schedules.

The first page of the new form is informational. It lists the taxpayer’s filing status, name, address, social security number and dependents. It also includes a signature area for the taxpayers and the tax preparer.

The second page of the new form contains the information used to compute the tax due for the year; it has been significantly simplified from prior year forms. If additional information needs to be reported, the TCJA has provided the following schedules to be used:

• Schedule 1 should be included in any tax return where the taxpayer receives income from capital gains (reported on Schedule D), ordinary gains (reported on Form 4797), business income (reported on Schedule C), rental and pass through income (reported on Schedule E), or any other type of income typically referred to as “Other Income.” This form will also report any adjustments to income, such as the deductible part of self-employment tax (reported on Schedule SE), the self-employed health insurance deduction, the deduction for contributions to an IRA and the student loan interest deduction.
• Schedule 2 will be included in any tax return where the taxpayer is subject to the Alternative Minimum Tax (reported on Form 6251) or needs to make an excess advance premium tax credit repayment.
• Schedule 3 will be used to claim nonrefundable credits such as the foreign tax credit (reported on Form 1116), any residential energy credits, general business credits or child and dependent care expenses.
• Schedule 4 will be used to compute other taxes such as self-employment taxes (reported on Form SE), additional taxes on IRAs, net investment income taxes (reported on Form 8960), household employment taxes (reported on Schedule H) and any Section 965 taxes due.
• Schedule 5 will be used to report any estimated tax payments as well as any payments made with an extension. This schedule will also be used to claim any refundable credits that the taxpayer is entitled to other than the earned income credit, such as the American opportunity credit or the additional child tax credit.
• Schedule 6 should be included for any taxpayers who have a foreign address or wish to designate a third- party designee to discuss their return with the IRS.

In addition to these new schedules, taxpayers should be prepared to fill out many of the standard, familiar forms and schedules when completing 2018 returns.

Taxes can be complex, and it is important to understand how these changes might affect filings. The examples included in this article are not all-inclusive and not intended as a substitute for the value and knowledge of consulting with a tax specialist. Please contact a member of the HBK Tax Advisory Group with your questions and concerns. We’re here to help.

A provision of the Tax Cuts and Jobs Act (TCJA) of 2018 allows investors to defer taxes on capital gains by investing them in properties and businesses in Qualified Opportunity Zones (QOZs). The purpose is to encourage investment that will revitalize low-income areas. Essentially QOZs allow investors to take capital assets that have appreciated, monetize them, and defer the gain for up to seven years, or through 2026.

A typical investor might be a client selling a stock that has amassed substantial capital gains over time. A QOZ unties the binds that keep that individual from selling by allowing him or her to re-invest the gains tax-deferred in a Qualified Opportunity Fund (QOF).

Qualified Opportunity Zones are designated by state governors and currently all 50 states have designated zones in their respective jurisdictions. Florida’s governor Rick Scott added its name to that list as of April 19, 2018 with his recommendations for zones in 427 communities across every county in the sunshine state. As in the case of TCJA, and most new tax legislation, subsequent regulations will be required to address some unresolved issues, but all QOFs do provide federal capital gains tax benefits. Here’s how it works:

If a client sells an investment that generates a capital gain before December 31, 2026, and re-invests the gain in a QOF within 180 days, the benefits are:
– Deferred taxes on the initial gain until December 31, 2026
– Elimination after five years of a portion of the deferred gain
– Elimination of more of the gain after 7 years
– Elimination of post-rollover appreciation after 10 years

The following guidelines must be considered for qualified, preferential tax treatment under a QOF:

• To qualify as a QOF, the corporation or partnership must have 90 percent of its assets invested in QOZ properties or businesses.
• A QOF investor can be any taxpaying entity: individual, partnership, S corporation, trust.
• An “unrelated person” is an entity in which the investor does not have an ownership stake of more than 20 percent. The rule would keep the investor from selling the original investment to himself, or an entity in which the investor holds a substantial stake, such as in a current partnership, for example.
• The provision applies only to capital gains, including 1231 and 1250 gains, but not gains taxed as ordinary income.

To achieve deferral or potentially eliminate the tax on a QOF investment, the investor must commit the capital gain to an investment in a QOF within 180 days of the sale of the original investment. Then:

• After five years of holding the investment in the QOF, the basis is increased by 10 percent of the initial deferred gain, thereby permanently excluding from income that 10 percent.
• After 7 years, the basis in the investment is increased by another 5 percent of the deferred gain, thereby permanently excluding that amount from taxable income.
• After 10 years of holding the QOF investment, the investor can elect to have the basis equal its fair market value when the investment is sold. Because the originally deferred gain will be taxed December 31, 2026, with a corresponding adjustment in basis, the rule has the effect of excluding from tax all post-rollover appreciation.

Even if an investment is not made in time to capitalize on the seven or five-year basis-point increases, there are still advantages to investing in a QOF. Invested capital gains are still eligible for deferral until December 31, 2026. As well, the investor remains eligible for the 10-year rule allowing all post-rollover appreciation to be permanently excluded from being taxed.

One of the requirements for qualification as a QOZ business is that less than 5 percent of the average of the aggregate unadjusted bases of property held by the entity must be attributable to nonqualified financial property (NQFP). Under Section 1397C(e), the definition of NQFP does not include reasonable amounts of working capital held in cash, cash equivalents, or debt instruments with a term of 18 months or less. If documented adequately, capital can be used for expenses, effectively maintaining the investment as a QOF at less than the prescribed 90 percent threshold.

Another round of regulations from the Treasury Department for QOFs is expected by the end of the year. Among the issues that need to be addressed is the requirement that at least half of all receipts from a QOZ business come from their zone of location. That might make sense for a single grocery store or apartment building, but not necessarily for a manufacturer selling its products throughout the country. The sales might be dispersed but the income, jobs and other benefits are clearly local.

Other questions hoping to be answered by the next round of regulations include:

• What are the federal tax benefits relative to the income generated from this investment?
• The QOFs will likely own a portfolio of businesses in the zone, but what are the benefits to the operating entities?

We will closely monitor future announcements from the U.S. Treasury Department on this topic and provide updates as soon as they are available. For questions, please contact Anthony Giacalone at agiacalone@hbkcpa.com.

The Internal Revenue Service has just released its first installment of the much anticipated proposed rules relating to Qualified Opportunity Zones (QOZ) that will help investors use a new tax incentive created by 2017 Tax Cuts and Jobs Act. QOZs are underdeveloped areas that have been certified by the federal government allowing for special tax breaks to promote investment in these nearly 9,000 U.S. regions. These proposed rules would govern investments made in QOZs to provide various tax advantages to investors in two ways. First, capital gains placed in certified opportunities zone funds will be deferred and not be taxed through the 2026 tax year, or until the time in which the investment is sold, whichever occurs first. Second, gains from these QOZ investments are “permanently” shielded from income taxes if such investments are held for at least 10 years. Otherwise, gains from the initial investments in qualified opportunity funds will be discounted by up to 15% if held for 7 years and 10% for 5 years. The proposed rules state that any type of capital gains including from marketable securities are eligible for this preferential tax deferral. Additionally, the opportunity to invest in these qualified opportunity funds is available to individual taxpayers, business entities, REITs and estates and trusts. The proposed rules also clarify how to calculate substantial improvements in the property. and The rules state that taxpayers do not need to include the value of the land for the purpose of calculating how much the law requires they spend on qualifying renovations, or refurbishments of the property. For example, if a taxpayer paid $10 million for a warehouse and land, with the building being valued at $500,000, the fund must spend at least what the building is valued, or $500,000 as opposed to the total $10 million purchase price, in renovations. This exclusion of land value for the purposes of determining substantial improvements made within a QOZ applies to both tangible property, such as equipment, and realty. This will create an increased importance as to the qualified valuations performed on property located in within the boundaries of a QOZ. Additionally, investors will have 180 days from the sale of stock or businesses to place the proceeds from those sales in opportunity funds to qualify for these tax breaks. The Internal Revenue Service (IRS) also stated in these proposed rules that funds have 30 months from when the money is placed in them to perform the required renovations. The Treasury also created a 70-30 rule that measures whether a given business counts as having “substantially all” of its assets in an opportunity zone. Under that rule, as long as 70% of a business’s tangible property is in a zone, the business doesn’t lose its ability to qualify for the tax break. In the proposed regulations, Treasury does ask for input on a couple of technical questions, such as what happens if a business abandons property in an opportunity zone and how to treat movable property, such as vehicles, that may possibly spend part of their time outside the QOZ. While these rules have provided some of the answers to questions on the minds of taxpayers, some additional items still remain unanswered.

• Will grace periods will be permitted related to the proceeds of large scale asset sales?
• Will the emerging cannabis and gambling industries will be permitted benefit from these tax advantages?
• What benefits will be able to be yielded by lessees of QOZ properties?
• Will partnerships and partners need to invest as a singular unit or if partners are permitted to invest their portions of asset sales individually into their own qualified opportunity zones?

The Treasury is expected to announce additional guidance on opportunities zones before the end of the year and are currently under review by the IRS. In the meantime, taxpayers can rely on the proposed regulations while the IRS solicits comments and considers changes in the final version. Since this is a developing area, HBK will continue to provide updates on the QOZ issue as it becomes available. Committing capital to a QOF is an option with many variables and it is a decision investors/taxpayers should weigh carefully. If there are any questions on this, please contact your local HBK team representative to discuss further. For more details or other related questions, please contact a member of the HBK Tax Advisory Group.

The Tax Cuts and Jobs Act (“TCJA”) created an investment vehicle for taxpayers through use of Qualified Opportunity Funds (“QO Fund”), which allows investors to:
• Defer capital gains
• Potentially reduce the amount of gain recognized through a basis adjustment if holding requirements are met
• Potentially permanently exclude the gain on appreciation for interests in a QO Fund

These provisions are set forth in new Internal Revenue Code Sections §1400Z-1 and §1400Z-2, and are intended to provide incentives for taxpayers to invest in low-income areas or “zones.” For additional reference, please see the IRS FAQs link. The following provides an analysis and examples of howthe QO Funds could work.

ANALYSIS
Designation of a QO Zone:
Under the Tax Cuts and Jobs Act, a state’s chief executive officer (generally a governor or the mayor of the District of Columbia) can designate certain census tracts that are low-income communities as Qualified Opportunity Zones. The state’s CEO had 90 days (plus another 30 days under an extension) after December 22, 2017, to nominate a tract by notifying the IRS in writing of the nomination. The IRS had 30 days (plus another 30 days under an extension) to certify the nomination and designate the tract as a QO Zone. Thus, designations had to occur before June 21, 2018, and those that were designated will remain in effect for 10 calendar years. Census tracts in Puerto Rico that are low-income communities are considered certified and designated as QO Zones effective on December 22, 2017.

LIST OF DESIGNATED QUALIFIED OPPORTUNITY ZONES PROVIDED VIA IRS WEBSITE
The spreadsheet located at https://www.cdfifund.gov/Pages/OpportunityZones.aspx was updated June 14,2018, to reflect the final QO Zone designations for all states.

What are QO Funds:
A QO Fund is an investment vehicle organized as a corporation or a partnership for investing in a QO Zone. A QO Fund cannot invest in another QO Fund, and each QO Fund has to hold at least 90% of its assets in QO Zone property (i.e., any QO Zone stock, any QO Zone partnership interest, and any QO Zone business property). A QO Zone property has to meet many requirements, including that substantially all of the entity’s business property is used in a QO Zone. A penalty will apply to the QO Fund if it fails to meet the 90% requirement.

Temporary gain deferral election:
If a taxpayer invests gains from the sale or exchange of property (i.e. stocks, bonds, etc.) with an unrelated person in a QO Fund within the 180-day period beginning on the date of the sale or exchange, the taxpayer can elect to defer the gain from the sale or exchange. This election will be made on the taxpayer’s 2018 tax return (filed in 2019) as directed by the Treasury. Recognition of deferred gain:

The taxpayer defers the gain until the later of the date:
• On which the QO Fund is sold or exchanged, or
• December 31, 2026

At that time, the taxpayer includes the lesser of:
• Amount of gain deferred or,
• Fair market value (FMV) of the QO Fund minus the taxpayer’s basis in the interest.

Basis in the investment:
A taxpayer’s basis in the investment is zero unless any of the following increases apply:
• 10 percent of the deferred gain if the investment is held for five years
• Five percent of the deferred gain if the investment is held for seven years
• Any deferred gain recognized at the end of the deferral period

Permanent gain exclusion election:
Taxpayers are permitted to make an election that would allow for the exclusion of any post-acquisition capital gains on an investment in a QO Fund if the investment in the QO Fund has been held for 10 years.

When elections cannot be made:
Taxpayers are not permitted to make either election if there is already an election in effect with respect to the same sale or exchange. Additionally, a taxpayer cannot make a temporary deferral election with respect to any sale or exchange after December 31, 2026.

Taxpayers who made the temporary deferral election have to recognize any deferred gain on December 31, 2026 (unless a sale or exchange causes the period to end before December 31, 2026). The end of the deferral period, -December 31, 2026 will occur before any taxpayer could have held their investment for ten years, the permanent exclusion election will not protect a taxpayer from recognizing any deferred gain. Thus, if the taxpayer holds their investment for 10 years, the permanent exclusion election presumably will only exclude the gain in excess of the deferred gain (that has already been recognized). The following flow chart illustrates an example scenario and timeline of how the deferral opportunity works.

For access to the related FAQs, please read the full article here.

For more information, please contact a member of the Tax Advisory Group.