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.