Qualified Opportunity Zone (QOZ)

 Qualified Opportunity Zone (QOZ)

 

ü  Established by The Tax Cuts and Jobs Act 20174 to provide a tax incentive for private, long-term investment in economically distressed communities

ü  Capital Gain Tax deferral or reduction: Investors in these programs have opportunities to defer and potentially reduce tax on recognized capital gains.

ü  Tax savings: Tax payer can avail saving in taxes when they retain the investment in the Qualified Opportunity Fund for the time frame stipulated. Meaning, if you are hot by a huge tax bill due to capital gains, investing in a Qualified Opportunity Fund may worth considering, provided you invest within a prescribed time frame.

What is Qualified Opportunity Zone?

IRS says: A QOZ is an economically distressed community where new investments, under certain conditions, may be eligible for preferential tax treatment. Localities qualify as QOZs if they were nominated for that designation by a state, the District of Columbia, or a U.S. territory and that nomination was certified by the Secretary of the U.S. Treasury via his delegation of authority to the Internal Revenue Service (IRS). That means, An Opportunity Zone is a community nominated by the state and certified by the Treasury Department as qualifying for this program. The Treasury Department has certified zones in all 50 states; Washington, D.C, and U.S. territories. QOZs were added to the tax code by the Tax Cuts and Jobs Act on December 22, 2017.

How does QOZ program work?

An investor can defer a capital gain (also net Sec.1231 gains) by investing the realized gain dollars into a Qualified Opportunity Fund. A taxpayer has 180 days starts from the last day of the year to invest into Qualified Opportunity Fund.

What are Section 1231 gains anyway?

These are the gains reported on Form 4797, Part I – Sale or exchange of properties used in trade or business.

What is Qualified Opportunity Fund?

A QOF is an investment vehicle that files either a partnership or corporate federal income tax return, is organized for the purpose of investing in QOZ property and elects to self-certify as a Qualified Opportunity Fund.

The taxpayer may invest the return of principal as well as the capital gain; however, the portion of the investment attributable to the capital gain will only be eligible for the QOZ tax benefits.

Investor can even take benefit of The Opportunity Zone program on the sale of stock, securities and any appreciated assets with a investment of the capital gains in a Qualified Opportunity Fund. The capital gain from the sale of assets must be investment in QOF within 180 days from the date capital gain realized. However, the pass through entities such as  S-Corp, Trust, Estate and Partnerships who receives K1, with reported capital gain have option to start the 180 day count from the investment period on any of the following dates:

 ü  the last day of the partnership/S-Corp taxable year

   ü  the same date that the S-Corp/partnership’s 180-day period begins or

   ü  the due date for the S-Corp/partnership’s tax return, without extensions, for the taxable year in which      the S-Corp/partnership realized the eligible gain  Tax deferral and savings

What are the tax benefits to invest in QOF?

Tax deferral through 2026

Taxpayer can elect to defer the tax on portion of or all of a capital gains if the tax payer invest the capital gains in Qualified Opportunity Fund within 180 of the date of realization of such capital gain. In case of flow-through entity 180 can be counted from year end date or tax return filing date.  Any taxable gain invested in a Qualified Opportunity Fund is not taxable (not recognized as gain) until December 31, 2026 or until the fund or interest in the fund is sold or exchanged.

Exclusion of Capital Gains - 10% or up to 15% and after 10 years there is no capital gain.

If the QOF investment is held for at least 5 years, there is a 10% exclusion of the deferred gain.  If held for at least 7 years, the 10% exclusion becomes 15%. 

Second, if the investor holds the investment in the QOF for at least 10 years, the investor is eligible for an adjustment in the basis of the QOF investment to its fair market value on the date that the QOF investment is sold or exchanged.  As a result of this basis adjustment, the appreciation in the QOF investment is never taxed.  A similar rule applies to exclude the QOF investor’s share of gain and loss from sales of QOF assets. 

You do not have to live, work or have existing business in the QOZ, you just have to invest in it.

The list of each QOZ can be found in IRS Notices 2018-48 and 2019-42. A visual map of the census tracts designated as QOZs may be found at Opportunity Zones Resources.

How do you make election to defer the gain?

You make an election to defer the gain, in whole or in part, when filing your federal income tax return.  You shall make the election on the return on which the tax on that gain would be recognized if you did not make the election. If you have already filed your tax return, you can still amend the return if you are well within 180 days limit.

How to Invest in Qualified Opportunity Funds (QOF)

A qualified opportunity zone fund can be established by any taxpayer by filing Form 8996 and submitting it with their federal income tax return. The purpose of this form is to certify individuals, partnerships or corporations as organizations for investing in qualified opportunity zones.

A qualified opportunity fund is an investment vehicle structured as a REIT or partnership with the specific objective of investing in opportunity zone assets.

The fund must hold and invest at least 90% of its assets in qualified opportunity zone properties and qualified opportunity zone businesses.

To get the tax saving and deferrals under the Tax Cuts and Jobs Act, investors are not allowed to invest their capital gains directly into an opportunity zone. Instead, all opportunity zone investments must pass through a qualified opportunity fund to qualify for the associated tax incentives.

50% of Gross Income Test Rule

Each taxable year, a QOZ business must earn at least 50 percent of its gross income from business activities within a QOZ.  The regulations provide three safe harbors that a business may use to meet this test.  These safe harbors take into account any of the following—

ü  Whether at least half of the aggregate hours of services received by the business were performed in a QOZ;

ü  Whether at least half of the aggregate amounts that the business paid for services were for services performed in a QOZ; or

ü  Whether necessary tangible property and necessary business functions were located in a QOZ.

A QOZ business satisfies the 50-percent-of-gross income test if it satisfies any one of these safe harbors. 

Jyoti Raj Adhikari, CPA