We have been following the news and IRS Bulletins pertaining to Opportunity Zones. We have had several clients and advisors ask us about these, so we have put this post together to introduce you to the concept. Many of the areas that Edmund & Wheeler, Inc. serves have Opportunity Zones, so it may be beneficial to learn more about them. Call us if you would like to discuss investing in an Opportunity Zone Vs. a 1031 Exchange.
The Tax Cuts and Jobs Act (TCJA) created a new investment vehicle called an Opportunity Zone (OZ) to encourage investment into distressed and low-income communities throughout the United States. The goal of this OZ tax incentive program is to attract taxpayers to invest capital through private investments in businesses and real estate in distressed communities to spur economic development in these communities.
Under the TCJA, states could nominate communities they want to be designated as a Qualified Opportunity Zone to encourage economic revitalization. A Qualified Opportunity Zone retains this designation for ten years. Governors had until March 21, 2018, to submit their recommendations for Zone designations by the U.S. Treasury unless the state requested a 30-day extension to April 20, 2018. If a governor did not submit an OZ nomination by this deadline, they essentially opted-out of this tax incentive. The U.S. Treasury has approved OZ submissions for American Samoa, Arizona, California, Colorado, Florida, Georgia, Idaho, Kentucky, Michigan, Mississippi, Nebraska, New Hampshire, New Jersey, New York, Oklahoma, Puerto Rico, South Carolina, South Dakota, Vermont, U.S. Virgin Islands, and Wisconsin.
Taxpayers can defer some and potentially eliminate other capital gain taxes by investing in a Qualified Opportunity Fund (“Fund”). The taxpayer sells any type of asset that has a capital gain and invests the proceeds into a Fund with 180 days. This Fund is required to have 90 percent (90%) of the Fund assets invested in Opportunity Zones. To become a Fund, an eligible taxpayer self-certifies and completes a form that the IRS is scheduled to release in the summer of 2018.
Opportunity Zone investments provide tiered capital gains tax benefits tied to investments at five (5), seven (7) and ten (10) year time frames. The tax benefits include temporary tax deferral and a small reduction in tax liability to, under certain circumstances, complete tax exclusion. There are three levels of tax benefits:
- Temporary deferral of capital gain taxes on gains invested in a Fund until the taxpayer exits the Fund or December 31, 2026, whichever occurs first.
- Deferred capital gains resulting from investments in the Fund held a minimum of five (5) years are given 10% reduction in the amount taxed and investments held at least seven (7) years are given a 15% reduction.
- If a taxpayer holds an investment for ten (10) years, the capital gains accrued on the Fund investment itself (i.e. the property profit) will receive a full step-up in basis for that ten-year period. This final benefit results in tax exclusion and is a permanent exclusion of taxable income for investments into a Fund.
Comparing An Opportunity Zone to a 1031 Exchange
A significant advantage of an OZ is that contributions to the Fund can be any type of asset or investment and is not limited to only real property like in a 1031 exchange. However, investing in low-income communities with a ten-year investment time horizon presents several disadvantages. In a 1031 exchange, taxpayers can invest in any market in the United States which provides an investment advantage to obtain better investment returns by redeploying equity immediately into communities that are providing high economic growth and strong investment returns today. Moreover, since there is no predetermined holding period in a 1031 exchange, taxpayers have the chance to reinvest equity multiple times compared to the ten-year holding period required to obtain the most beneficial tax advantages in the OZ program.
| Opportunity Zone | 1031 Exchange |
| Allows for the investment of any type of investment | Only real property qualifies |
| Investment time restrictions of 5, 7 or 10 years | No time restrictions if held for investment |
| Tax deferral and possible tax exclusion after 10 years | Tax deferral |
| Limited to a Qualified Opportunity Zone | Can invest anywhere in the United States |
| Must reinvest within 180 calendar days | Must reinvest within 180 calendar days |
Questions & Answers from the IRS Website
Q. What is an Opportunity Zone?
An Opportunity Zone is an economically-distressed community where new investments, under certain conditions, may be eligible for preferential tax treatment. Localities qualify as Opportunity Zones if they have been nominated for that designation by the state and that nomination has been certified by the Secretary of the U.S. Treasury via his delegation authority to the Internal Revenue Service.
Q. Who created Opportunity Zones?
Opportunity Zones were added to the tax code by the Tax Cuts and Jobs Act on December 22, 2017
Q. Have Opportunity Zones been around a long time?
No, they are new. The first set of Opportunity Zones, covering parts of 18 states, were designated on April 9, 2018.
Q. What is the purpose of Opportunity Zones?
Opportunity Zones are an economic development tool—that is, they are designed to spur economic development and job creation in distressed communities.
Q. How do Opportunity Zones spur economic development?
Opportunity Zones are designed to spur economic development by providing tax benefits to investors. First, investors can defer tax on any prior gains until the earlier of the date on which an investment is sold or exchanged, or December 31, 2026, so long as the gain is reinvested in a Qualified Opportunity Fund. Second, if the investor holds the investment in the Opportunity Fund for at least ten years, the investor would be eligible for an increase in basis equal to the fair market value of the investment on the date that the investment is sold or exchanged.
Q. What is a Qualified Opportunity Fund
Qualified Opportunity Fund is an investment vehicle that is set up as either a partnership or corporation for investing in eligible property that is in an Opportunity Zone and that utilizes the investor’s gains from a prior investment for funding the Opportunity Fund.
Q. Do I need to live in an Opportunity Zone to take advantage of the tax benefits?
No. You can get the tax benefits, even if you don’t live, work or have a business in an Opportunity Zone. All you need to do is invest in a Qualified Opportunity Fund.
Q. I am interested in investing in an Opportunity Zone. Is there a list of Opportunity Zones available?
Yes. The current list of approved Opportunity Zones can be found at Opportunity Zones Resources. This list will continue to be updated as more Opportunity Zones are approved. A complete list of approved Opportunity Zones will be published later this spring after all Opportunity Zones have been nominated, certified and designated.
Q. How does a taxpayer become certified as a Qualified Opportunity Fund?
To become a Qualified Opportunity Fund, an eligible taxpayer self certifies. (Thus, no approval or action by the IRS is required.) To self-certify, a taxpayer merely completes a form (which will be released in the summer of 2018) and attaches that form to the taxpayer’s federal income tax return for the taxable year. (The return must be filed timely, taking extensions into account.)
Q. I sold some stock for a gain in 2018, and, during the 180-day period beginning on the date of the sale, I invested the amount of the gain in a Qualified Opportunity Fund. Can I defer paying tax on that gain?
Yes, under § 1400Z-2(a)(1) of the Internal Revenue Code, you may elect to defer the tax on some or all of that gain. If, during the 180-day period, you had invested in one or more Qualified Opportunity Funds only an amount that was less than your entire gain, you may still elect to defer paying tax on part of the gain, up to the amount that you invested in that way.
Q. How do I elect to defer my gain on the sale of the stock?
You may make an election to defer the gain, in whole or in part, when filing your 2018 Federal Income Tax return in 2019 (that is, you may make the election on the return on which the tax on that gain would be due if you do not defer it).
Q. I sold some stock on December 15, 2017, and, during the required 180-day period, I invested the amount of the gain in a Qualified Opportunity Fund. Can I elect to defer tax on that gain?
Yes, as long as it was invested in the 180-day period, under § 1400Z-2(a)(1) of the Internal Revenue Code, you may elect to defer the tax on that gain. A deferral election may be made on your 2017 Federal Income Tax return. Information about the sale of your stock is required to be included in that return using IRS Form 8949. Precise instructions on how to use that form to elect deferral of the gain for your 2017 return will be forthcoming shortly.
Q. Can I still elect to defer tax on that gain if I have already filed my 2017 tax return?
Yes. You may elect to defer the gain, but you will need to file an amended 2017 return. As part of that amended return, you will follow the election procedure described in the answer to the preceding question.
Q. I have comments that I would like to make on § 1400Z-2. How can I share those comments with the IRS?
Please send all comments to CC.ITA.Section.1400@irscounsel.treas.gov.
Q. How can I get more information about Opportunity Zones?
Over the next few months, the Treasury Department and the Internal Revenue Service will be providing further details, including additional legal guidance, on this new incentive. More information will be available at Treasury.gov and IRS.gov.
Disclaimer
These FAQs are not included in the Internal Revenue Bulletin, and therefore may not be relied upon as legal authority. This means that the information cannot be used to support a legal argument in a court case.
Taxpayers should seek advice from tax and/or legal advisors to discuss both short-term and long-term investment planning objectives and to determine whether an Opportunity Zone or 1031 exchange helps to meet those objectives.
Is it possible to 1031 out of an opportunity zone in 2026 to further defer any tax payment? Or does this effectively put a limit on any deferred cap gains invested in OZs meaning all pay cap gains are effectively due in 2026 and my options to defer longer cease?
Hi Andrew:
This is a topic that comes up frequently. Technically, there would be no reason why you would not be able to exchange out of an OZ if all of the other exchange rules were followed (entity issues, constructive receipt, etc.) However, the taxes on the gain you deferred originally will be triggered in 2026 (minus 15%) if you sell the property or not. Any gain that you realize in 2026 from your initial investment would be excluded, so there would be no reason to exchange at all. We are still patiently waiting for further guidance from Treasury on the details of this program.