The Tax Cuts and Jobs Act of 2017 (TCJA), enacted on December 22, 2017, included a provision, commonly referred to as the federal opportunity zones incentive, that, until recently, has garnered little attention.
The Opportunity Zone Incentive, still in its infancy, is intended to provide tax benefits to taxpayers that invest in qualified opportunity zones (QOZs), which were created to stimulate economic development and job creation in distressed communities. To qualify as a QOZ, the tract must be designated as a low-income community under Section 45D(e):
• With a poverty rate of at least 20%, or
• With a median family income that does not exceed 80% of area median income, or
• Contiguous with a designated low-income community and the median family income does not exceed 125% of the median family income of the contiguous designated low-income community.
The Opportunity Zone Incentive provides three federal tax incentives to encourage investment in QOZs:
1. Gains reinvested directly in a QOZ, or through an investment vehicle known as a Qualified Opportunity Fund (QOF), are deferred until the earlier of either the sale of the investment or December 31, 2026.
2. The basis of any investment in a QOF held for at least five years is increased by an amount equal to 10% of the amount of gain deferred under the Opportunity Zone Incentive. If the investment is held for at least seven years, there is an additional 5% basis increase.
3. If a qualifying investment is held for at least ten years, any built-in appreciation during the life of the qualifying investment is excluded from income.
Given these potentially significant tax benefits, individuals and entities with recent significant gains may want to consider participating in the Opportunity Zone Incentive. 90% of the assets of a QOF must be held in businesses located or property used in a QOZ. To be eligible for the tax benefits associated with investing in such designated distressed communities, investors must roll gains from prior investments into a QOF within 180 days of realizing such gain.
Unlike previous efforts to encourage economic development in low-income communities, the Opportunity Zone Incentive is less directly dependent on federal subsidies. There is no assurance that a QOZ designation will attract investment into a particular community. Instead, the market will largely dictate which QOZ and type of Qualified Opportunity Zone Property (QOZP) get developed.
QOZP must generally be new construction or “substantially improved,” meaning rehabilitation costs must exceed the cost of acquisition during the 30 months following acquisition. Qualified Opportunity Zone Business Property cannot include investments in golf or country clubs, racetracks and gambling facilities, suntan facilities, massage parlors or liquor stores. In addition, a QOF may not invest in mortgage pools or merely debt investments.
The U.S. Department of Treasury has yet to issue regulations to accompany the TCJA. Leaders in the industry are currently contemplating many undetermined factors related to the Opportunity Zone Incentive, including:
• The type of properties most likely to get developed in order to best utilize the Opportunity Zone Incentive
• The duration of the Opportunity Zone Incentive
• The type of restrictions that might be imposed when raising funds
• How the Opportunity Zone Incentive can be combined with tax credits
Notwithstanding the technical questions regarding the Opportunity Zone Incentive, it is an attractive option for taxpayers with significant recent gains who are keen on long-term investments to consider. Private equity funds, venture capital, wealthy individuals and families are among those likely to invest in QOZs. Various real estate developers and fund managers have already established QOFs and are in the process of raising capital as well as locating and entitling properties to be acquired and developed.
More information
Lists and maps of QOZs and other resources regarding opportunity zones can be found at: www.cdfifund.gov/pages/opportunity-zones.aspx.
Brett D. Siglin is a member at Jennings Strouss who focuses his practice on a broad range of business law matters involving corporate structuring, joint ventures, bond financing, syndication of equity, contract negotiation, regulation and compliance, tax incentives, real estate acquisition and development.