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There are three components that are required to have a successful Qualified Opportunity Zone investment:
- ONE: a capital gain. Gains from any type of asset sale, which would be subject to either long or short term capital gains taxes are eligible.
- TWO: a Qualified Opportunity Zone Fund. The “fund” does not require any sort of Securities filing or prospectus (unlike a mutual fund) unless it is seeking widespread investors from the public. In fact, the QOZ fund is simply an LLC, which has specific language, a checking account, and a business plan. That is all. In fact, anyone can set up a fund that has a capital gain and is seeking to put the dollars to work in the opportunity zone world.
- THREE: a Qualified Opportunity Zone Business Investment. The investor has 31 months to identify a qualified opportunity zone investment. In the meantime, the business plan that needs to be written can be very general. We will share the various nuances of the types of investments which qualify in a follow up correspondence.
During the safe harbor 31-month period, the fund has specified uses of the dollars invested. Here are a few alternatives.
Use of funds inside an OZ fund:
During the 31-month safe harbor period the fund must hold its dollars in either notes, loans, deposits, or other investments which mature within 18 months. At the end of the 18 months, these dollars must once again be placed in cash equivalent accounts, but may be re-invested as soon as the next day for another period running through the 31-month safe harbor allowance times.
Another allowable OZ fund alternative is a related third party loan. These loans may be up to 18 months as part of an OZ business plan if drafted properly. The loans must be repaid within 18 months but may then be reissued for the duration of the 31- month safe harbor period.
At any time during these loan terms, the borrower, typically the fund owner, is permitted to repay the loan and place the proceeds into another qualified opportunity zone investment.
At the end of 31 months, the investor must either declare an investment, or pay the deferred capital gains taxes.
The most important message is this…..
- Qualified Opportunity Zone legislation (part of the 2017 Tax Cuts and Jobs Act) allows an investor to reduce, defer or eliminate capital gains.
- The Opportunity Zone Program offers great flexibility in terms of investment opportunities.
- The Opportunity Zone time frame is structured to allow for 31 months (which can even get extended further) to enable the investor the much needed time to locate the property or investment that is most suitable for them.
Please allow my team of tax attorneys, CPAs and advisors to help you determine whether or not the Opportunity Zone is appropriate for your specific tax and investment strategies. (615) 429-7883
The Qualified Opportunity Zone legislation was part of the 2017 Tax Cuts and Jobs Act (TCJA).
The purpose of this legislation was simple, government has tried countless programs to help stimulate development in economically distressed communities, usually, most programs failed or those that did work, had severe funding shortages. A bipartisan effort was undertaken to try a different method which was, what if we let private enterprise take a shot at solving this dilemma. Thus, the birth of the Opportunity Zone (OZ) idea.
Since funding was always a major issue, the act empowered private individuals and business to start and fund these programs with their own money. The incentives for them to do so rested on two tax ideas. Use money derived from capital gains as the seed capital for an OZ investment, and if the investors were successful in meeting all the rules of the program, and held their investment for at least 10 years, then when sold, there would be no taxes due on gain from the new OZ business.
The seed dollars from capital gains had a big carrot for those investing. The capital gains tax due from a sale today, which is normally subject to immediate taxation, if invested into an OZ fund, would receive tax deferral on that gain until 12/31/2026. In other words, investors could put that money to work for themselves today, which normally would have gone to the tax man.
At the end of 12/31/2026, the taxes owed on the original seed capital gain would become due. But, the investor had the ability to use those dollars in the meantime, and put the principal of the time value of money to work for themselves.
Presently, there is pending legislation in Washington to extend this window of tax deferral for an additional two years. The reason the extension is enjoying wide bipartisan support, stems from the fact it took Treasury two years to adopt final rules and regulations on the OZ legislation, and then COVID slowed the process for an additional 2 years. While not a guarantee this extension will pass, OZ experts feel confident it has a winning chance of passage.
What you need to have a successful Qualified Opportunity Zone investment:
Three components are required for a successful OZ investment.
- ONE, a capital gain. Gains from any type of asset sale, which would be subject to either long or short term capital gains taxes is eligible.
- TWO, a Qualified Opportunity Zone Fund. The fund does not require any type of securities disclosures of investments unless it is seeking wide spread investors from the public. In fact, a fund is an LLC, with special language, a checking account, and a business plan. That is all, so anyone can set up a fund that has a capital gain and is seeking to put the dollars to work in the opportunity zone world.
- THREE, a Qualified Opportunity Zone Business Investment. We will share the various nuances of the types of investments which qualify in a separate letter. But, the business plan can be very general at first, and more specific in the future. The important aspect to know today is the fund has 31 months to identify a qualified opportunity zone investment. In that safe harbor 31-month period, the fund has specified uses of the dollars invested. We will cover those in a moment.
Use of funds inside an OZ fund:
During the 31-month safe harbor period the fund must hold its dollars in either notes, loans, deposits, or other investments which mature within 18 months. At the end of the 18 months, these dollars must once again be placed in cash equivalent accounts, but may be re-invested again the next day for another period running through the 31-month safe harbor allowance times.
The second set of OZ regulations allowed for related party loans for up to 18 months as part of an OZ business plan if drafted as to allow these loans. The loans must be repaid within 18 months but may then be reissued for the duration of the 31- month safe harbor period.
At any time during these loan terms, the borrower, probably the fund owner, is permitted to repay the loan and place the proceeds into another qualified opportunity zone investment.
At the end of 31 months, you must either declare an investment, or pay the deferred capital gains taxes.
Most using this mechanism have sound business reasons to use a related party loan. But, many will not use this feature as they believe an investment into an OZ business may arise at any time and they want the dollars available to make the needed capital placements.
The most important takeaways are these:
- The Opportunity Zone Program allows one to defer, reduce or eliminate capital gains.
- The program has various interpretations on application of benefits.
- Opportunity Zones have great flexibility.
- Learning the many benefits, and the potential applications to your situation, is time well spent
Below is a frequently asked questions section from the IRS website.
Feel free to reach out and schedule a review of the Opportunity Zones and their potential applications for you.
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 of authority to the Internal Revenue Service.
How were Opportunity Zones created?
Opportunity Zones were added to the tax code by the Tax Cuts and Jobs Act on December 22, 2017.
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. Opportunity Zones have now been designated covering parts of all 50 states, the District of Columbia and five U.S. territories.
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.
What is a Qualified Opportunity Fund?
A 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 a Qualified Opportunity Zone.
How does a corporation or partnership become certified as a Qualified Opportunity Fund?
To become a Qualified Opportunity Fund, an eligible corporation or partnership self-certifies by filing Form 8996, Qualified Opportunity Fund, with its federal income tax return. Early-release drafts of the form and instructions are posted, with final versions expected in December. The return with Form 8996 must be filed timely, taking extensions into account.
Can a limited liability company (LLC) be an Opportunity Fund?
Yes. A LLC that chooses to be treated either as a partnership or corporation for federal tax purposes can organize as a Qualified Opportunity Fund.
Facts about opportunity zones
The Tax Cuts and Jobs Act included changes for businesses and individuals. One of these is the creation of the Opportunity Zones tax incentive, an economic development tool that allows people to invest in distressed areas. This incentive’s purpose is to spur economic development and job creation in distressed communities by providing tax benefits to investors. Low income communities and certain contiguous communities qualify as Opportunity Zones if a state, the District of Columbia or a U.S. territory nominated them for that designation and the U.S. Treasury certified that nomination. Following the nomination process, 8,764 communities in all 50 states, the District of Columbia and five U.S. territories were certified as Qualified Opportunity Zones (QOZs). Congress later designated each low-income community in Puerto Rico as a QOZ effective Dec. 22, 2017. The list of each QOZ can be found in IRS Notices 2018-48 and 2019-42. There’s also a visual map of the census tracts designated as QOZs.
Benefits of investing in opportunity zones
Opportunity Zones offer tax benefits to investors who elect to temporarily defer tax on capital gains if they timely invest those gain amounts in a Qualified Opportunity Fund (QOF). Investors can defer tax on the invested gain amounts until there is an event that reduces or terminates the qualifying investment in the QOF (an “inclusion event”), or December 31, 2026, whichever is earlier.
Deferral of eligible gain
Gains that may be deferred are called “eligible gains.” They include both capital gains and qualified 1231 gains, but only gains that would be recognized for federal income tax purposes before January 1, 2027, and that aren’t from a transaction with a related person. To obtain this deferral, the amount of the eligible gain must be timely invested in a QOF in exchange for an equity interest in the QOF (qualifying investment). Once this is done, taxpayers may make an election to defer the gain on their federal income tax return for the taxable year in which the gain would have been recognized if they had not deferred it.
Taxpayers may make an election to defer the gain, in whole or in part. For additional information, see How to Report an Election to Defer Tax on Eligible Gain Invested in a QOF in the Form 8949 instructions.
Qualified Opportunity Funds
A QOF is an investment vehicle that files either a partnership or corporate federal income tax return and is organized for the purpose of investing in QOZ property. To become a QOF, an eligible corporation or partnership self-certifies by filing Form 8996 with its timely filed federal income tax return (including extensions). A QOF must hold at least 90% of its assets, measured on two annual testing dates, in qualified opportunity zone property, or pay a monthly penalty for every month it is out of compliance. Further, the eligible entity that elected or is electing to be a QOF must file a completed Form 8996 annually with their timely filed federal tax return (including extensions) to report that the QOF meets the 90% investment standard or to figure the penalty if it fails to meet the investment standard. This is required even in years the corporation or partnership has no taxable income. See Form 8996 instructions. An LLC that chooses to be treated either as a partnership or corporation for federal income tax purposes can organize as a QOF.
When does my 180-deferral eligibility time frame begin?
A23. The date on which you receive a K-1 notifying you of the eligible gain is not relevant. Partners in a partnership, shareholders of an S corporation, and beneficiaries of estates and non-grantor trusts have the option to start the 180-day investment period on any of the following dates:
- the last day of the partnership taxable year (December 31, 2019);
- the same date that the partnership’s 180-day period begins (July 1, 2019); or
- the due date for the partnership’s tax return, without extensions, for the taxable year in which the partnership realized the eligible gain (March 15, 2020).
Q37. What is a QOF?
A37. A QOF is an investment vehicle that files either a partnership or corporate federal income tax return, is organized for investing in QOZ property and elects to self-certify as a Qualified Opportunity Fund.
A38. To become a QOF, an eligible corporation or partnership elects to self-certify by annually filing Form 8996 with its federal income tax return. See Form 8996 instructions. The return with the Form 8996 must be filed timely, taking extensions into account.
A39. Yes. An LLC that chooses to be treated either as a partnership or corporation for federal income tax purposes and is organized for investing in QOZ property can be a QOF.
Section 1400Z-2(d)(3)(A). Nonqualified financial property includes debt, stock, partnership interests, options, future contracts, forward contracts, swaps, annuities, and similar property (excluding reasonable amounts of working capital held in cash, cash equivalents, or debt instruments with a term of 18 months or less, or ordinary course trade or business notes receivable). Section 1400Z-2(d)(3)(A).
Working Capital Safe Harbor for QOZBs – The first draft of the Opportunity Zones regulations permits a QOZB that acquires, constructs and/or substantially rehabilitates tangible business property to treat cash, cash equivalents and debt instruments with a term of 18 months or less as a reasonable amount of working capital for up to 31 months if certain requirements are satisfied. The second tranche of regulations expands the working capital safe harbor to include the development of a trade or business in a QOZ, and allows for the 31-month period to be extended, to the extent of governmental inaction or delay so long as the application for such governmental action was completed within the initial 31-month period. Further, a QOZB may avail itself of multiple applications of the working capital safe harbor. Notably, the working capital safe harbor remains applicable to QOZBs, not to QOFs making direct investment.