Tax Cuts and Jobs Act Creates Opportunity Zones in Low Income Communities

Summary

Taxpayers investing capital gains from the sale or exchange of property in a Qualified Opportunity Fund may elect to defer paying taxes on those capital gains until they sell their investments in the Qualified Opportunity Fund, or December 31, 2026, whichever is earlier.

 

Details

Background

On December 22, 2017, the Tax Cuts and Jobs Act was signed into law, establishing qualified opportunity zones in low income communities.  To be certified as a qualified opportunity zone, the nominated area must have a poverty rate of at least twenty percent and be an area for which the median family income does not exceed eighty percent of the statewide family income; or, if located in a metropolitan area, not exceed eighty percent of the metropolitan area median family income (i.e., be a “low income community”).  Certain tracts contiguous with low income communities may also be certified if the median family income of the tract does not exceed 125 percent of the median family income of the low income community with which the tract is contiguous.

 

Capital Gains Invested in Opportunity Zones
Taxpayers may elect to defer paying tax on capital gains from the sale or exchange of property, if such capital gains are invested in a Qualified Opportunity Fund, which invests at least ninety percent of its assets in qualified opportunity zone property.  For this purpose, “qualified opportunity zone property” is property which is qualified opportunity zone stock (i.e., stock in a domestic corporation that is a qualified opportunity zone business during “substantially all” of the applicable holding period, and the stock is acquired after December 31, 2017, at its original issue in exchange for cash), qualified opportunity zone partnership (i.e., any capital or profits interest in a domestic partnership that is a qualified opportunity zone business during “substantially all” of the applicable holding period, and the interest is acquired after December 31, 2017, in exchange for cash), or qualified opportunity zone business property (i.e., tangible property used in the trade or business of a qualified opportunity zone business if the original use of the property commences with the qualified opportunity fund or the fund “substantially improves” the property, and the property acquired by purchase after December 31, 2017).  A “qualified opportunity zone business” is a trade or business in which:

• Substantially all of its tangible property, owned or leased, is qualified opportunity zone business property;
• At least 50 percent of its total gross income is derived from the active conduct of its business;
• A substantial portion of its intangible property is used in the active conduct of its business;
• Less than five percent of the average of its aggregate unadjusted bases of the property is attributable to nonqualified financial property; and
• No portion of its proceeds is used to provide (including the provision of land for) any private or commercial golf course, country club, massage parlor, hot tub facility, suntan facility, racetrack or other facility used for gambling, or any store the principal business of which is the sale of alcoholic beverages for consumption off premises.

The deferral period ends the earlier of when taxpayer sells its investment in the Qualified Opportunity Fund, or December 31, 2026, at which time the taxpayer must include the amount of the gain in its gross income.  The amount of the gain determined by subtracting from the lesser of the amount of excluded gain or the fair market value, the amount of the taxpayer’s basis in the investment.  The taxpayer’s basis in the investment is determined based on how long the taxpayer holds the investment.  The taxpayer’s basis in the investment is initially deemed to zero, but increases as the holding period of the investment reaches certain milestone periods:

• For investments held for five years, the taxpayer’s basis is increased by 10 percent of the amount of deferred gain.
• For investments held for seven years, the taxpayer’s basis is increased an additional five percent of the amount of deferred gain.
• For any taxpayer that holds its investment beyond the maximum deferral date (i.e., December 31, 2026) and for a minimum of 10 years, the taxpayer’s basis in its investment shall be equal to the fair market value of the investment on the date it is sold or exchanged, resulting in no additional recognized gain.

 

BDO Insights

• For investments held fewer than five years, the gain is deferred until the date of sale; however, no portion of the gain is excluded.
• Taxpayers seeking to maximize their increase in basis (i.e., increase their basis from zero to 15 percent of the deferred gain amount) must invest in a Qualified Opportunity Fund before December 31, 2019.