What are Opportunity Zones and How to Create a Qualified Opportunity Fund?
By Steven L. Relis, CPA
November 7, 2018
Opportunity zones were created by Congress to provide incentives for investing in low-income communities thus encouraging economic growth and investment. As of the writing of this summary, the rules regarding the program are in a state of flux as the Treasury Department and the IRS are seeking comment on its proposed guidance that was released on October 19, 2018; therefore, the following is subject to change and clarification:
What are the Tax Benefits?
Opportunity zones provides the following tax benefits:
- Temporary deferral of capital gains that are reinvested into a qualified opportunity fund (“QOF”) within 180 days of sale or exchange – The deferred gain must be recognized on the earlier of the date on which the opportunity zone investment is disposed of or December 31, 2026.
- Step-up in basis for capital gains reinvested into a QOF within 180 days of sale or exchange – The basis is increased by 10% if the investment is held for 5 years and an additional 5% if held for 7 years.
- Permanent exclusion from taxable income for capital gains from the sale or exchange of an investment held in an opportunity zone if the investment is held for 10 years.
What is an Opportunity Zone Investment?
- Must hold at least 90% of its assets in qualified opportunity one property. Compliance with the 90% asset test is determined by the average of the %age of the qualified opportunity zone property held in the QOF as measured on the last day of the first 6-month period of the taxable year of the QOF and on the last day of the taxable year of the QOF.
- At least 50% of gross income must be derived from the active conduct of a trade or business within an opportunity zone. For a full list of qualified opportunity zones go to (https://www.cdfifund.gov/Pages/Opportunity-Zones.aspx). Disqualifying businesses are golf courses, country clubs, massage parlors, hot tub facilities, suntan facilities, racetracks, casinos and liquor stores.
- A substantial portion of tangible property must be used in the active conduct of a trade or business within an opportunity zone. For purposes of determining whether “substantially all” of a business’s tangible property is opportunity zone business property, the proposed rules define “substantially all” to mean 70 % or more.
- The US Treasury has proposed that cash and cash equivalents designated as working capital will not be counted as “nonqualified financial property” for up to 31 months if certain conditions are met, including a written plan on how the working capital will be used to invest in opportunity zone property, a written schedule covering the 31-month period, and (ultimately) substantial compliance with that schedule by the business.
- Property subject to construction or substantial improvement in accordance with the working capital plan will not fail to qualify as opportunity zone business property solely because the planned expenditures have not been completed (and thus can contribute to meeting the 70% “substantially all” test if it otherwise meets the definition of opportunity zone business property).
- The property must be acquired by the QOF or qualified opportunity zone business after Dec. 31, 2017. The original use of the property in the opportunity zone must commence with the QOF or qualified opportunity zone business. Substantially all of the use of the property must be in the opportunity zone during substantially all of the QOF or opportunity zone business’s holding period.
What is a Qualified Opportunity Fund (QOF)?
- QOF’s must be classified as a corporation or partnership for income tax purposes, meaning a limited liability company (LLC) can qualify. Regulated Investment Companies (RIC’s) and Real Estate Investment Trusts (REIT’S) and certain other pass-through entities, including common trust funds described in code section 584, as well as, qualified settlement funds, disputed ownership funds, and other entities taxable under §1.468B of the Income Tax Regulations can also qualify. QOF’s must also be created or organized in one of the 50 U.S. states, DC, or a U.S. territory.
- Pre-existing entities can qualify as QOF’s or Opportunity Zone businesses as long as they satisfy the necessary requirements.
- QOF’s will be able to choose the first month in which they are treated as a QOF. The last day of the QOF’s taxable year is a test date for the 90-% asset test.
- A QOF must value its assets for purposes of the 90-% asset test using values reported on the QOF’s audited or filed financial statements (or using the cost of the assets if it does not have audited of filed financial statements).
- Though opportunity zone designations expire at the end of 2028, taxpayers may continue to hold a QOF interests invested in those zones and still may step-up the basis of their QOF investments to fair market value if they hold the investments for ten years.
How to create a Qualified Opportunity Fund
Assuming the entity meets the requirements as described above and assuming the investment is located in a qualified opportunity zone, companies can self-certify the entity as a QOF using IRS Form 8996.
About the author – Steven L. Relis, CPA is a co-managing partner with Koutoulas & Relis, LLC, a South Florida based CPA Firm. He has extensive experience working with many clients in various industries including high tech, real estate, construction, manufacturing and professional services. He is a licensed Certified Public Accountant in the States of Florida and New York and is a member of the American, Florida and New York Institutes of Certified Public Accounting.
If you have any questions or comments regarding this article, please email Steve at email@example.com.