A Guide to Understanding the Opportunity Zone
There is a new section within the updated Tax Law called “The Opportunity Zone” that is designed to spur development in economically distressed areas by providing tax benefits to investors.
Development of the Opportunity Zones
Jobs and businesses in economically distressed areas have dramatically declined recently. According to the Local Initiative Support Coalition, more than half of America’s most economically distressed communities contained both fewer jobs and businesses in 2015 than they did in 2000.
Additionally, the U.S. economy is increasingly dependent on a handful of places for growth. Five metro areas produced as many new businesses as the rest of the country combined from 2010-2014. It is estimated that U.S. investors currently hold nearly $2.3 trillion in unrealized capital gains.
To address these issues, Congress passed the Tax Cuts and Jobs Act in 2017 and included the new “Opportunity Zone”. This added code section provides tax incentives for individuals who have unrealized capital gains and choose to invest those gains into an Opportunity Zone Fund.
What is a certified Qualified Opportunity Fund?
A certified Qualified Opportunity Fund is an investment vehicle set up as a US corporation or a partnership that intends to invest at least 90% of its holdings in qualified opportunity zone property. There are restrictions on the types of investments allowed. These are the three following categories:
- Stock ownership in businesses that conducts most or all of their operations within a qualified Opportunity Zone.
- Partnership Interest in businesses that operates in a qualified Opportunity Zone.
- Property, such as real estate located within an Opportunity Zone.
To become certified, the eligible corporation or partnership will self-certify. This is done by attaching a form to the federal income tax return for the taxable year. 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 a recognized gain in a Qualified Opportunity Fund and elect to defer the tax on that gain.
Benefits of investing in a Qualified Opportunity Fund
The incentives provided by this code section is a temporary tax deferral for capital gains reinvested, a step-up in basis for those capital gains and the potential for a permanent exclusion of capital gains from taxable income.
- Defer Capital Gains: The taxpayer gains the ability to defer paying capital gains tax on any realized capital gain with a possibility of recording a step up in basis depending on how long you hold the Qualified Opportunity Fund investment.
- Step-Up in Basis: If the investment is held for 5 years, you would receive an increase in basis of 10% of the original capital gain that was deferred. If the investment is held for 7 years, you would receive an additional increase in basis of 5% of the original capital gain that was deferred. The deferred capital gain amount would not have to be recognized until the investment is sold or December 31, 2026, whichever is the earliest.
- Permanent Exclusion: Although the maximum amount of a step up in basis of the deferred capital gains you will receive is 15% for investments held longer than seven years, there is a special rule for the new investment if it is held for at least 10 years. If an investment is held by the taxpayer for at least 10 years, the taxpayer can elect to have their basis amount of the new investment equal to the fair market value of the investment on the date it is sold, resulting in no capital gain recognition.
Opportunity Zone Locations
To qualify as an Opportunity Zone, each census tract was nominated by the state it is located in and certified by the Secretary of the United States Treasury. Each state could nominate up to 25% of the number of low-income communities in the state. Using Alabama as an example, 629 of the 1,181 census tracts located in the state qualifies as low-income communities. The governor was authorized to nominate 158 tracts as an Opportunity Zone.
You can view a map of the certified Opportunity Zones on these websites: the Treasury’s Community Development Financial Institutions Fund or the Economic Innovation Group.
At hb&k, you can depend on one of our trusted advisors to guide you through the process of properly organizing and maintaining compliance as an Opportunity Zone Fund. We offer consulting and planning services as it relates to taking advantage of the new Opportunity Zones section of the tax code. Click here to download hb&k’s guide on Opportunity Zone Funds.