On April 17, 2019, the Internal Revenue Service issued proposed regulations and further guidance related to Qualified Opportunity Zone (QOZ) investments.
The Tax Cuts and Jobs Act signed into law by President Donald Trump on December 22, 2017, introduced Subchapter Z of the Tax Code, which established the QOZ program. Under this program, Federal income tax incentives are provided to qualified taxpayers who invest in certain designated economically-distressed communities (called opportunity zones).
For taxpayers, there are three distinct income tax benefits associated with a QOZ investment:
- Temporarily defers the tax on a capital gain that would be recognized from the disposition of a capital asset
- Depending on the taxpayer’s holding period of the QOZ investment, there are provisions that permanently eliminate the tax on up to 15% of the deferred capital gain
- If the QOZ fund investment is held for at least 10 years, a taxpayer may elect to permanently exclude the gain from the sale or exchange of the QOZ investment
If a taxpayer realizes a capital gain from the sale or exchange of a capital asset, the taxpayer has 180 days from the sale or exchange date to invest the gain in a QOZ fund. The amount of the capital gain invested in the QOZ fund is the deferred gain amount. This deferral, however, is only temporary. The taxpayer is required to include the deferred gain in their taxable income the earlier of the date that the taxpayer sells the QOZ fund investment OR December 31, 2026. In addition, depending on the taxpayer’s holding period of the QOZ fund investment, a partial exclusion of the deferred gain of up to 15% may be available.
When a taxpayer initially elects to defer the gain, the taxpayer’s basis in the QOZ fund investment is reduced by the amount of gain deferred. If the taxpayer holds the QOZ investment for at least five years, the tax basis of the QOZ investment will be increased by 10% of the deferred capital gain amount. If the taxpayer holds the QOZ investment for an additional two years (seven years total), then the tax basis of the QOZ investment will be increased by an additional 5% of the deferred capital gain amount (15% total). When the eventual deferral period ends (the earlier of the date that the taxpayer sells the QOZ fund OR December 31, 2026), the taxpayer’s basis of the QOZ fund investment will be increased by the amount of the deferred capital gain taxed.
Finally, and perhaps the most significant tax benefit, is the potential to permanently eliminate the tax on the gain recognized from the QOZ fund investment. If the taxpayer holds the QOZ fund for at least 10 years, the taxpayer can elect for the basis in the QOZ fund to be equal to the fair market value of the QOZ fund on the sale or exchange date. Essentially, a portion of any deferred capital gain carried into the QOZ fund has the potential to permanently escape tax on future appreciation.
Although the QOZ program provides several tax incentives, taxpayers must consider the merits of the investment. As with any investment, it is important to weigh the risks against the potential benefits.
The QOZ program is intended to encourage investment and economic development in distressed communities. It also provides significant tax incentives worth exploring. The professionals at The Mercadien Group can assist you in understanding the income tax benefits associated with a QOZ fund investment. Please contact us today at firstname.lastname@example.org or 609-689-9700.