Updated: Apr 28, 2020
Buried in the Tax Cut and Jobs Act of 2017, was an intriguing provision that has many investors taking note. The Qualified Opportunity Fund Program is a federal tax incentive designed to attract investments into lower income communities – the idea being that investment in these areas will help create jobs, and in turn, revitalize these communities.
What are the incentives?
There are 3 ways that an investor can benefit:
1. Capital gains from previous investments are deferred, much like a 1031 exchange, until that investor either sells their share in the fund, or until December 31, 2026, whichever comes first. However, the investments don't have to be "like-kind," as they would with a 1031 exchange. In addition:
2. If that investor holds their investment for 7 years, that deferred gain will be reduced by 15% (or 10% if held for at least 5 years, but less than 7.)
3. If the investment is held for 10 years, all of the post investment gain is tax free when the investor sells.
What's the catch?
To be eligible for these benefits:
The investment must have been made by a Qualified Opportunity Fund.
Fortunately, this part is easy. A Qualified Opportunity Fund is an investment vehicle that is set up as either a partnership, or corporation, for investing in eligible property located in a Qualified Opportunity Zone. Investors can self-certify by filing form 8996.
However, "arms-length" transaction rules apply. One cannot simply form a QOF to invest exclusively in one's own property.
At least 90% of the investments made by a Qualified Opportunity Fund (QOF) must be in “Qualified Opportunity Zone Property.”
For tangible property owned or leased by a QOZ business, substantially all must be used in the QOZ. Substantially All has been defined to mean at least 70%.
In order to be a qualified Opportunity Zone investment, “Substantial Improvement” to the property is required. Simply put, substantial improvement means investment into the property needs to equal or exceed the property value, excluding the cost of the land.
The investment dollars have to be Capital Gains to qualify. This can include disposition of stock or real property.
Non-capital gains may be invested in a QOF, but they do not qualify for OZ benefits. While debt is not an eligible interest in a QOF to qualify for QOZ tax benefits, preferred stock and a partnership interest with special allocations are allowed. The eligible interest can also serve as collateral for a loan, whether it is a purchase-money borrowing or otherwise.
In what type of properties can a QOF invest?
A wide variety are allowed, including residential housing, restaurants, retail, warehousing, or even office. However, "no portion of the proceeds” (dollars invested in a QOF), “may be 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”
Is there a time limit?
In order to realize the tax benefits, capital gains must be invested into a QOF within 180 days from the date the gain was realized.
Once invested into a QOF, the law allows up to 31 months to deploy the funds into a project. (However, the investment must be held and accompanied by a written schedule for capital deployment.)
Since the deferral provision currently expires on December 31, 2026, the investment must be made by December 31, 2019 in order to realize the 15% basis reduction of 7 years.
How were the zones determined?
Low income communities were identified using information from the US Census Bureau data gathered from 2011 through 2015. Areas that qualified had a poverty rate of at least 20 percent, or a median family income was equal to, or less than, 80% of the statewide family income. Governors were given until March 21, 2018 to nominate the low income census tracts to be designated as QOZ's, and were limited to designating no more than 25% of the low income communities in the state.
Where can I find these Opportunity Zones?
There are 8700 zones throughout the United States, and 427 in Florida alone.
For an excellent Florida Opportunity Zone search tool, click the map below:
(Simply search the map, or you can enter a specific address)
To view any Opportunity Zone in the nation, click the map below.
(Adobe Flash Player is required)
While the program was designed to operate with minimal oversight and regulation, it is important to follow the guidelines outlined to ensure that you, and your investors, receive the full benefits. The QOZ program represents a powerful opportunity to defer taxes, especially if the investment is successful. However, Qualified Opporunity Funds are multiplying, and the dollars are currently pouring in. If you have interest in creating a fund, or even participating in one, it's important to start planning now.