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New York Opts Out of Providing Opportunity Zone Tax Benefits

April 23, 2021
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One of the unfavorable tax provisions recently signed into New York State (“NYS”) law involves NYS/City decoupling from the favorable federal capital gains tax treatment afforded under the federal Opportunity Zone Program, specifically Internal Revenue Code (“IRC”) section 1400Z-2. By way of background, the 2017 Tax Cuts and Jobs Act included a new federal incentive—Opportunity Zones—meant to spur investment in undercapitalized and underserved communities. The program provided three potential tax benefits for investing in Qualified Opportunity Funds (“QOF”), the investment vehicles used for making investments in Opportunity Zone projects and businesses:

  • Temporary deferral of taxes on previously earned capital gains - Investors can defer eligible capital gains by timely investing the gains into a QOF in exchange for an equity interest in the QOF. The capital gains are not taxed until the earlier of the date on which the opportunity zone investment is disposed of or December 31, 2026.
  • Basis step-up - For eligible capital gains invested in a QOF for at least five years, the investors’ basis in the QOF investment increases by 10%. If invested for at least seven years, the investors’ basis increases by 15%. The 7-year basis step up required investment in a QOF by the end of 2019 under current law.
  • Permanent exclusion of taxable income on new gains - For QOF investments held for at least 10 years, investors pay no taxes on any capital gains produced through their investment in the QOF through a step-up in basis to fair market value.

NYS and City Tax Law Change - Beginning in tax years 2021 and forward, NYS/City will no longer recognize the tax benefits associated with the federal Opportunity Zone Program with respect to the above noted deferral of capital gains and basis step-up under IRC 1400Z-2(a)(1)(A). Any federal tax deferral of capital gains associated with investing in a QOF should be required to be added to NYS taxable income. In subsequent years, when the deferred gain is recognized for federal tax purposes, NYS should permit a subtraction modification to determine NYS taxable income. It is currently unclear whether or not NYS/City tax will continue to allow the federal tax benefits associated with any capital gains realized from the sale of a QOF investment after 10 years. The recent change in NYS/City tax law did not specifically address this provision of the federal law.

Finally, as a result of NYS/City being one of just a few states that have decoupled from the federal tax treatment of the Opportunity Zone Program, it is currently possible a taxpayer could be subject to state tax on the capital gain both in NYS and again, in a different state when the gain is recognized for federal income tax. For example, beginning in 2021, a NYS resident is not entitled to defer qualified capital gains associated with the federal Opportunity Zone Program. If the taxpayer subsequently moves out of NYS to a state which conforms with Opportunity Zone Program, the taxpayer will likely be required to pay state tax again on the deferred gain. Whether the state that taxes the deferred gain will allow a resident tax credit for taxes paid to NYS is unclear in many states. A similar issue can arise for NYS nonresidents with respect to NYS-sourced eligible capital gains.

Given the above NYS law change is new, it is likely NYS (as well as other states) will provide additional guidance over the coming months. Should you have any questions, please reach out to your Citrin Cooperman advisor or Jaime Reichardt at jreichardt@citrincooperman.com