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Socially Conscious Investing: Qualified Opportunity Zones

June 5, 2018

Blake Boshnack

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Situated deep in the Tax Cuts and Jobs Act is a socially-conscious investment provision that is intended to spur long-term economic growth and development through the establishment of Qualified Opportunity Zones (“Zone”). The Zones will allow investors the opportunity to help bolster the economy and the development of affordable housing in low-income neighborhoods, while providing significant tax incentives to the investor. Though the list of Zones is still being developed, it is expected that the full list of Zones will be released later this year. You can view a map of the current Zones here.

There are two options for investing in a Zone:

  • Invest directly in a business located within a Zone, or
  • Establish a Qualified Opportunity Fund (“Fund”).

If the investor chooses to establish a Fund, 90% of the Fund’s assets are required to be invested in a Zone to be eligible for the tax incentives offered. The Fund can invest in a variety “qualified” assets, including property, stock, and partnership interests.

These Qualified Opportunity Zone assets must be used in a trade or business that was acquired by the Fund from an unrelated party after December 31, 2017. Additionally, the asset will need to be substantially improved by the owner within any 30-month period following the acquisition, with the new adjusted basis of the property exceeding the basis of the property at the acquisition date.

Tax Incentives
Short- and long-term capital gain tax, whether related or un-related to a Zone or Fund, can be deferred if the capital gain is invested into a Fund or Zone within 180 days of the disposition date. Since the gain is being deferred, the initial basis of the investment into the Zone or Fund will be zero.

However, if the investment is held for a period of five years, the taxpayer is entitled to a step-up in tax basis equal to 10% of the original deferred gain (investment). If held for an additional two years, an additional 5% step up in basis will be credited to the taxpayer’s tax basis, which will allow for a permanent exclusion of up to 15% of the investment gain. To ensure this was not a permanent deferral, if the investment in the Zone or Fund is held at December 31, 2026, a mandatory recognition of an amount equal to the lesser of the remaining original deferred gain (accounting for the 10% or 15% step-up), or the fair-market value of the investment in the Fund, is triggered.

If the investment made to the Zone or Fund is maintained for a 10-year period or more the taxpayer can elect to step up the basis in the investment to the fair-market value at the date of disposition. In other words, all post-acquisition capital gains from the investment are tax free.

As is the case with much of the Tax Cuts and Jobs Act, regulatory guidance is expected within the coming months to provide clarification on the nuances of maximizing the benefits available under this new and intriguing code section.