The tax incentives of investing in an Opportunity Zone were introduced by the Tax Cuts and Jobs Act at the end of 2017. Since then, the lack of guidance in this legislation has left a lot to the imagination regarding the opportunities available in this new provision of the tax code. The final regulations issued on December 19th finally offer some specific direction, which is even better than we imagined.
O Zone Basics – A Quick Refresher
The tax advantages of investing in an opportunity zone occur when a capital gain is realized. When all or some of the the gain is reinvested in an opportunity zone fund or qualified opportunity zone business, a portion of the gain can be deferred for federal tax purposes. Generally speaking, tax on the gain can be deferred until 2026. In addition, after holding the investment for 5 years, 10% of the gain can be permanently excluded from being taxed, and furthermore, after holding the investment for another 2 years (7 years total), another 5% of the gain can be excluded. And if that wasn’t enough, if the investment is held for at least another 3 years (10 years total), any appreciation on the investment can be excluded from taxable income. It should be noted that the additional 5% gain exclusion timing does not work for investments after 12/31/19.
Also, be aware that California does not conform, so gain deferral or exclusion is not available for calculating taxes in California.
What’s new in O Zones?
544 pages of final regulations issued by the IRS provide additional guidance needed to help us understand:
- What types of gains can qualify to be deferred when invested in Opportunity Zones,
- The timing around reinvesting different types of gains,
- How to determine the level of new investment (anti-abuse provisions), and
- Specifics around Large C Corporation investments in Opportunity Zones.
So where is the opportunity?
The final regulations look at gross Section 1231 gains on property sales without regard to 1231 losses. This means that netting of all gains and losses is not required when determining the amount of 1231 gains eligible for reinvestment in an opportunity zone. The benefit here is having more eligible gains for reinvestment.
The new opportunity zone provisions also create more flexibility in reinvestment timing. When a 1231 gain is recognized, a taxpayer has 180 days of the transaction to reinvest it in an opportunity zone rather than having to wait to reinvest until after the end of the year. When a gain is recognized in a passthrough entity, the taxpayer has the option to reinvest within 180 days of the transaction date, the end of the year, or the due date of the passthrough entity tax return.
Installment sales have also become more attractive candidates for opportunity zone investment. In fact, transactions that occurred in prior years are now eligible for deferral when installment payments that are received currently are reinvested in opportunity zones. In addition, a taxpayer may elect to reinvest proceeds within 180 days of receipt, or within 180 days of the end of the tax year in order to aggregate all installment sale proceeds into one or more investment.
Steering Clear of Anti-Abuse
The final regulations put forth concepts to prevent abuses of the opportunity zone provisions. These concepts focus on specific areas such as selling assets to opportunity zone businesses and reinvesting proceeds in that business. The regulations also discuss the levels of reinvestment required in order for a fund or business to qualify as an opportunity zone. The regulations address these concepts in order to keep the provisions in line with the intent of Congress when they included Opportunity Zones in the language of the Tax Cuts and Jobs Act. Their goal was to drive investment and subsequent improvement or economic development into specific geographic areas.
To keep clear of anti-abuse provisions and potentially identify your opportunities to defer and even exclude gains and future appreciation, contact your tax professional at Lindsay & Brownell.