IRS Publishes New Guidance on Opportunity Zones
Observers of a new federal program received welcome news Friday, October 19, when the U.S. Treasury Department released long-anticipated guidance around Opportunity Zones, a program that will drive substantial private capital into urban and rural communities across the country.
The Opportunity Zones program was created last year under the Tax Cuts and Jobs Act. The program is designed to stimulate economic growth and investment in designated low-income communities by offering substantial benefits to taxpayers who invest unrealized capital gains in businesses located within these zones through investment vehicles known as “qualified opportunity funds.”
Specifically, the program provides three main tax incentives to encourage investment in opportunity zones.
First, it allows a taxpayer to defer inclusion in gross income for gains that are reinvested in a qualified opportunity fund.
Second, it provides a mechanism to reduce the amount of tax owed by the taxpayer on the amount of gain invested in a qualified opportunity fund if certain requirements are met.
Finally, it excludes from gross income any appreciation on the taxpayer’s investments in qualified opportunity funds that are held for at least 10 years. These benefits target billions of dollars in idle capital with the goal of getting it off the sidelines and into the economy.
Since the program’s inception, there has been significant interest in the potential of opportunity zones but uncertainty has limited the program’s use as investors have struggled with the practical challenges of structuring Opportunity Zone projects to comply with the new law.
Included in last Friday’s announcement is a first tranche of proposed regulations and Revenue Ruling 2018-29.
Among other things, the Proposed Regulations –
Specify that the tax benefits only apply to capital gains;
Define who is an “eligible taxpayer” for purposes of the statute;
Instruct how tax attributes will be treated under the deferral provisions;
Instruct how taxpayers (including partnerships and other pass-through entities) will make the deferral election;
Specify that a taxpayer may make the basis step-up election (tax-free appreciation) up until Dec. 31, 2047; and
Clarify for a partnership or corporation to qualify as Qualified Opportunity Zone Property (QOZBP), the “substantially all” requirement means that 70% of its tangible property must be located in an opportunity zone.
Revenue Ruling 2018-29 provides additional guidance concerning how the "original use requirement" for QOZBP should be applied to land and existing buildings. This Revenue Ruling clarifies that if an Opportunity Fund purchases an existing building on land that is wholly within an Opportunity Zone then –
The original use requirement is not applicable to the land;
The original use of the building is not considered to have commenced with the QOF;
The substantial improvement measurement does not include the adjusted basis of the land; and
The fund is not required to separately substantially improve the land.
These publications provide much-needed clarity and will encourage more activity by investors, developers, businesses, communities, and practitioners alike. While more guidance is coming, Opportunity Zones are off to a good start.