On April 17, the IRS issued guidance that offered additional information on investments in qualified opportunity zones. The proposed regulations are meant to provide guidance under section 1400Z-2 of the Internal Revenue Code and relate to gains that taxpayers can defer as a result of investing in a qualified opportunity fund (QOF). The proposed regulations also highlight rules for investments in a QOF that a taxpayer holds for at least 10 years. Also part of the guidance are updates to previously proposed regulations.
The Tax Cuts and Jobs Act, enacted in December 2017, amended the Internal Revenue Code to include Section 1400Z-1 and 1400Z-2, both of which are designed to encourage investment and economic growth in distressed communities, or qualified opportunity zones. Taxpayers who invest capital in businesses located in a qualified opportunity zone through a QOF are eligible for income tax benefits. Under the new proposed regulations, taxpayers can:
- Defer all or part of a gain that is invested into a QOF that would otherwise be included in their income. They can defer the gain until the sale or exchange of the investment or December 31, 2026, whichever is sooner.
- Permanently exclude gain from the sale or exchange of an investment in a QOF if they hold the investment for at least 10 years.
Also under the new IRS guidance, tangible property acquired after December 31, 2017, under a market rate lease can qualify as a “qualified opportunity zone business property” if substantially all the use of the property was in a qualified opportunity zone for substantially all the holding period. The guidance also clarifies the definition of substantially all. Under the previous regulations, a business or trade satisfied the “substantially all” test if at least 70% of its tangible property was a qualified opportunity business property. Under the new proposed regulations:
- At least 70% of the property must be used in a qualified opportunity zone for “use of the property.”
- During the holding period of the property, a tangible property must be qualified opportunity zone property for at least 90% of the qualified opportunity zone business’ or QOF’s holding period.
Finally, the new guidance points out that deferred gains might become taxable in certain situations if an investor transfers their interest in a QOF. A gift transfer might cause the deferred gain to become taxable. Non-taxable transfers include inheritance by a surviving spouse or transfer of an ownership interest in a QOF, upon death, to an estate or revocable trust that becomes irrevocable upon death.
The IRS invites comments on the proposed regulations and has also announced that it expects to address administrative rules for a QOF that doesn’t maintain the 90% investment standard. Additionally, the IRS expects to revise Form 8996 (Qualified Opportunity Fund, OMB Control number 1545-0123) for tax year 2019 and following. Capstan will continue to follow the issue and will blog on any future updates and additional proposed regulations.
If you have questions about the proposed regulations and most recent guidance from the IRS, please don’t hesitate to contact us. Our office number is 215-885-7510. We can also be reached via email:
Terri S. Johnson tjohnson@capstantax.com
Carly Ferris cferris@capstantax.com
Bruce A. Johnson bjohnson@capstantax.com
Photo by Louis Velazquez on Unsplash.