Last year marked a milestone in U.S. history: The 10-year anniversary of the country’s Great Recession of 2008. While the U.S. economy has largely recovered from the devastating effects of the 2008 recession, distressed communities continue to lack economic growth. According to the 2018 Distressed Communities Index (DCI), which reflects data compiled by public policy and advocacy organization Economic Innovation Group, the number of businesses in prosperous communities increased by over 180,000 from 2012 to 2016, while distressed communities lost 13,300. The DCI also indicated that distressed communities continue to have the highest housing vacancy rate in the country. The underlying question becomes, “How can economic growth be expanded to distressed communities?” The Opportunity Zone Tax Incentive seeks to answer that question.
The U.S. Department of the Treasury (Treasury Department) and Internal Revenue Service (IRS) are offering investors a tax incentive to encourage long-term private investment in distressed communities across the country through the Tax Cuts and Jobs Act of 2017. This program is often referred to as the Opportunity Zone Tax Incentive. Under the program, distressed communities, or “Opportunity Zones,” were nominated by governors of all 50 states, the District of Columbia and five U.S. territories. Nominations were based on eligible census tracts, and once designated by the IRS, became Qualified Opportunity Zones (QOZs). As of today, the list of QOZs on the Treasury Department's CDFI webpage consists of over 8,700 communities throughout the country and are scheduled to expire on December 31, 2028.
Tax Benefits for Investors
Eligible taxpayers who invest capital gains into a Qualified Opportunity Fund (QOF) can defer paying federal capital gains tax until the QOF is sold or exchanged, or until December 31, 2026. For example, a taxpayer who invests in a QOF on December 31, 2019, could potentially defer gains up to seven years, while a taxpayer investing on December 31, 2024 could defer gains for up to two years.
To qualify for deferral, capital gains must:
- Be invested in the QOF within 180 days from the sale of an asset
- Be an equity interest (not a debt interest)
- Elect deferral by filing the appropriate tax forms the year the gain would otherwise be included as income
Investors can receive up to three primary tax benefits for investing capital gains into a QOF:
- Temporary Deferral – The tax payment is deferred until the investment is sold or exchanged, or until December 31, 2026 (whichever comes first).
- Partial Exclusion – If the QOF investment is held for longer than five years, there is a 10 percent exclusion of the deferred gain. If held for more than seven years, the exclusion becomes 15 percent.
- Elimination – If the QOF investment is held for at least 10 years, the investor has the potential to eliminate any tax payment.
What is a Qualified Opportunity Fund (QOF)?
The IRS defines a QOF as “any investment vehicle which is organized as a [U.S.] corporation or a partnership for the purpose of investing in a Qualified Opportunity Zone Property (QOZP).” The IRS mandates that the QOF, whether newly formed or pre-existing, must hold at least 90 percent of its assets in a QOZP or incur penalties each month it does not. To become a QOF, an eligible corporation or partnership self-certifies by filing the appropriate tax form with its federal income tax return.
There are three types of investments termed Qualified Opportunity Zone Property (QOZP). All types need to be: (1) acquired by the QOF after December 31, 2017 and (2) acquired from a domestic corporation or partnership that is (or will be organized as) a qualified opportunity zone business when the property is issued or exchanged:
- Partnership Interest
For more information about the Opportunity Zone Tax Incentive program, visit the Treasury Department’s Opportunity Zone Resources web page.
Opportunity Zone Tax Incentive and the Near Future
Could the Opportunity Zone Tax Incentive be the driving force to expand economic development into distressed communities? As with any place-based incentive program, only time will tell. For now, investors still have a lot of questions and concerns regarding the program’s proposed regulations. The IRS and Treasury Department have been receptive, recently holding a public hearing to solicit comments, with anticipation of releasing final regulations in Spring 2019. The program remains a hot topic in the commercial real estate community, and QOFs are expected to progressively funnel investments into QOZs throughout the country.
As with any real estate transaction, title and closing services will be essential to these properties. Old Republic Title’s nationwide network of professionals is ready to assist investors with their title and escrow needs. To find out more about Old Republic Title’s title insurance and closing services, contact your local Old Republic Title representative.
* The information addressed herein is as of April 3, 2019. Old Republic Title, its officers and employees do not provide, and this communication is not intended to be tax or legal advice. Old Republic Title makes no representations or warranties regarding the accuracy of the information or tax consequences addressed herein. You should consult a tax or legal professional of your choosing to advise you of the benefits and risks of your specific transaction.
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