By Jonathan Woloshin, Thomas McLoughlin, and Andrew Lee
One of the least publicized provisions of the Tax Cuts and Jobs Act was the creation of an incentive program for community reinvestment and development known as Opportunity Zones (OZ). The OZ program is designed to promote private sector investment in economically distressed communities throughout the nation. Investors in the OZ program would be eligible for the deferral of taxation on realized capital gains, and depending upon the duration of the holding period, a reduction in their total tax liability. The program is currently designated to run through 31 December 2026. Under the OZ program, only the capital gain need be reinvested, rather than the sum of the original investment.
Some may view the OZ program as similar to the New Markets Tax Credit (NMTC) Program from 2016. Despite some similarities, the key difference is that the OZ program does not place any annual limitations on the total dollar amount of investment. As such, the OZ program has the potential to raise significantly more capital than the NMTC Program. In effect, the law now allows investors to apply their capital gains from the disposition of other property, which otherwise might be subject to taxation, to finance investments in distressed communities.
The OZ program lets investors defer realized capital gains by investing those gains in a vehicle designated as a Qualified Opportunity Fund (QOF). There is no residency or work location requirement associated with the QOF investment. Taxpayers are simply required to self-certify to the IRS that their capital gain was reinvested within a specific time frame. The taxpayer is required to complete a form and attach that form to their federal income tax return. Investors in a QOF may defer an unlimited amount of capital gain provided the gains are reinvested in a QOF within 180 days of the asset sale. Investors have the option of investing all or a portion of their capital gains from each specific asset sale.
The OZ program also provides incentives for longer-term projects. An investor holding an OZ investment for at least five years will be entitled to a 10% increase in the tax basis of their investment. If the holding period is extended to seven years, the tax basis increase expands to 15%. A deferral of some taxation may be available for investments held by the taxpayer for shorter periods of time.
Some details about OZ's are still being ironed out as we await regulations from the Department of Treasury this summer, and those regulations are worth keeping an eye on. Investors are urged to consult their tax and legal advisors regarding the specific details of the tax implications of the OZ program.