Update on Qualified Opportunity Zone Funds

The Tax Cuts and Jobs Act (TJCA) provides for shelter from capital gains tax for investment into qualified opportunity funds (QOF) and the permanent exclusion of capital gains from the sale or exchange of an investment in the QOF.

Temporary deferral applies for capital gains that are reinvested in a QOF—an investment vehicle organized as a corporation or a partnership for the purpose of investing in qualified opportunity zone property (other than another qualified opportunity fund) that holds at least 90% of its assets in qualified opportunity zone property. Qualified opportunity zone property includes: any qualified opportunity zone stock, any qualified opportunity zone partnership interest, and any qualified opportunity zone business property.

The maximum amount of the deferred gain equals the amount invested in a QOF by the taxpayer during the 180-day period beginning on the date of sale of the asset to which the deferral pertains. For amounts of the capital gains that exceed the maximum deferral amount, the capital gains are recognized and included in gross income.

Upon a sale or exchange of an investment in opportunity zone funds that are held for at least 10 years, the taxpayer may elect to treat the basis of such investment in the hands of the taxpayer as the fair market value of the investment at the date of such sale or exchange.

Notice 2018-48, 2018-28 IRB 9, issued earlier this year, carries a complete list of census bluedesignated as qualified opportunity zones. IRS recently issued proposed regs explaining the gain deferral aspects of QOFs (Proposed regs issued on deferral of gains on qualified opportunity fund investments), along with a Revenue Ruling explaining what constitutes qualified opportunity zone property (IRS clarifies key terms for determining what is “qualified opportunity zone business property”).

Areas designated as Qualified Opportunity Zones. The FAQs point taxpayers to a list of designated Qualified Opportunity Zones in Notice 2018-48, and also explain how to obtain a visual map of census tracts designated as Qualified Opportunity Zones. Additionally, the FAQs provide detailed instructions for how to determine the census tract for a specific address.

Incentives for development. IRS explains that Opportunity Zones are designed to spur economic development by providing the following tax benefits to investors:

Investors can defer tax on any prior gains invested in a QOF until the earlier of the date on which the investment in a QOF is sold or exchanged, or Dec. 31, 2026. If the QOF investment is held for longer than five years, there is a 10% exclusion of the deferred gain; and if held for more than seven years, there’s a 15% exclusion of the deferred gain.

If the investor holds the investment in the QOF for at least ten years before selling it, the investor is eligible for an increase in basis of the QOF investment equal to its fair market value on the date that the QOF investment is sold or exchanged.

Forming and qualifying a QOF. A QOF is an investment vehicle that is set up as either a partnership or corporation for investing in eligible property that is located in a Qualified Opportunity Zone. The entity can be a limited liability company (LLC) that chooses to be organized either as a partnership or corporation for federal tax purposes.

The special tax benefits are available even if the taxpayer doesn’t live, work, or have a business in an Opportunity Zone. All that’s necessary is that the taxpayer invest a recognized gain in a QOF and elect to defer tax on the gain.

An eligible partnership of corporation self-certifies as a QOF on a statement (to be released by IRS) attached to its timely filed return (including extensions).