The Tax Cuts and Jobs Act of 2017 provides powerful tax incentives, which can defer, reduce, and potentially eliminate, capital gains tax for qualifying investments. The Act aims to stimulate development in economically-challenged areas designated as Qualified Opportunity Zones. Qualified Opportunity Funds (investing entities which meet certain criteria established by the IRS and the Department of the Treasury) can enjoy beneficial tax treatment if they invest in tangible property (including real estate) or equity interests in companies located in Qualified Opportunity Zones. Investors in Qualified Opportunity Funds have the additional opportunity to defer gain from the sale of other unrelated assets if they invest in such a Fund within 180 days after the sale.
The gain deferral from a prior sale is similar to that available for real estate investors only through a “like-kind exchange” under Section 1031 of the Internal Revenue Code. Unlike 1031 exchanges – which are limited to direct investments in real property – investors in Qualified Opportunity Funds can defer tax on gains from the sale of a wide range of assets, including real estate, securities, intellectual property and assets that constitute a trade or business. In addition, the investors only need invest gain, not the entire proceeds of the sale. The available tax benefit depends on how long the investor holds onto its Qualified Opportunity Fund investment. A five year holding period will result in some permanent deferral. A ten year holding period would permit electing investors to avoid recognizing 15% of the deferred gain and any gain on the appreciation of the investment in the Qualified Opportunity Fund. As usual, the devil is in the details. The statute is complex and many of the operational rules have been left to regulation and other forms of agency guidance.
In June, the IRS announced that Qualified Opportunity Zones have been certified in all fifty states, plus Puerto Rico and the US Virgin Islands. To reap tax advantages under the Act, a Qualified Opportunity Fund investing directly in Qualified Opportunity Zone real estate must either (a) be the initial developer of the property or (b) “substantially improve” a developed property by spending an amount equal to or greater than the cost basis of the property. The IRS has not yet provided guidance on important questions like calculating the cost basis among properties in a multi-property acquisition for purposes of establishing the necessary minimum investment for redevelopment. It is also unclear whether there will be limits on the type of securities that a Fund can purchase in a business located in a Qualified Opportunity Zone.
Before establishing – or investing in – a Qualified Opportunity Fund, it is important to note that the applicable rules are still taking shape. Please contact us if you would like to be kept apprised of the substantive and procedural guidelines governing Qualified Opportunity Fund creation and investment.
Christine A. Reuther counsels clients on an array of tax- and fund-related matters. She can be reached at email@example.com or 610-341-1071.
Andrew Maguire negotiates, documents and closes transactions across a broad spectrum of commercial real estate asset classes. He can be reached at firstname.lastname@example.org or 610-341-1032.