IRS Releases New Guidance for Opportunity Zones
- Posted: March 22, 2019
- Posted by: Travis Lynk
- Last Reviewed: March 27, 2019
The 2017 Tax Cuts and Jobs Act created the Opportunity Zone program, which went into effect on January 1, 2018. On October 19, 2018,the U.S. Department of the Treasury released proposed regulations clarifying key issues for investors under newly created IRS Code 1400Z-2. These are the most significant issues that may impact taxpayers wishing to take advantage of the tax benefits in the Opportunity Zone program.
The Act simply states that “capital gains” qualify for tax incentives under the Opportunity Zone program. The current guidance clarifies that only short- and long-term capital gains for income tax purposes, and Section 1231 property gains, qualify for investment. Section 1245 and Section 1250 gains are excluded.
Although short-term capital gains qualify for investment under the Act, they will still be taxed at ordinary income tax rates as opposed to long-term capital gains tax rates when they are ultimately recognized.
The guidance defined new rules for gains resulting from a partnership or other pass-through entity. The new rules state that gains can be invested in a Qualified Opportunity Fund at the partnership level, or by the individual partners if the partnership chooses to distribute gains to the partners.
If the partnership elects to invest the gains, the 180-day window applies. However, if a partner makes the election, he or she may choose to start the 180-day window either at the time the gain was realized by the partnership, or at the end of the business’s taxable year. This gives partners maximum flexibility for tax-planning purposes.
Required Tax Forms
The Act initially stated that taxpayers had 180 days to invest capital gains in a Qualified Opportunity Fund. The latest guidance specified that taxpayers must use IRS Form 8949 to notify the IRS that capital gains are invested in an Opportunity Fund. Industry experts expect that this form will soon be updated to include specific fields for reporting Qualified Opportunity Fund investments.
Reasonable Working Capital
The tax code specifies that Qualified Opportunity Funds must invest at least 90% of their assets in Opportunity Zone property. To pass the 90% test, the percentage of assets held in Opportunity Zone property at the end of the first half of the fund’s taxable year and on the last day of the taxable year must be equal to or greater than 90%, with no allowances for working capital.
But the latest guidance permits working capital held in reserve to count toward the 90% test, provided the fund has a written plan documenting how and when the working capital will be spent. This “safe harbor” clarification gives Qualified Opportunity Funds more flexibility to develop and improve properties without failing the asset test.
Opportunity Fund Certification
Although the Act states that Qualified Opportunity Funds self-certify without approval from the IRS, the guidance clarifies that Qualified Opportunity Funds must use the new IRS Form 8996 to certify that the fund was created with the express purpose of investing in Opportunity Zone property. The new form also provides necessary information for passing the 90% asset test and describes penalties for noncompliance.
The Act specifies that a Qualified Opportunity Fund must “substantially improve” Opportunity Zone property within 30 months of acquisition. “Substantially improve” is defined as spending an amount equal to or greater than the cost of the property.
The new guidance clarifies that the scope of the improvements isbased on the value of the existing building only, not the land on which the building is located. It also specifies that the Qualified Opportunity Fund is not required to improve the land, only the existing structures.
This should reassure developers in cities such as New York or San Francisco, where land costs may exceed the cost of the structure.
Program Expiration Date
The original legislation specified that the Opportunity Zone program would expire in 2028, which suggested that there was a 10-year limit on Qualified Opportunity Fund investments. However, the new guidance stipulates that Qualified Opportunity Fund investments may grow tax-free through December 2047.