Opportunity Zones: 8 Answers from the Latest IRS Guidance
- Posted: February 20, 2019
- Posted by: Travis Lynk
- Last Reviewed: February 27, 2019
In October 2018, the IRS released new guidance regarding the Opportunity Zone program, clarifying a range of topics for investors. Although there is a 60-day comment period before the guidelines are finalized, taxpayers can be certain of these eight key points when evaluating Opportunity Funds as potential investment vehicles:
1. Gains treated as either long- or short-term capital gains under Internal Revenue Code sections 1221 and 1231 are eligible for deferral and investment under the Opportunity Zone program. Carried interest gain may potentially be eligible in certain situations. Depreciation recapture, on the other hand, is not eligible.
2. The proposed guidelines allow taxpayers to take advantage of the 10-year step-up in basis to fair market value through December 31, 2047, meaning that investments made after 2018 will still qualify, even though the Opportunity Zone program is set to expire in 2028.
3. The Opportunity Zone program permits any taxpayer to take advantage of the incentives available under the program. Under the new guidelines, a “taxpayer” is defined as an individual, an S or C corporation, partnership, trust, estate, or common trust fund as described in IRC 584. Additionally, in the case of partnerships, if the partnership entity chooses not to defer and invest realized capital gains, the individual partners can make the deferral election.
The guidance also allows for flexibility in tax planning. Partnership entities have 180 days from the date of sale or exchange of the asset to defer and invest capital gains, while individual partners have 180 days from the end of the partnership’s taxable year to defer and invest distributed gains.
4. Taxpayers can roll over interest in one Qualified Opportunity Fund to another Qualified Opportunity Fund within 180 days of disposing of the original interest, provided the rollover represents the entire original Qualified Opportunity Fund interest. It is expected that similar regulations will be issued covering the sale and replacement of Opportunity Zone property within a Qualified Opportunity Fund, although this was not addressed in the October 2018 guidance.
5. Statutory guidelines permit Qualified Opportunity Funds to invest in Opportunity Zone businesses, which are defined as businesses with “substantially all” of their property meeting the definition of qualified Opportunity Zone property. The new guidance quantifies “substantially all” as 70%, meaning that at least 70% of the assets of a qualifying Opportunity Zone business must be properties acquired during or after 2018, and are either substantially improved or first put into service in an Opportunity Zone within 31 months.
6. Qualified Opportunity Funds must pass the 90% asset test, which requires funds to have at least 90% of their assets invested in qualified Opportunity Zone property in order to maintain Qualified Opportunity Fund status. The new regulations define the mechanism by which Qualified Opportunity Funds self-certify and document compliance using IRS form 8996. Qualified Opportunity Funds must self-certify before they can accept taxpayer investments.
7. Qualified Opportunity Funds can accept any type of capital from investors; however, only untaxed capital gains qualify for the tax deferral and step-up in basis. If a fund takes on debt and allocates it to partners, the debt does not qualify as a separate investment.
8. The guidance directs Qualified Opportunity Funds and Opportunity Zone businesses to look to their financial statements for asset valuation. In the absence of a financial statement, the cost basis will be used for valuation.
The U.S. Department of the Treasury made significant progress with the release of the latest guidance, and additional guidance and clarification is expected in January 2019.