Final Regulations on Opportunity Zones:
Frequently Asked Questions
After considering over 300 formal comment letters and additional taxpayer feedback, the Treasury Department and IRS have issued final regulations on Opportunity Zones to provide clarity and certainty for investors and communities.
The questions and answers below describe changes made to the proposed regulations that are reflected in the final regulations in response to engagement with the public.
What types of gains may be invested and when?
- General rule — The final regulations amend the proposed regulations’ general rule that only capital gain may be invested in a Qualified Opportunity Fund (QOF) during the 180-day investment period by clarifying that only eligible gain taxable in the United States may be invested in a QOF.
- Sales of business property — The proposed regulations only permitted the amount of an investor’s gains from the sale of business property that were greater than the investor’s losses from such sales to be invested in QOFs, and required the 180-day investment period to begin on the last day of the investor’s tax year. The final regulations allow a taxpayer to invest the entire amount of gains from such sales without regard to losses and change the beginning of the investment period from the end of the year to the date of the sale of each asset.
- Partnership gain — Partners in a partnership, shareholders of an S corporation, and beneficiaries of estates and non-grantor trusts have the option to start the 180-day investment period on the due date of the entity’s tax return, not including any extensions. This change addresses taxpayer concerns about potentially missing investment opportunities due to an owner of a business entity receiving a late Schedule K-1 (or other form) from the entity.
- Investment of Regulated Investment Company (RIC) and Real Estate Investment Trust (REIT) gains — The rules clarify that the 180-day investment period generally starts at the close of the shareholder’s tax year and provides that gains can, at the shareholder’s option, also be invested based on the 180-day investment period starting when the shareholder receives capital gains dividends from a RIC or REIT.
- Installment sales — The rules clarify that gains from installment sales are able to be invested when received, even if the initial installment payment was made before 2018.
- Nonresident investment — The final regulations provide that nonresident alien individuals and foreign corporations may make Opportunity Zone investments with capital gains that are effectively connected to a U.S. trade or business. This includes capital gains on real estate assets taxed to nonresident alien individuals and foreign corporations under the Foreign Investment in Real Property Tax Act rules.
When may gains be excluded from tax after an investment is held for a 10-year period?
- Sales of property by a Qualified Opportunity Zone Business (QOZB) — In the proposed regulations, an investor could only elect to exclude gains from the sale of qualifying investments or property sold by a QOF operating in partnership or S Corporation form, but not property sold by a subsidiary entity. The final regulations provide that capital gains from the sale of property by a QOZB that is held by such a QOF may also be excluded from income as long as the investor’s qualifying investment in the QOF has been held for 10 years. However, the amount of gain from such a QOF’s or its QOZBs’ asset sales that an investor in the QOF may elect to exclude each year will reduce the amount of the investor’s interest in the QOF that remains a qualifying investment.
- Applicability to other gains — The final rules clarify that the exclusion is available to other gains, such as distributions by a corporation to shareholders or a partnership to a partner, that are treated as gains from the sale or exchange of property (other than inventory) for Federal income tax purposes.
How does a Fund determine levels of new investment in a Qualified Opportunity Zone?
- Aggregation of property for purposes of the substantial improvement test — QOFs and QOZBs can take into account purchased original use assets that otherwise would qualify as qualified opportunity zone business property if the purchased assets:
- Are used in the same trade or business in the Qualified Opportunity Zone (QOZ) or a contiguous QOZ for which a non-original use asset is used, and
- Improve the functionality of the non-original use assets in the same QOZ or a contiguous QOZ.
- Aggregation of property for purposes of the substantial improvement test (continued) — In certain cases, the final regulations permit a group of two or more buildings located on the same parcel(s) of land to be treated as a single property. In these cases, any additions to the basis of the buildings in the group are aggregated to determine satisfaction of the substantial improvement requirement. Thus, a taxpayer need not increase the basis of each building by 100% as long as the total additions to basis for the group of buildings equals 100% of the initial basis for the group.
- Vacancy period to allow a building to qualify as original use — The final regulations reduce the five-year vacancy requirement in the proposed regulations to a one-year vacancy requirement, if the property was vacant for at least one-year prior to the QOZ being designated and remains vacant through the date of purchase. For other vacant property, the proposed five-year vacancy requirement is reduced to three years. In addition, property involuntarily transferred to local government control is included in the definition of the term vacant, allowing it to be treated as original use property when purchased by a QOF or QOZB from the local government.
- Leasing — The final regulations provide several changes to leasing provisions in the proposed regulations:
- State and local governments, as well as Indian tribal governments, will be exempt from the market-rate requirements for leased tangible property,
- Leases between unrelated parties are generally presumed to be at market rate terms, and
- Short-term leases of personal property to lessors using the property outside a QOZ may be counted as Qualified Opportunity Zone Business Property (QOZBP).
- Working capital safe harbor — The final regulations provide several refinements to the working capital safe harbor:
- They create an additional 62-month safe harbor for start-up businesses to ensure that they can comply with the 70-percent tangible property standard, the 50-percent gross income requirement, and other requirements to qualify as a QOZB;
- They provide that a QOZB can receive an extra 24 months to use working capital if the QOZ is in a Federally-declared disaster area;
- They clarify that the safe harbor can only be used for a 62-month period and that amounts remaining at the conclusion of the period cannot be counted as tangible property for purposes of the 70-percent tangible property standard; and
- They allow a QOZB to treat equipment, buildings, and other tangible property that is being improved with the working capital as QOZBP that is “used in a trade or business” for purposes of the requirement that a QOZB must be engaged in a trade or business.
- In addition, the final regulations provide that a QOZB not utilizing the working capital safe harbor may treat tangible property undergoing the substantial improvement process as being used in a trade or business.
- Measurement of “use” for the 70-percent use test— The final regulations provide that, if tangible property is used in one or more QOZs, satisfaction of the 70-percent use test is determined by aggregating the number of days the tangible property in each QOZ is utilized. Accordingly, the final regulations set forth a clearer way for determining satisfaction of the 70-percent use test, including a safe harbor for certain tangible property used both inside and outside the geographic borders of a QOZ.
- Determinations of location and “use” of intangible property — The final regulations provide that intangible property qualifies as used in the QOZ if:
- The use of the intangible property is normal, usual, or customary in the conduct of the trade or business, and
- The use contributes to the generation of gross income for the trade or business.
- Other clarifications regarding business property of QOFs or QOZBs —
- Real property straddling census tracts — The final regulations include both a square footage test and an unadjusted cost test to determine if a project is primarily in a QOZ, and provide that parcels or tracts of land will be considered contiguous if they possess common boundaries, and would be contiguous but for the interposition of a road, street, railroad, stream or similar property. Importantly, the final regulations also extend the straddle rules to QOF’s and QOZB’s with respect to the 70-percent use test.
- Brownfield sites — The final regulations provide that both the land and structures in a Brownfield site redevelopment are considered to be original use property as long as the QOF or QOZB make investments into the Brownfield site to improve its safety and compliance with environmental standards.
- Self-constructed property — The final rules provide that self-constructed property can count for purposes of the QOF’s 90-percent asset test and the QOZB’s 70-percent asset test, and is valued at the purchase price as of the date when physical work of a significant nature begins.
- De minimis exception for “sin businesses” — The final regulations provide that a QOZB may have less than 5 percent of its property leased to a so-called “sin business” described in 26 U.S.C. §144(c)(6)(B). For example, a hotel business of a QOZB could potentially lease space to a spa that provides tanning services.
How can large C Corporations invest in Opportunity Zones?
- The final regulations provide an election for a consolidated group of C Corporations to treat a lower-tier QOF C Corporation as a member of the consolidated group if:
- Only other members of the consolidated group hold 100% of the QOF member’s stock, and
- The QOF member complies with special intergroup transaction rules to remain a member of the group.
- The regulations also provide alternative retroactive elections for a consolidated group that had formed a QOF C Corporation before the May 1, 2018, proposed regulations to elect to treat the treat the QOF C Corporation as:
- Always having been a QOF partnership, or
- Never having been a member of the consolidated group.
Interview with Mark Politi on Raising Capital with Qualified Opportunity Zone Funds for Businesses & Real Estate
US Treasury, SBA, HUD and the IRS designed Opportunity Zones Tax Guidelines to Incentivize and Unlock Capital Gains Investment and Spur Economic Growth and Job Creation across the United States
Interview with Mark Politi on raising capital with Qualified Opportunity Zone Funds for Businesses & Real Estate. US Treasury, SBA, HUD and the IRS designed Opportunity Zones Tax guidelines as big part of the 2017 Jobs Act to incentivize and unlock capital gains investment and spur economic growth and job creation across the United States. This bipartisan economic stimulus tax incentive has largely been misunderstood and dismissed by households and corporations skeptical of its legitimacy. They are missing out on one of the biggest tax breaks in US history.
Mark Politi is a nationally recognized speaker and expert on Qualified Opportunity Zone Funds.
Interview with CEO Mark Politi
What are Qualified Opportunity Zones and What is the Market Potential?
Question: What are Qualified Opportunity Zone Funds?
Mark Politi: As part of the new IRS tax laws enacted as part of the 2017 Jobs Act, $6.1 trillion in unrealized capital gains are being unlocked ($3.8 trillion are held by American households and $2.3 trillion are held from US corporations). Opportunity zones are designated (by state and local government) geographic regions of cities across the United in typically low- and middle-income areas of the country. Many areas have had trouble attracting any kind of investor capital.
Question: If I am a capital gains investor, what is in it for me as an investor by investing in an Qualified Opportunity Zone Fund and will I be able get rid of my Capital Gains tax bill?
Mark Politi: If an investors invest in qualified opportunity zone funds, whether it’s in real estate or business specific funds (non-real estate), the investor can postpone of the current capital gain tax payment for six years, get a reduction (step down in basis) of 10% of the overall capital gains tax bill at 6 years and a complete elimination of the future capital gains earned on that opportunity zone investment if they hold onto it for 10 years or longer. The complete elimination of future capital gains invested in an opportunity zone investment is a big deal and many investors are missing out on it.
Question: Why would a business want to create, develop and launch their own Qualified Opportunity Zone Fund to raise capital for their business or real estate instead of going the traditional route to Venture Capital?
Mark Politi: Instead of pleading with friends, family, business colleagues, VC’s and others to invest in your business or real estate project. Opportunity Zone tax incentives are only available for accredited investors who have a current capital gain tax liability. You cannot not offer these tax incentives to a regular investor. The Treasure Department, SBA, HUS and the IRS have provided businesses and real estate firms with these unique Opportunity Zone tax incentives to attract these capital gains investors to redeploy their investments into Opportunity Zone Fund investments by giving them these unique tax breaks that no one else can get.
Question: Are there active capital gains investors out there, especially during the COVID19 Pandemic and would they be interested in investing in my Opportunity Zone Fund that we set up?
Mark Politi: From February 2020 to May 2020, over $700 Billion in personal capital gains were taken by investors seeking to exit from their investments. Where did they go? They have up to 180 days to deploy their capital gains by investing in a 1031 Exchange (a Real Estate Sale), where they only postpone the capital gain that will still be owed to the IRS in the future. Or if they took capital gains from stock, many did not realize that they could leverage Opportunity Zone Tax incentives from their stock sale to minimize their capital gains liability and eliminate future capital gains as long as it’s held in the Qualified Opportunity Zone Fund for 10 years.
Question: If I were an accredited investor at the Top tax bracket and let’s say I have a $1,000,000 capital gain from the sale of Real Estate or Stock, what may be my capital gains tax liability and what are my options in investing in an Opportunity Zone?
Mark Politi: Whether it was Real Estate or a stock sale that resulted in a $1,000,000 capital gain, you could receive the following by investing in a Qualified Opportunity Zone Fund.
1) You can postpone your Capital Gains tax bill until 12/31/2026
2) If you held the investment in that Qualified Opportunity Zone Fund for 10 years or longer, you would have Zero Federal Capital gains when you exited the investment.
4) The same investment with the same rate of return in a non-opportunity zone fund investment, would have a 23.8% Capital Gains tax bill due at the 10 year mark. So, in this example, on $1,000,000 the capital gain investor would owe $238,000.
Question: Is it difficult or complicated to Raise Capital and launch your own Opportunity Zone Fund?
Mark Politi: Because of the complexities of the Opportunity Zone guidelines that were just recently updated as of December 2019, Business and Real Estate executives and their executive management teams have been seeking expert guidance on how to correctly create, develop and launch a Qualified Opportunity Zone Fund. We provide expert consultation and guide our clients through the whole process and continue to advise them before, during and after the capital raise throughout the life cycle of the fund.