What Are Qualified Opportunity Zones?
We’ll demystify the following topic in this video. My name is Chris at Hauseit. Hauseit
is the largest Assisted FSBO and buyer agent commission rebate company in NYC, established
2014.
Qualified opportunity zones are census tracts in all 50 states, all U.S. territories and
Washington D.C. that have been designated by their respective governors as low income
or economically distressed areas, and thus eligible for tax deferred investment through
qualified opportunity zone funds.
As we’ll discuss in the following article, investors can roll unrealized capital gains
into qualified opportunity zone funds and defer taxation until the investment is sold.
Furthermore, there are additional tax exemptions on the appreciation of the opportunity fund
investment itself, based on a sliding scale with benefits increasing as the length of
the hold period increases.
What is the Opportunity Zone program?
The Opportunity Zone program was created by the Tax Cuts and Jobs Act of 2017 and allows
investors to defer capital gains taxes on investments by “rolling” the amount of
the gains into opportunity zone funds which make long term investments in businesses or
real estate in designated opportunity zones.
Depending on how long the investment in the opportunity zone fund is held, the investor
may have part or all of his or her potential capital gains from the investment be exempted
from capital gains taxation.
For the avoidance of doubt, it is any potential gain on the opportunity zone investment that
may be exempted, not the original capital gains that have been “rolled” into the
fund.
The original capital gains taxation on the proceeds which were “rolled” into the
opportunity fund is simply delayed vs exempted.
Remember that this program was created for people with large mounts of unrealized capital
gains, such as large paper wealth from start-up stock that has appreciated significantly in
value.
A lot of these Silicon Valley millionaires and billionaires are loath to sell their stock
and then have to pay capital gains tax, so this program enables them to “roll” their
gains to this program and defer that taxation on the gains.
How the tax deferment works
If an investor sells stock, real estate or other property that has appreciated in value,
he or she will normally be liable for capital gains tax on the appreciation. This can be
deferred by rolling the gains into a Qualified Opportunity Fund within 180 days of the sale.
This way, the investor is able to get his or her principal back, and also defer taxation
on the appreciation. Furthermore, if the investment in the Qualified Opportunity Fund is held
for at least five years prior to December 31, 2026, the capital gain on the investment
can be reduced by 10%.
If the investment is held for at least 7 years, the gain on the investment is reduced by 15%.
If the investment is held for at least 10 years, then the capital gains tax on the investment
is 100% reduced.
What are opportunity zones?
Opportunity zones are designated low income areas in all 50 states, Washington D.C. and
five US territories including American Samoa, Guam, Northern Mariana Islands, Puerto Rico
and the US Virgin Islands. Interestingly enough, all of Puerto Rico has been classified as
an opportunity zone.
Up to 25% of low-income neighborhoods which meet the income guidelines of the program,
as well as up to 5% of non-low income census tracts that meet other income and geographic
requirements, in each state, district or territory can be designated as an opportunity zone.
There are 8,764 Qualified Opportunity Zones and areas certified as economically distressed
communities retain their designation for ten years.
Governors had until April 2018 to nominate census tracts in their districts to be designated
as opportunity zones. They had to have the following low income requirements per IRS
Section 45D (e):
A poverty rate of 20% or more or a median family income of at most 80% of the statewide
median income for census tracts in non urban areas. Furthermore, the median family income
of the tract could be no higher than 80% of the greater statewide median family income
or the overall metropolitan median income if the census tract is in an urban area.
A maximum of 25% of the census tracts in each jurisdiction could be nominated if they met
the criteria. An additional 5% of census tracts could also qualify if they met a different
set of income and geographical qualifications of (a) being in a census tract that was contiguous
with a designated opportunity zone and (b) having a median family income of 125% or less
of the median family income of the adjacent opportunity zone.
Where can I find a list of qualified opportunity zones?
You can find a complete list of qualified opportunity zones by checking out Notice 2018–48
and Notice 2019-42 on the IRS website.
You can find a visual representation of all the census tracts that have been designated
as qualified opportunity zones on the HUD website.
As an interesting side note, 57% of all census tracts in the United States were considered
for the opportunity zone program. The Treasury Department had to tamp down on this enthusiasm
by assessing each proposed tract and only certifying those that fully met the criteria.
In the end, the Treasury department certified about 8,800 tracts as opportunity zones in
June 2018.
What are opportunity zone funds?
To participate in the program investors must invest through Qualified Opportunity Funds
which are required to invest at least 90% of their assets in one or more qualified opportunity
zones.
How do you become a Qualified Opportunity Fund?
It’s a rather informal process to become a Qualified Opportunity Fund. A corporation,
LLC or partnership simply self-certifies to the IRS by filing Form 8996 with its federal
income tax return. The return with Form 8996 must be filed timely, taking extensions into
account. Qualified Opportunity Funds are restricted
to investing in the following:
Partnership interests in businesses operating in opportunity zones
Stock ownership in businesses conducting most or all operations in opportunity zones
Property such as real estate based in opportunity zones
A Qualified Opportunity Fund is allowed to develop new buildings or re-hab existing buildings.
However, if it is a re-hab such as a condominium conversion vs new construction, then the fund
must spend more in the improvement of the building vs the cost of buying the original
building.
Furthermore, development must be completed within 30 months of the purchase. It is unclear
whether pandemics will affect the time limit.
Requirements to be an eligible opportunity zone business
To qualify for the program, businesses must earn at least 50% of its gross income from
business activities within a qualified opportunity zone for each taxable year.
There are three safe harbor tests that a business may use and it’s okay for a business to
satisfy just one of the following tests:
The 50% of hours of services received or uses test
The amounts paid for services test The necessary tangible property and business
functions test
Problems with the opportunity zone program
The opportunity zone program has unfortunately been subject to abuses, as evidenced by the
fact that many upscale urban areas were also designated as opportunity zones.
For example, much of downtown Indianapolis was designated as an opportunity zone while
several low income, economically distressed neighborhoods around downtown were ignored.
In another egregious example, a super yacht marina in West Palm Beach, Florida was designated
as an economically distressed opportunity zone.
Congress did not include any reporting requirements in the Tax Cuts and Jobs Act of 2017, which
meant that beneficiaries of the program were not required to disclose the value of the
projects they invested in nor the value of the tax breaks they received, making it very
difficult to assess the merits of the program.
Opportunity funds also suffer from other issues such as governance issues with multiple partners,
and the difficulty of raising enough capital with just one owner.
Delays due to the pandemic
In April, the IRS issued Notice 2020-23 which included relief for certain time sensitive
actions such as the 180 day period in which capital gains need to be rolled into a qualified
opportunity zone fund. If the taxpayer’s 180 day deadline fell between April 1st, 2020
and July 15th, 2020, then the deadline was automatically moved up to July 15th, 2020.
It’s anyone’s guess what will have after July 15th.
Another topic that has yet to be addressed by the IRS is the 12 month re-investment rule,
where a qualified opportunity fund has 12 months from the date of sale of qualified
opportunity zone assets to reinvest the proceeds into other qualified assets.
Typically, a federally declared disaster will mean that the fund will have another 12 months
to complete the re-investment, but it’s unclear whether this will apply to COVID-19.
Pro Tip: Qualified investment fund investments have a 30 month working capital safe harbor
which grants businesses 30 months to use working capital held as cash. If the project is delayed
due to a federally declared disaster, then the business can have another 24 months to
use up the working capital. Will this be enough time given
the pandemic?