Tax Alert: IRS Issues New Guidance For Qualified Opportunity Zone Investments

The Tax Cuts and Jobs Act (“TCJA”) established the Qualified Opportunity Zone (“QOZ”) program to encourage investment in economically distressed and low-income communities across the United States, District of Columbia and U.S. possessions. Qualified Opportunity Zone investments allow for temporary deferral of inclusion in gross income for capital gains invested in a Qualified Opportunity Fund (“QOF”) and the permanent exclusion of capital gains from the sale or exchange of an investment in the QOF.

  • Temporary Tax Deferral: Taxpayers may defer capital gains generated within 180 days of the sale of the underlying property by investing in a QOZ Fund.  The gain is deferred to the earlier of (a) the date of the sale of the QOZ Fund or (b) December 31, 2026.  Special rules exist when the capital gain is generated by a pass-through entity.
  • Permanent Tax Exclusions: Taxpayers who maintain ownership in the QOZ Fund for 5 years are eligible to receive a 10% step-up in basis, while taxpayers who maintain ownership in the QOZ fund for a total of 7 years are eligible to receive an additional 5% step-up in basis (i.e., 15% total basis step-up after the 7-year holding period is attained).  Additionally, by maintaining the investment for at least 10 years, qualifying taxpayers are not subject to tax on the appreciation of the investment.

While proposed regulations were originally issued in October 2018, taxpayers were left with many unanswered questions.  In response to this uncertainty, the IRS issued new proposed regulations on April 17, 2019 to provide further guidance to address various issues. The highlights of the new proposed regulations are as follows:

  • Clarification of the substantially all definition surrounding the holding period and business use of eligible QOZ business property;
  • Additional business eligibility requirements, including tests for determining whether appropriate levels of income are generated by an active trade or business for purposes of the 50% gross income test;
  • QOF Reinvestment Rules surrounding the reinvestment of proceeds from disposed QOF property;
  • Treatment of leased property;
  • Changes to the working capital safe harbor;
  • Detail of transactions that will require immediate recognition of previously-deferred investor gains; and
  • Treatment of IRC Sec.1231 gains

Sax LLP will provide a detailed analysis of the proposed regulations shortly.

Please contact your Sax advisor or Michael Benguigui at [email protected] to discuss any questions you may have regarding investments in Qualified Opportunity Zones.