The Opportunity with Opportunity Zones: The IRS Releases New Regulations
On October 19, 2018, the Internal Revenue Service released proposed regulations for Qualified Opportunity Zones (QOZs). QOZs are a community development tool benefiting low-income areas by bringing significant financial incentives for investors including real estate owners, operators and developers who invest in economically distressed communities.
The recently released rules provide investors with guidelines on how they can qualify for special tax breaks in Qualified Opportunity Zones and specify that only capital gains can qualify for the benefit. The IRS has provided details on what types of entities can invest in Qualified Opportunity Zone Funds, along with which projects will qualify.
These proposed regulations have been long awaited and are likely to spur even more activity from investors and funds who were awaiting guidance and hoping to close deals before the end of the year. The Treasury Department will issue another set of regulations later this year addressing questions about the ongoing operations of a fund, including whether a fund can buy and sell assets over its lifetime.
Under the Tax Cuts & Jobs Act (“TCJA”), investors can take proceeds that would be subject to capital gains taxes (i.e.: those from the sale of a business or stock) and put them into Qualified Opportunity Zone Funds to defer and potentially reduce their capital gains taxes. They can also avoid taxes on the funds’ gains completely.
The idea is becoming increasingly popular among people already investing in real estate to enhance investment returns on low-income housing and commercial real estate projects by investing in more challenging communities. There are approximately 8,700 Opportunity Zones throughout the U.S. spanning low-income areas of major cities.
- The New Jersey approved designations include (but are not limited to) tracts of land in the Atlantic, Bergen, Camden, Essex, Hudson, Middlesex, Monmouth, Morris, Ocean, Passaic and Union Counties. Please click here to reference the complete list.
- The New York approved designations include (but are not limited to) tracts of land in the Bronx, Kings, New York (Manhattan), Nassau, Queens, Richmond (Staten Island), Rockland, Suffolk and Westchester Counties. Please click here to reference the complete list.
- Nationwide: Please click here for a national map of Opportunity Zones.
Calculations for Opportunity Zones
The IRS rules specify that funds do not have to include the value of the land when calculating how much the law requires them to spend renovating or refurbishing property, according to a Treasury official. For example, if a fund were to pay $1 million for a warehouse and land, with the building valued at $400,000, the fund must spend at least what the building is valued, not the total purchase price in the renovations.
This is a significant benefit for investors in urban areas where land can be a significant portion of a project’s cost. Developers can spend less to meet the rules for what constitutes “substantially improving” a building under the law. For some projects, such as affordable housing, investors could have been forced to pay more to improve the building than they would have been able to recoup in rental income.
Timeline for Opportunity Zones
Investors will have 180 days from the sale of their stock or business to put the proceeds in an Opportunity Fund to qualify for the tax breaks. The capital gains taxes on those proceeds are deferred until 2026 and could be reduced by as much as 15 percent. Investors can avoid capital gains taxes altogether on any appreciation of the fund if they hold the investments for at least 10 years.
The IRS proposed rules state that funds will have 30 months from when they receive investors’ funds to complete renovations.
The IRS also issued a Revenue Ruling (Rev. Rul. 2018-29) detailing special rules for capital gains invested in Qualified Opportunity Zones along with a draft Form 8996, Qualified Opportunity Fund and corresponding instructions for Form 8996.
Investing within a Qualified Opportunity Fund can be truly beneficial to anyone will a large capital gain, real estate owners, operators and developers who are seeking significant tax incentives by deferring and reducing their existing capital gains and eliminating any potential future capital gains within a Qualified Opportunity Zone investment. This new opportunity will spur long-term capital investments to low-income communities throughout the country that would otherwise not have been able to attract this investment capital.
The advisors at Sax will be sure to keep you updated on relevant developments as they emerge. For any questions on Qualified Opportunity Zones or setting up a Qualified Opportunity Fund, please contact George Livanos at [email protected].