Great excitement is greeting the U.S. Treasury’s first set of guidance on provisions in the 2017 tax law that encourage investment in Qualified Opportunity Zones, or QOZs, in return for deferral or forgiveness of taxes on capital gains.
After all, the proposed rules clear up some key uncertainties that were causing investors to hesitate. Even better, they articulate generous views of which types of taxpayers may benefit (most) and the capital gains they may use (most), and even extend the time allotted for reinvesting gains (under certain circumstances).
Such generous tax relief suggests investments in Qualified Opportunity Funds (QOFs) should be on your radar if you’re looking to defer taxes on significant gains achieved in this long bull market.
However, these investments come with a major caveat: The ideal investor would be comfortable holding for at least 10 years to secure the largest benefit available: full forgiveness on gains generated in the QOF.
Additional guidance from the government is needed in key areas. For example, many potential investors are waiting for clarity on the treatment of fund-level debt, fund-level reinvestments, and withdrawals/distributions.
Still, the proposed rules, released October 19th, are a major step and can be relied upon, even though they’re still subject to a 60-day comment period and final rules may differ.
Investors in general and real estate investors in particular are interested in QOZs because the potential tax incentives seem so large:
These incentives left many prospective investors eagerly waiting to hear exactly how they could take advantage.
That is a very short window to vet potential investments and meet the requirements of qualified property.
Under proposed regulations, investors still have to reinvest capital gain into a QOF within 180 days. However, QOFs that use and hold the equity in certain subsidiaries that qualify as QOZ businesses may qualify for a 31-month working capital safe harbor. This safe harbor makes it easier to qualify as qualified property for purposes of the 90% test. However, the QOF must have a written plan for acquisition, construction and substantial capital improvement of identified tangible business property and must in fact execute on the plan during that grace period.
As taxpayer-friendly as all of the guidance is, several areas still could use additional clarification, such as:
Among the first investors seeking to take advantage of the QOZ tax break are naturally those involved in single market deals, mainly real estate projects that already were in the pipeline, notes Katherine Rosa, Global Head of Alternative Investments for J.P. Morgan.
For a broader group of less-specialized investors to go full steam ahead, Rosa and her team are looking for more guidance, such as whether a fund-of-funds structure will be blessed, which would allow for more diversified investments.
More fundamentally, Rosa cautions, because QOZs are by their nature in areas that may require extra incentives to lure financing, investors need to carefully assess—independent from the tax benefits—the underlying risks of projects.
Might an investment in QOF work for you now or later? Please feel free to contact your J.P. Morgan advisor to discuss these and other investment opportunities.
For a more detailed analysis of Opportunity Zones, please see our Washington Watch Spotlight: Opportunity Zones: Great promise. Current confusion., published in September.
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