The new tax law has encouraged investment in certain low-income communities, promising deferral, and even forgiveness, of potentially substantial capital gains taxes—but many aspects of the provision remain murky, leaving investors concerned about complying with a host of requirements and possibly facing costly penalties.
At the heart of these new tax incentives are Qualified Opportunity Zones, or QOZs. These economically challenged areas are nominated by states and certified by the Secretary of the U.S. Treasury. There are now thousands of certified QOZs across the United States and its territories.1 Taxpayers (presumably including individuals, corporations, partnerships and trusts) who invest realized capital gains from the sale or exchange of assets into Qualified Opportunity Funds (QOFs) may become eligible for preferential tax treatment, including:
Those benefits would seem to make it worthwhile for taxpayers to comply with some detailed requirements, but—like a number of provisions in the 2017 tax act—there are multiple unanswered questions, some of which are outlined within a more thorough article here. Without detailed guidance from Treasury, it may be difficult for many taxpayers to make informed decisions about whether and how to invest in these funds.
Unlike previous programs aimed at spurring investment in low-income communities, which often came in the form of limited tax credits, the QOZ approach allows for advantageous tax treatment on an unlimited amount of capital gain regardless of the taxpayer’s income level.
Here’s a closer look at the benefits QOFs offer:
Temporary gain deferral: A taxpayer can elect to defer recognition of an unlimited amount of capital gain from the sale or exchange of property with an unrelated person if that capital gain2 is reinvested in a QOF within 180 days.3
QOF basis adjustments: The opportunity zone provision rewards long-term investment—the longer a QOF is held, the bigger the benefit:
Recognition of deferred gain: The remaining gain may be deferred until the QOF is sold or exchanged, or until December 31, 2026, whichever comes first. At that time, the taxpayer recognizes tax on the original deferred gain (or the difference between the fair market value of the investment on the recognition date and the taxpayer’s basis, if that amount is less due to the aforementioned basis adjustments and/or negative investment performance).4
Forgiveness of tax on new gain: A taxpayer holding a QOF for at least 10 years may elect to exclude from income all new capital gains arising from the QOF investment, whenever it is subsequently sold or exchanged.
Want to find out more about Qualified Opportunity Zones and funds? See a more detailed Washington Watch Spotlight for further information including:
As guidance is issued that addresses QOZs, we plan to keep you apprised of any changes to this opportunity. Your J.P. Morgan representative, in conjunction with your outside advisors, can help evaluate whether investing in QOFs may make sense for you.
1 These census tracts retain their status as opportunity zones for a 10-year period. A list of approved opportunity zones can be found in IRS Notice 2018-48, available here: https://www.irs.gov/pub/irs-drop/n-18-48.pdf.
2 The title of I.R.C. §1400Z-2 is “Special Rules for Capital Gains Invested in Opportunity Zones” and the Committee Report indicates that the election applies to “capital gains.” The rest of the code section, however, merely refers to “gain(s),” and does not specify “capital” gain. Thus, it is unclear whether other types of gain may also be eligible for opportunity zone benefits.
3 To the extent a taxpayer invests more than gain realized from recent sales or exchanges into a QOF, the investment will be bifurcated into two investments—one eligible for QOF benefits, and another that is not. There does not appear to be a tracing doctrine regarding the realized capital gain, so cash from any source may be able to be invested in a QOF.
4 It appears that the amount of gain recognized is identical whether the QOF is sold or exchanged before December 31, 2026, or if the taxpayer continues to hold the QOF on that date and faces an imputed income tax event. An apparent typo in I.R.C. §1400Z-2, however, leaves this ambiguous.
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