New Regulations Help Clarify Qualified Opportunity Zones
The IRS released new proposed regulations for Qualified Opportunity Zones on April 17, 2019. The new regulations seek to clarify the vague statutory language of Internal Revenue Code Section 1400Z-1 and 1400Z-2, outlining the tax benefits of Qualified Opportunity Zones.
What Are Qualified Opportunity Zones?
Qualified Opportunity Zones (QOZs) are census tracts that have been designated by their respective state governments as “economically distressed communities.” These tracts exist in all 50 states, the District of Columbia, and five U.S. territories. The Qualified Opportunity Zone designation, put in place by the Tax Cuts and Jobs Act of 2017, allows for business entities organized as partnerships or corporations to create Qualified Opportunity Funds by investing in property in the designated zones.
To incentivize investment in Qualified Opportunity Funds, the IRS allows taxpayers to defer recognition for up to 10 years on any capital gains that are invested in such funds. As an added bonus, capital gains from the appreciation of qualified opportunity stock are not taxable if the stock is held for a sufficient period of time. This can yield massive potential tax savings for smart taxpayers. For more basic information, please refer to our blog on Qualified Opportunity Zones.
Here are four key takeaways from the new regulations that may help clarify your understanding of QOZs:
1 Inclusion Events
The IRS made several important clarifications in the new proposed regulations. It outlines what does, and does not, cause an “inclusion event” (the recognition of deferred gain) for a taxpayer taking advantage of this program. For example, gifting stock in a Qualified Opportunity Fund to another person triggers an inclusion event, while a transfer on death, or from an estate to a beneficiary, does not. A conversion of a Qualified Opportunity Fund from a C-Corporation to an S-Corporation also does not cause an inclusion event, and moreover the invested capital proceeds for the current investor are not counted as a “second class of stock” for the purposes of the S election.
2 Section 1231 Gain
Additionally, the IRS clarified that Section 1231 gains (that is, gains on sale for property used in a business longer than one year) are treated the same as capital gains from the sale of stocks, securities, or other capital or investment assets. This means that taxpayers who have proceeds from 1231 sales can invest them in QOZs to take advantage of gain deferral.
3 QOZ Business Property
The new proposed regulations also offer much-needed guidance on what is, and is not, considered when determining if a Qualified Opportunity Fund’s property is “qualified opportunity zone business property” for the purposes of meeting the annual self-certification of Qualified Opportunity Fund status with the IRS.
Property acquired by lease, even a lease from a related party, can be considered qualified if certain conditions are met. While a property’s original use in a QOZ must be with the taxpayer, the taxpayer may instead “substantially improve,” on an asset-by-asset basis, the property to enable it to qualify.
If a Qualified Opportunity Fund sells its qualified property, the proceeds of the sale are given a grace period of 12 months to be treated as qualified opportunity zone property for the purposes of reinvestment in other qualified property. Such a sale also does not trigger gain recognition for the partners or shareholders in the fund. This means that QOZ businesses are able to turn over property and reinvest in new businesses with no penalty to the fund or the shareholders.
4 Bright-line Tests for QOZ Businesses
The new regulations also lay down bright-line tests for businesses that conduct operations both inside and outside a QOZ to determine if the entire business is to be considered a “QOZ business.” By applying tests based on a number of factors, including the character and location of business operations performed and number of work-hours allocated to employees inside and outside the zone.
The new proposed regulations provide new clarity and insight both for prospective investors in Qualified Opportunity Funds as well as business owners or investors seeking to establish their own Qualified Opportunity Funds. We are ready to assist you in either endeavor; please contact us for more information.
Topics: Tax Topics