On October 19, 2018 the Department of Treasury issued proposed regulations for Opportunity Zone Investors and has sent these rules over to the IRS. The proposed regulations provide guidance under new section 1400Z-2 of the Internal Revenue Code relating to gains that may be deferred by investors for investments in a qualified opportunity fund (QOF).
Being able to defer paying taxes for years has had many people interested in how the program would ultimately work. The purpose behind Opportunity Zones is to encourage investments in low-income communities by offering investors an opportunity to defer capital gains, with the possibility of further reducing the amount of gain realized through a basis adjustment for properties held for more than 5 or 7 years.
The Scope of the Opportunity Zone Investors Regulations
Specific guidance clarifies that only capital gains are eligible for deferral. Ordinary gains and gains from sales to related parties are not eligible. Estimates suggest that as much as $6 trillion could qualify, giving this program the potential to be one of the largest economic development programs in the US. This requires investors to take chances and bets on communities that were largely cut off. Some have suggested designated areas that local governments are already making investments in from which businesses could benefit from, offering additional incentives to investors. This could also have the adverse effect, leaving abandoned communities further ignored without any additional incentives, or this could possibly only benefit developers who were already planning investments because of the other available incentives.
Qualifying for the Opportunity Zone Credit
Under the proposed regulations, certain businesses wouldn’t qualify and there are specific milestones that must be hit within a specified number of days. For example, the original draft version required gains to be invested into a qualified fund within 180 days, but this can be particularly challenging for larger deals without more guidance. The new proposal extended this time for as long as 30 months, provided that a plan exists that can be audited by the IRS. Further guidance has been proposed regarding the Substantially All requirement in Section 1400Z-2(d)(3)(A)(i) where states if at least 70 percent of the tangible property owned or leased by a trade or business is qualified opportunity zone property then the trade or business would satisfy the substantially all requirement. While the “substantially all” phrase is used throughout the regulations, the specific guidance only applies to Section 1400Z-2(d)(3)(A)(i). We can hopefully anticipate that the next round of guidance provides a better understanding of the definition around the various meaning of “substantially all” as it is used through the regulations.
In addition, the proposed regulations offer that land will be excluded from the basis when determining if the building has been substantially improved. Omitting this requirement provides some ease to investors who were concerned about repurposing vacant or otherwise unutilized land.
New forms will be used for reporting required information to the IRS such as the Form 8996, Qualified Opportunity Fund, which is used to certify that a corporation or partnership is organized to invest in qualified opportunity zone property. It will be filed annually to certify that the qualified opportunity fund meets certain standards and the Form 8949, Sales and Other Dispositions of Capital Assets, to report income from the sale of capital assets. This form will be filed along with the Federal income tax return for the taxable year in which the gain would have been recognized if it had not been deferred.