IRS Continues to Provide Pro-Taxpayer Regulations on Investing in Opportunity Zones
- Tax Planning
On April 17th the Internal Revenue Service issued another 169 pages of new regulations, providing more details about managing and investing in Qualified Opportunity Zones. Within this proposal Congress would provide very generous tax breaks to investors in Qualified Opportunity Funds and investors that directly operate businesses in Qualified Opportunity Zones. While the new regulations are only proposed, taxpayers can rely on them to guide their transactions and tax filings as long as they are applied consistently.
Qualified Opportunity Zones were created as part of the Tax Cuts and Jobs Act of 2017 to incentivize private investment in economically underperforming areas. The U.S. Treasury Department has identified 9,000 Opportunity Zones across the U.S. and five U.S. possessions.
Investors in Qualified Opportunity Zone Funds qualify for three tax benefits:
- Deferral of capital gains that are reinvested in a qualified opportunity fund within 180 days after the recognition of such gains or reinvested gains,
- Exclusion of up to 15% of such reinvested gains,
- Permanent exclusion of all gains generated from the Qualified Opportunity Funds if the investment is held for at least 10 years.
For further background on the original provisions released in 2018, you can read our update here.
“While much has been made about the deferral of capital gains and the exclusion of up to 15% of such reinvested gains, the most meaningful aspect of the program for investors, in our mind, is the ability to invest in a long term real estate opportunity and avoid taxation on the realization of those gains.” says Shannon Saccocia, Boston Private’s Chief Investment Officer. “Our view is that the majority of the return generated to investors related to this program will come in the form of these gains, rather than the tax deferral. One caveat to that thesis is that while all 50 states have designated opportunity zones, there are going to be more attractive locations in which to invest, and it is critical that an evaluation of each potential investment be made in order to determine the best way to garner exposure to this program.”
The new regulations answer several important questions raised by investors in Qualified Opportunity Funds and those who operate businesses directly in Qualified Opportunity Zones, as both would qualify for the tax breaks.
How long do investors have to reinvest capital gains in a Qualified Opportunity Zone or Fund to take advantage of the generous tax breaks?
Prior regulations required investors to reinvest their net capital gains in a Qualified Opportunity Fund or directly in a Qualified Opportunity Zone business within 180 days of the sale of the asset. This rule doesn’t work for taxpayers who may have multiple capital gains and loss transactions during a year and need time to calculate their net gains and losses. The regulations fix this problem by providing 180-days after year end for reinvesting capital gains in a Qualified Opportunity Fund.
Investor impact: Investors who have several capital gains and loss transactions during the year and are looking at deferring gains by investing in a Qualified Opportunity Fund have six months after year-end to reinvest net gains and defer taxes.
Does leasing property (e.g. a building) to a Qualified Opportunity Fund or business in a Qualified Opportunity Zone qualify as a business that would entitle the owner to the tax benefits of Qualified Opportunity Zone investing?
The answer depends on whether the leasing activity rises to a trade or business. The regulations make clear leasing property via a triple net lease without more owner involvement does not qualify as operating a business in a Qualified Opportunity Zone. The same rule is used in the 2017 tax reform law regarding whether leasing property using a triple net lease without more owner activity is a trade or business which entitles the business owner to the lower federal income tax rates accorded to pass-through businesses like sole proprietorships, S Corporations, limited liability companies, and partnerships.
Investor impact: Qualifying your rental portfolio located in a Qualified Opportunity Zone as a trade or business is necessary to take advantage of the Qualified Opportunity Zone tax benefits. Before entering these transactions, it may be necessary to increase your involvement in managing your real estate portfolio to qualify for the tax breaks.
Will gifts of Qualified Opportunity Fund investments and transfers at death trigger taxes?
The new regulations clarify that gifts of Qualified Opportunity Fund investments may trigger taxes on deferred gains to the donor. Transfers of Qualified Opportunity Fund investments at death and contributions to a grantor trust provided the taxpayer is the owner of the trust, will not trigger taxes on deferred gains in most cases.
Investor impact: To maximize the tax deferral of reinvested gains in a Qualified Opportunity Fund, the investment must be held at least seven years. Planning a gift of Qualified Opportunity Fund investments after this time can minimize taxes on deferred gains.
Is an investor taxed on deferred gains if the Qualified Opportunity Fund sells some or all of its assets during the 10-year holding period needed to exclude gains from the Fund.
Taxes on deferred gains are not triggered as long as the fund reinvests the proceeds in other qualifying businesses within 12 months of the sale. However, taxpayers owning shares in the Qualified Opportunity Fund will have to pay their share of taxes on any gains from the sale of the asset by the Qualified Opportunity Fund.
Investor impact: There are many Qualified Opportunity Funds in market. Selecting one that is well funded and has the experience to navigate all the complicated rules is important.
Can investors contribute property other than cash to a Qualified Opportunity Fund and defer the gain related to the property’s value?
The new regulations clarify that property, not services, can be contributed to a Qualified Opportunity Fund. This provision provides significant planning opportunities to investors who sell appreciated property for cash and contribute other property with a value at least equal to the gain to a Qualified Opportunity Fund. This dual transaction has the effect of generating cash for the investor while deferring the gain on the appreciated property.
Investor impact: Before contributing property as a Qualified Opportunity Zone investment make sure you have valuation that is sound and will hold up on audit. These are complicated transactions and the advice of a tax expert is critical.
We will continue to keep you informed on additional guidance issued by the Treasury Department. While the Opportunity Zone investing provisions offer some of the most generous tax breaks in the Tax Cuts and Jobs Act of 2017 it is also one of the most complicated. Therefore, it is important to consult your accountant and other tax advisors before investing in Qualified Opportunity Funds or businesses.
Boston Private is ready to help.
As you consider the impact of how these investments might benefit your portfolio we encourage you to consult with your financial advisor. Our team of wealth management professionals has been selected for their depth of experience and they are committed to helping you achieve your unique financial goals.
Boston Private is pleased to announce a partnership with Doug Fisher, a Washington Policy expert, who will offer a series of insights into a number of reform proposals making their way through Congress in 2019. Doug is Director of Retirement Policy at the American Retirement Association. In this role, Doug works with the ARA membership to protect, advise and grow their businesses through ideation and advocacy in the benefits area. Before joining ARA, Doug led Fidelity's legislative policy and thought leadership development teams involving retirement, health and welfare benefit plans. Doug has advised many Fortune 1,000 companies on the impact of legislation and regulation on the design and delivery of benefits. Before joining Fidelity, Doug served as tax counsel to the U.S. Senate Finance Committee and was involved in writing the pension, health and insurance provisions of the Small Business Job Protection Act of 1996; the Balanced Budget Act of 1997, including the Roth IRA, Simple retirement plan, medical savings account (predecessor to the health savings account); and the Health Insurance Portability and Accountability Act of 1996 (HIPAA).
- Tax Planning
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