On October 19, the Treasury Division (“Treasury”) launched eagerly anticipated steerage relating to the “qualified opportunity fund” (“QOF”) program that was enacted as a part of the Tax Cuts and Jobs Act in December 2017. The widely taxpayer-friendly steerage – within the type of proposed laws, a income ruling and a draft self-certification type for QOFs, along with draft directions for the shape – solutions many questions on this system, though sure particulars stay open and additional steerage is predicted earlier than the top of the yr. The dialogue under will first present some background on this program, then present a excessive degree abstract of sure key parts of the brand new steerage, earlier than concluding with a take a look at areas the place questions stay.
Usually, this program supplies tax incentives for funding in sure economically distressed communities referred to as “opportunity zones.” Opportunity zones are census tracts that fulfill relevant necessities to be thought-about low-income and have been designated as alternative zones by the governors of every state, which designations have been then accredited by Treasury earlier this yr. An inventory and map of present alternative zones can be found right here.
An investor can benefit from this new program by reinvesting capital achieve realized from the sale or change of any capital asset to an unrelated get together right into a QOF inside 180 days of the date of disposition of that capital asset. Tax on that achieve will then be deferred till 2026 or upon sale or change of the QOF curiosity, whichever is earlier. If the curiosity within the QOF is held for at the least 5 years earlier than the deferred achieve is triggered, then the investor’s foundation within the QOF curiosity is elevated to the extent of 10% of the deferred achieve, with the outcome that 10% of the deferred achieve is completely excluded from revenue for the investor. If the curiosity within the QOF is held for a minimum of seven years earlier than the deferred achieve is triggered, then that 10% will increase to 15%. If the QOF curiosity has been held for lower than 5 years as of December 31, 2026, the investor will acknowledge all the deferred achieve at the moment.
Along with the deferral of the achieve used to make the QOF funding, if the investor holds the funding within the QOF for at the least ten years, then, upon disposition of the investor’s curiosity within the QOF, the investor receives a rise in foundation within the QOF curiosity to its truthful market worth on the time of sale. Which means, if all necessities are glad, all post-acquisition achieve within the QOF curiosity is excluded from revenue for the investor.
To ensure that a QOF investor to profit from these tax incentives, the QOF should maintain at the least 90% of its combination belongings in “qualified opportunity zone property” (“QOZP”), which is tangible property that a QOF acquires after 2017 and makes use of in a commerce or enterprise, and that satisfies the next two exams:
Using the property within the certified alternative zone originates with the QOF, or the QOF considerably improves the property; and
Throughout considerably all the QOF’s holding interval for such property, considerably all of using such property was in a professional alternative zone.
QOZP could also be inventory or partnership pursuits in an entity that invests in certified alternative zone enterprise property, or it might be direct funding in certified alternative zone enterprise property.
Whereas the framework for this program has been in place since December 2017, there have been many particulars relating to specifics that have been unclear. Consequently, although some buyers started to research potential investments, most taxpayers have been ready to take concrete motion on this space till extra steerage was launched. Many open questions have been answered within the steerage launched this month, though extra steerage is required and Treasury has stated such additional steerage is predicted earlier than the top of the yr.
Key Questions Answered by the New Guidance
Q: Will achieve realized by way of a pass-through entity akin to a partnership be eligible for these incentives? In that case, does the partnership have to make the qualifying funding?
A: If a partnership has eligible capital positive aspects that it seeks to reinvest pursuant to this program, both the partnership can elect to defer some or all the achieve or, if the partnership doesn’t make that election, any companion that was allotted all or a portion of these capital features might elect to defer some or all of his or her share of the features. If the companion finally makes the election to defer the achieve, the 180-day timeframe inside which the achieve have to be reinvested doesn’t begin till the final day of the partnership taxable yr through which the belief occasion occurred, since that’s deemed to be the date on which the companion acknowledges its share of the achieve. If the partnership elects to defer the achieve and reinvest pursuant to this program, the 180-day clock will begin on the date the partnership bought or exchanged the asset giving rise to the capital positive factors.
The proposed laws additionally make clear that any taxpayer, together with entities reminiscent of partnerships, C firms, S firms, trusts or estates, is eligible to elect deferral underneath these guidelines.
Q: What if an investor invests in a QOF with a mixture of eligible capital achieve and different funds?
A: The proposed laws make clear that the supply of those guidelines allowing a foundation step-up on the sale of a QOF curiosity held for at the least 10 years, such that each one post-acquisition achieve on that QOF curiosity is excluded from revenue, applies solely to the portion of the QOF curiosity that was bought with eligible capital achieve. If an investor makes use of eligible capital achieve to fund a portion of the funding, and different funds to fund one other portion of the funding, the portion funded with different funds isn’t eligible for the tax profit.
As well as, the proposed laws make clear that the funding in a QOF have to be an fairness curiosity to profit from these guidelines; debt won’t qualify.
Q: When is the newest date on which an funding in a QOF may be made?
A: An funding in a QOF could also be made at any time previous to June 30, 2027. It’s because achieve eligible for deferral have to be achieve that, absent the deferral, can be acknowledged on or earlier than December 31, 2026. Thus, within the case of achieve that might have been acknowledged on December 31, 2026, if the investor elects to defer that achieve and make investments it in a QOF, that investor has 180 days to take action.
Q: The present alternative zones retain that designation for 10 years. What occurs after 2028, when that designation expires?
A: As soon as an investor has invested in a QOF and held that QOF curiosity for at the very least 10 years, the investor might proceed to carry the funding for longer than 10 years and nonetheless profit from the idea step-up that leads to exclusion from revenue of post-acquisition achieve in that QOF curiosity. The proposed laws make clear that this remedy will apply even after the expiration of the designation of a specific alternative zone on the finish of 2028. Underneath the proposed laws, an investor might make the election to extend their foundation within the QOF curiosity for all tendencies of qualifying pursuits that happen after a 10-year holding interval and earlier than January 1, 2048.
Q: What does it imply to “substantially improve” property in a professional alternative zone?
A: Beneath the principles as set forth initially, to considerably enhance property means to undertake enhancements that double the idea of the property inside 30 months of acquisition of the property. In response to considerations that this might be a troublesome normal to satisfy, as a part of the current steerage, Treasury additionally issued a income ruling that concludes, within the case of land and a constructing bought concurrently, the land itself doesn’t should be individually improved and the idea within the land needn’t be included within the foundation that have to be doubled to fulfill the requirement for the property general. It will make it simpler for buyers in vacant or run-down buildings to fulfill the “substantial improvement” requirement, even when the constructing is situated on land that comprised a good portion of the acquisition worth of the property.
Q: What entities could also be QOFs and the way is QOF standing licensed?
A: The proposed laws make clear that a QOF could also be a partnership, company or LLC taxable as both a partnership or an organization. QOFs is probably not disregarded entities, nevertheless, so a QOF is probably not a single-member LLC. Additionally, pre-existing entities could also be used as QOFs, so long as they’re able to fulfill the requirement that the entity didn’t personal a big quantity of tangible property that was acquired previous to December 31, 2017.
As mentioned in beforehand issued steerage, a QOF will have the ability to self-certify as to its QOF standing. With the proposed laws, Treasury launched a draft of the shape (and a draft of the relevant directions for the shape) that a QOF will use to make such self-certification, by attaching the shape to its well timed filed federal revenue tax return (making an allowance for extensions). The shape can be required to be hooked up to the QOF’s return for all related tax years.
One element relating to self-certification offered within the proposed laws is that a QOF can be permitted to point on its self-certification type the primary month during which it needs to be handled as a QOF, which supplies flexibility for entities that could be shaped at one level within the yr however might not make the required investments to qualify as a QOF till later that yr.
As well as, the draft type and directions point out that a QOF shall be required to incorporate a press release relating to its function of investing in certified alternative zones in its organizational paperwork.
Whereas the steerage that Treasury has launched so far offers much-needed element relating to sure features of the certified alternative zone guidelines, important questions stay open, together with amongst different issues:
whether or not sure transactions undertaken by a QOF might set off the inclusion of deferred achieve previous to when it will in any other case be included underneath these guidelines;
what is going to represent a “reasonable period” by which a QOF might reinvest proceeds from the sale of qualifying belongings with out incurring a penalty;
administrative guidelines relating to implications and processes within the occasion a QOF fails to take care of the required investments; and
additional element relating to info reporting necessities.
Treasury has stated that additional steerage is predicted earlier than the top of 2018.
The proposed laws could also be relied upon as of the date of their launch, despite the fact that they don’t seem to be but ultimate. A public listening to is scheduled for January 10, 2019, at which era feedback acquired in response to the proposed laws shall be mentioned.
Whereas this space of tax regulation is presently creating, and extra particulars are but to return, this steerage usually is taxpayer-friendly and seems to point that Treasury needs to facilitate widespread use of this program. This presents distinctive alternatives for buyers to deploy capital in a method that’s meant to spur financial progress in communities that the majority want it, whereas offering these buyers with probably vital tax advantages.