Round Two: Opportunity Zone Proposed Regulations
A message from the Land of O.Z.
The highly anticipated second round of Proposed Regulations on the new Opportunity Zone (OZ) law were recently issued by the IRS and U.S. Department of the Treasury. The regulations are only proposed and are subject to further revisions based on comments received prior to the Treasury Department’s public hearing scheduled for July 9, 2019. Though additional guidance is expected in the next couple of months regarding administrative rules and information reporting requirements, the additional guidance provides answers to key questions and can be relied upon by taxpayers.
Opportunity Zone Background
Before we dive into the proposed regulations, let’s recap with some background on what Opportunity Zones may mean for you or your community. Investors in Qualified Opportunity Funds (QOF) are allowed deferral of all or part of a gain that would otherwise be includible in current taxable income. The deferred gain will also be reduced by up to 15% if the QOF is held by the investor for 7 years. The gain is deferred until the QOF investment is sold or December 31, 2026, whichever comes first. If the new investment in the QOF is held for at least 10 years, investors are able to permanently exclude a gain on the new investment in the QOF. Permanent exclusion of gain on the new investment is the most significant investor benefit in the new law.
Optimism in OZ Proposed Regulations
Based on our analysis of the new round of proposed guidance, we continue to be pleased with the regulations and their friendliness to the economic efforts of communities and for investors. The latest proposed regulations provided the following guidance:
- Any gain from the sale to or exchange with an unrelated party on any property held by a taxpayer qualifies for deferral if invested within 180 days of the date of sale. There was uncertainty on which gains from the sale of business property were qualified gains and when the re-investment period began. Capital gains from the sale of real estate or personal property used by a trade or business (Section 1231) are netted (gains reduced by losses) and the 180-day period begins on the last day of the tax year.
- The proposed regulations defined that unimproved land in an OZ would need to be improved by more than an insubstantial amount within 30 months to qualify as a QOF investment. The holding of land for investment does not give rise to a trade or business, and the land cannot be QOZ property. Purchased real estate property generally must be substantially improved, as determined on an asset-by-asset basis.
- The property must be original use to be a qualified opportunity zone (QOZ) property. For a building or structure that has been unused or vacant for an uninterrupted period of at least five years, original use begins on the date after that period when any person uses or places the property in service in an OZ.
- Leased property can qualify as QOZ property.
- At least 50% of the gross income must come from the OZ for the active conduct of a qualified OZ business. Three safe harbors are provided to determine if sufficient income is derived from a trade or business in a QOZ to meet this requirement.
- To allow for the proper exclusion of gains from taxation, taxpayers are allowed to exclude from gross income some or all of the capital gain arising from the disposition of property in a QOF reported on a Schedule K-1.
With this new guidance, it’s clear that the time to take action is now. Funding sources for projects are developing. As a result, Opportunity Zone communities should continue to vet projects to locate in the designated OZ tracts and taxpayers should begin investing and making a big impact on these OZ communities!
Galen Pfeifer, CPA, Partner, specializes in working with clients investing in Opportunity Zones. With over three decades of experience, he also leads Adams, Brown, Beran & Ball, Chtd.’s Mergers, Acquisitions & Valuations (MAV) Service Line. In addition to being a CPA and holding the Accredited in Business Valuation (ABV) credential, Galen is also a Personal Financial Specialist (PFS) and Certified in Financial Forensics (CFF). For more information, contact him.