The Qualified Opportunity Zones (QOZ) Program was created by the Tax Cuts and Jobs Act to encourage economic growth in distressed communities through tax benefits. The program holds enormous potential for commercial real estate investment and development in the designated zones.
Under the program, U.S. states and territories, including Washington, D.C., nominated areas (by census tract) to be “Opportunity Zones,” which the IRS chose from when making the final designations, released in early 2018. The Zones are in underserved communities and vary in size.
Investors must create “Opportunity Funds” (O Funds) to invest in the Zones. Anyone can create an O Fund, but it must be structured as a partnership or corporation organized for the purpose of investing in QOZ property. Capital gains invested into an O Fund within 180 days of a sale to a non-related party are eligible for:
- Deferral of federal tax while held in the O Fund
- A 10-percent reduction in tax after five years, and an additional 5-percent reduction after seven (for a total of 15 percent) through an adjustment in basis
- Gains accrued while in the O Fund are tax-free if the initial investment is held for 10 years
Non-gains funds can also be invested into an O Fund, but are treated as a separate investment for federal tax purposes. Only gains accrued on capital gains invested into an O Fund on which tax is deferred are excluded from tax at the end of the 10-year period.
At least 90 percent of O Fund assets must be in QOZ property, which can be stock, partnership interests, or other tangible property used in a trade or business (e.g., real estate). The Treasury Department’s proposed rules state that O Funds will be able to self-certify and report compliance with the 90 percent asset requirement on federal income filings.
Business property acquired by an O Fund in a Zone must be new or “substantially improved,” meaning the fund must invest at least as much on improvements as was paid for the used asset. The proposed rules state that the “substantial improvement test” does not need to include the value of the land a building sits on, thus reducing the required investment amounts. Additionally, QOZ business property must be “substantially all” in a QOZ, meaning that 70 percent or more of the property must be in the Zone.
QOZs are a federal program, but the states may still play a role. States that want to make their Zones more attractive to investors might conform their tax laws to the federal laws by relieving investors from paying state capital gains rates on income earned from QOZ investments. The states will likely be reviewing their tax codes in response to the program, though not all will choose to make such changes.
Further rules are expected to clarify other aspects of the program, including how to handle reinvestments by O Funds and how to define “original use” of QOZ business properties. In January 2019, the IRS will hold a hearing on the topic, and final rules are expected in the spring. Until then, some of the proposed regulations are in effect, including those relating to eligible gains and dispositions of investments in the O Funds.
The National Association of REALTORS® (NAR) is closely monitoring this issue and will provide feedback on the proposed regulations to ensure that the program is successful. For more information, please see the “Opportunity Zones” page on nar.realtor, which includes links to the IRS FAQ page and a map of all the designated QOZs.
This column is brought to you by the NAR Real Estate Services group.
Erin Stackley is a senior policy representative for the National Association of REALTORS®. For more information, please visit www.nar.realtor.
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Thanks so much!