December 31st is always an important date on the tax calendar because it marks the last day taxpayers can fine-tune their tax position. This year, December 31st is especially important because it is the last day taxpayers can invest and receive the full benefits of the qualified opportunity zone (QOZ) program. The program, which was written into law with the passage of the Tax Cuts and Jobs Act (TCJA), rewards taxpayers for investing capital gains into economically depressed “zones” across the country by delaying – and potentially eliminating – their capital gains tax. But the full benefits are only available to taxpayers who invest in opportunity zones on or before December 31, 2019. To help clients, prospects and others understand the benefits, GBQ has provided a summary of important points below.
Details on the December 31st Deadline
The QOZ program rewards all taxpayers who invest capital gains into a qualifying zone, but the longer they hold their investments, the sweeter the reward.
Tier 1: Less than Five Years
When taxpayers hold their investment in a QOZ for less than five years, they can defer their gain until they pull their investment.
Tier 2: Five Years or Longer but Less than Seven
When taxpayers hold their investment for at least five years but less than seven, they can (1) defer their gain until they pull their investment, and (2) exclude 10% of their original gain when it becomes taxable.
Tier 3: Seven Years or Longer but Less than Ten
When taxpayers hold their investment for seven years or longer but less than ten, they can (1) defer their gain until they pull their investment, and (2) exclude 15% of their original gain when it becomes taxable.
Tier 4: Ten Years or Longer
When taxpayers hold their investment for at least ten years, they can (1) defer their gain until they pull their investment, (2) exclude 15% of their original gain when it becomes taxable, and (3) increase their basis in the investment equal to its fair market value, eliminating the tax on appreciation that occurred within the opportunity zone.
These benefits aren’t available indefinitely, though. Recognition of the original gain will be triggered for all taxpayers – regardless of how long they hold their investment in a QOZ – on December 31, 2026. This means that taxpayers who want to receive the full 15% exclusion of their original gain must invest in a QOZ by December 31, 2019, seven years before the gain recognition is automatically triggered. Taxpayers can hold their investment in the QOZ beyond 2026 if they wish. If they make it to the ten-year mark, they can receive the step-up in basis and eliminate tax on their investment’s appreciation.
Although the full 15% gain exclusion can be enticing, it’s important for taxpayers not to rush into an investment decision. The extra 5% gain exclusion will not offset a bad investment.
Taxpayers are not permitted to invest directly into a qualifying zone property; instead, they must invest through an entity called qualified opportunity fund (QOF) which will then invest into the QOZ business or property. QOF can be structured either as a partnership or corporation. To receive the QOZ tax benefits, QOF must follow certain rules, such as holding 90% of its assets in QOZ property. The IRS released two sets of proposed regulations that explain in more detail the rules related to QOFs and how to qualify for the QOZ benefits. While the final regulations have not yet been issued, taxpayers can rely on the proposed regulations to ensure they qualify to receive full tax benefits.
If you have questions about investing in or forming QOF or need assistance with a tax planning or compliance issue, GBQ can help. For additional information call 614-221-1120 or click here to contact us. We look forward to speaking with you soon.