Opportunity Zones (“OZs”) were added to the US Tax Code by the 2017 Tax Cuts and Jobs Act (“TCJA”). OZs are economically-distressed communities where new investments, under certain conditions, may be eligible for preferential tax treatment. Communities are nominated by the states and approved by the Treasury Department as designated OZs.
OZs are designed to spur economic development by providing tax benefits to investors. First, investors can defer tax on any prior gains invested in a Qualified Opportunity Fund (“QOF”) until the earlier of the date on which the investment in a QOF is sold or exchanged, or December 31, 2026. If the QOF investment is held for longer than 5 years, there is a 10% exclusion of the deferred gain. If held for more than 7 years, there is a 15% exclusion of the deferred gain. Second, if investments in the QOF are held for at least ten years, investors are eligible for an increase in basis of the QOF investment equal to its fair market value on the date that the QOF investment is sold or exchanged. Importantly, investors do not have to live in the OZs in order to take advantage of the benefits; they need only invest a recognized gain in a QOF and elect to defer the tax on that gain.
Last week, the Treasury Department released the first set of proposed regulations and a related revenue ruling for OZs. The proposed regulations provide for the types of gains that may be deferred, the timing to invest such gains in QOFs, and the mechanism for selecting deferral of such gains. The proposed regulations also address self-certification of the QOF, valuation of QOF’s assets, and identification of OZ businesses.
Revenue Ruling 2018-29 addresses issues related to the qualification of an existing building and land in an OZ as OZ Business Property (“OZBP”). OZBP is tangible property used in a trade or business of the QOF (1) that is purchased by the QOF after December 31, 2017; (2) the original use of which commences with the QOF or the QOF substantially improves the property; and (3) during the QOF’s holding period, substantially all of the use of such property is in the OZ. OZBP is treated as substantially improved by the QOF if, during any 30-month period beginning after the date of acquisition, additions to basis exceed the adjusted basis of such property at the beginning of such 30-month period.
The Revenue Ruling notes that, given the permanence of land, land can never have its original use in an OZ commencing with a QOF. The Ruling then holds that, regarding an existing building located on land that is wholly within an OZ, the original use of the building in the OZ is not considered to have commenced with the QOF, and the original use requirement is not applicable to the land on which the building is located. Second, substantial improvement to the building is measured by the QOF’s additions to the adjusted basis of the building. Finally, measuring substantial improvement to the building does not require the QOF to separately substantially improve the land upon which the building is located.
The Treasury Department and IRS anticipate providing additional information, including additional legal guidance, on this new tax benefit over the next few months.
Angie Adolph is a partner in the tax and municipal finance groups at Kean Miller, LLP. She has extensive experience in bond transactions and in the development of Public-Private Partnerships and Cooperative Endeavor Agreements.