The 2017 Tax Cut and Jobs Act created the federal Qualified Opportunity Zone (QOZ) program that offers flexible tax savings and diversification tools for taxpayers generating large capital gains. The goal of the program is to spur investments in economically challenged areas in order to promote business growth and economic revitalization, thereby providing social, community, and individual resident benefits. Individuals, C and S Corporations, REITs, partnerships, trusts, and other pass-through entities can sell their appreciated capital assets (both short-term and long-term) and elect to reinvest all or a portion of the capital gain income into Qualified Opportunity Funds (QOF).
To participate in the QOZ program, the taxpayer must generally roll all or a portion of their short-term or long-term capital gain into a QOF within 180 days of the recognition date of the gain. However, final regulations extend that period under certain fact patterns. The QOF must then timely invest the deferred gains into undeveloped or developed real estate, a new or existing QOZ-based business, or other qualified QOZ property.
How it Works:
A taxpayer investing $1,000,000 of deferred tax gain into a QOF on June 30, 2018, will start with a $0 tax basis in the QOF since the gain has not been recognized. On July 1, 2023, after meeting the 5-year holding requirement, the taxpayer will receive a 10% step-up to $100,000, leaving $900,000 of deferred tax gain; on July 1, 2025, the 7-year step-up of an additional 5% will bring the cumulative tax basis to $150,000 and lower the deferred gain to $850,000. On December 31, 2026, or an earlier disposition, the deferred gain of $850,000 will be includable in the taxpayer’s 2026 tax return, and their QOF tax basis will then be $1,000,000 ($150,000 basis step-up plus the $850,000 deferred gain recognized).
Once the investor has held the QOF for at least ten years, the tax basis in the QOF will fluctuate with the changing fair market value, and the taxpayer can elect to exempt the post-investment federal tax gain upon disposition for as long as 2046 – allowing decades of potential tax-free appreciation.
The IRS Notice 2020-39 (summarized below) provides answers about Coronavirus-related extensions and other tax reliefs for QOFs and Investors.
For questions, reach out to our Opportunity Zone Team:
Blake Christian, (435) 200-9262, Blake.Christian@hcvt.com
Ryan Mark | 310.566.6803 | Ryan.Mark@hcvt.com
Alejandra Lopez | 562.216.5516 | Alejandra.Lopez@hcvt.com
Gina Ballard | 562.216.1809 | Gina.Ballard@hcvt.com
Abi Yanke | 435.200.9267 | Abi.Yanke@hcvt.com
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Relief for Qualified Opportunity Funds and Investors Affected by Ongoing Coronavirus Disease 2019 Pandemic
The key components of Notice 2020-39 (issued 6/04/2020) are listed below:
- This notice extends the termination date of the 180-day reinvestment period. The termination of the 180-day reinvestment period would otherwise end between April 1, 2020, and December 31, 2020, will now have until December 31 to fund the Qualified Opportunity Fund (QOF). The prior COVID extension was July 15, under Notice 2020-23.
- There are significant 2019/2020 long-term tax planning opportunities and a unique situation where a taxpayer might file a return (current extended due date – October 15) before funding their QOF. Amended returns will be allowed if the taxpayer had not estimated the funding amount before filing their return.
- This extension will avoid complications associated with the early adoption of the Final Regulations for taxpayers with pre-March 15th, 2020 gains.
- The 30-month “Substantial Improvement” test (i.e., doubling of basis) is extended to at least 39 months (the regular April – December 2020 period is essentially frozen). Additional COVID-related extensions may also be available under the Opportunity Zone (OZ) Regulations.
- Failure to meet the 90% qualified asset test at the QOF level during any testing period falling in the April 1 – December 31, 2020 period is effectively ignored although IRS Form 8996 must still be completed and filed.
- Working Capital Safe Harbor period will also be extended from 31 to 55 months. Presumably, the 62-month period will also get extended to 86 months, but not confirmed.
- Lastly, Notice 2020-39 reinforces that any distributions and/or sale of partnership interests or QOF stock received by QOFs will have 12 extra months to reinvest in a manner consistent with pre-COVID-19 pandemic intentions. This extension also includes proceeds from the sale of QOF stock, Qualified Opportunity Zone Business Property (QOZBP), or partnership interests.
- Such property will retain its QOZBP status during that period. Tax gains during this period will still be taxable.