IRS proposed regulations and a related revenue ruling clarify the type, timing, and tax deferral provisions for maximizing the tax benefits of a Qualified Opportunity Zone (Zone) investment. The earlier a taxpayer invests in a Zone, the greater potential step-up in tax savings.
The IRS issued proposed regulations and a related revenue ruling addressing the treatment of new investments in a Qualified Opportunity Zone (Zone), a tax incentive program mandated in the Tax Cuts and Jobs Act (IRC Sec. 1400Z-1 and 1400Z-2). The guidelines clarify the type of gains that may be deferred and invested in Zones; time frames for investing gains and obtaining tax benefits; rules addressing the tax deferral, and more.
Zone investments offer both a temporary deferral and partial exclusion of taxable gains in exchange for investing in a low-income community or Zone. Taxpayers have 180-day window to invest a gain in a Zone to qualify for deferral.
With the type, timing, and tax deferrals set in the proposed rules, it’s a good time for investors to work with their advisors to time a sale or exchange that triggers a gain to get the greatest tax benefits from Zone investments. The gain must be recognized on the earlier of i) the date on which the investment is sold or exchanged, or ii) Dec. 31, 2026, to maximize the length of the deferral and incentives. Taxpayers that miss the 8-year window can still elect the permanent exclusion if the investment is held longer than 10 years.
The program encourages taxpayers to invest in underfunded communities (see New in 2018: Opportunity Zone Investments) by providing them with three tax incentives.
- Defer recognizing a capital gain for up to eight years for gains re-invested in a Zone. Deferred gains will be recognized either when Zone interest is sold or, at the latest, December 31, 2026. This means the earlier you invest in a Zone, the greater the tax savings.
- Exclusion of up to 15 percent of original gain when the Zone investment is held for specified time periods.
- An exclusion of the gain eventually recognized from Zone investments that are held for at least 10 years.
The proposed regulations clarify who is an eligible taxpayer and who isn’t. Individuals, partnerships, corporations, estates, trusts and others are eligible taxpayers.
The proposed regs further provide that only capital gains invested in a Qualified Opportunity Fund (Fund) are eligible for tax deferral. Qualifying funds are any partnership or C corporation organized to make investments in Zone property. Investors must reinvest gains in a Fund within 180 days of the recognized gain to qualify for a tax deferral. In turn, the Fund must hold at least 90 percent of its assets in Zone stock, partnership interests, or property.
What’s the savings
Tax savings step-up based on how long the Fund investment is held.
- Investors who hold their Fund investment for five years can see 10% of the deferred gain permanently excluded.
- Holding the investment for seven years would exclude another 5% of the deferred gain.
- Investments held for at least 10 years qualify to increase their basis to the fair market value of the investment on the date it is sold, meaning none of the appreciation beyond the deferred gain is recognized as long as the investment is sold before December 31, 2047.
Timing the investment
Taxpayers with capital gains from a sale occurring between December 22, 2017 and January 1, 2027 should consider this tax saving investment. The earlier, however, a taxpayer invests in a Zone, the greater the potential step-up in tax savings.
Time a Zone investment to get the most out of these tax savings. If you are a taxpayer with a large capital gain in 2018 or expect a gain before January 1, 2027, let’s sit down and see whether the timing of this investment vehicle might be right for your portfolio.
More information on Opportunity Zones is on the Tax Reform page of IRS.gov.
Click here for complete list of Opportunity Zones.
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