Press Room: Tax Release
Treasury Releases Proposed Regulations on Qualified Opportunity Zones
Treasury and IRS have released the first set of proposed regulations on the new Qualified Opportunity Zone (QOZ) tax incentives created by the Tax Cuts and Jobs Act (TCJA). The proposed regulations clarify many of the open issues that were not adequately addressed by the statutory language, including the type of gains that are eligible for deferral, the time by which amounts must be invested in Qualified Opportunity Funds (QOFs), and the manner in which investors may elect to defer eligible gains. In addition to the proposed regulations, Treasury and IRS issued a revenue ruling on the original use requirement for land purchased after 2017 that is wholly within a QOZ and a draft form for investment vehicles to use in certifying themselves as QOFs.
What Are Qualified Opportunity Zones?
The TCJA created a new tax incentive aimed at attracting investments in low-income communities and designated contiguous census tracts certified by Treasury as QOZs. A taxpayer who invests capital gain from an actual, or deemed, sale or exchange into a QOF can defer the payment of tax on the gain until 2026. A QOF is any corporation or partnership organized for the purposes of investing at least 90% of its assets in QOZ Property (a defined term).
The potential tax benefits associated with the new incentive include:
- Deferral of tax on all gains invested in a QOF until 2026,
- Potential elimination of tax on up to 15% of the gains invested in a QOF, and
- Elimination of tax on all gains earned above the amount invested in a QOF.
The proposed regulations clarify that only capital gains for federal income tax purposes are eligible for deferral. There was some prior confusion regarding whether Congress intended both ordinary and capital gains to be eligible for the deferral since capital is not included in the body of the statute. The proposed regulations further provide that gain to be deferred must be gain that would be recognized if deferral under the QOZ provisions were not permitted. In addition, the gain must not arise from a sale or exchange with a related person, as defined in the QOZ provision. Individuals, C corporations, partnerships and certain other pass-through entities are eligible for deferral under the new QOZ incentive. The proposed regulations provide special rules for partnerships and other pass-through entities, and for taxpayers to whom these entities pass through income and other tax items. If a partnership does not elect to defer eligible gains, its partners may elect to defer their allocable share of such gains, provided that the other necessary requirements are met.
With respect to the time that amounts must be invested in QOFs to qualify for deferral, the proposed regulations provide that a taxpayer must generally invest in a QOF during the 180-day period beginning on the date of the sale or exchange giving rise to the gain. Where a later sale or exchange triggers an inclusion of deferred gain, and the taxpayer makes a qualifying new investment in a QOF, the taxpayer may elect to defer the inclusion of the previously deferred gain as long as certain specified circumstances are met. Specifically, the taxpayer must have disposed of its entire QOF investment.
Further, the proposed regulations provide that the first day of the 180-day period is the date on which the gain would be recognized for federal income tax purposes. This is significant where special provisions within the Internal Revenue Code specify a deemed date that a sale or exchange transaction occurs. Thus, for eligible gains from a partnership, the 180-day period generally begins on the last day of the partnership’s taxable year, but the partner may elect to use the partnership’s 180-day period. Comments are requested as to whether the final regulations should contain exceptions to the 180-day general rule and what other additional circumstances could be clarified by future regulations.
The proposed regulations clarify the ability of a taxpayer that holds a QOF investment for at least 10 years to increase the basis of the investment to the fair market value of the investment on the date that the investment is sold or exchanged. The proposed regulations further provide rules for the certification of investment vehicles as QOFs. Corporate and partnership taxpayers are generally permitted to self-certify as a QOF and draft Form 8996, Qualified Opportunity Fund was released contemporaneously with the proposed regulations for this purpose. Additional rules for QOFs are provided in the proposed regulations, including guidelines for designating when a QOF begins, whether pre-existing entities may qualify as QOFs, and the application of the asset test that requires QOFs to undergo testing to determine whether the entity holds at least 90% of its assets in QOZ Property.
Rev. Rul. 2018-29
Treasury and IRS also released Rev. Rul. 2018-29 to address the substantial improvement requirements of a QOF that buys an existing building on land wholly located in a QOZ and whether the original use of the building or land can be considered to have commenced with the QOF. In general, the original use of an existing building on land wholly in a QOZ is not considered to have commenced with the QOF, and the substantial improvement to the building is measured by the QOF’s additions to the adjusted basis of the building. Rev. Rul. 2018-29 holds that the substantial improvement requirement does not apply to the land. Another set of proposed regulations on QOZs is expected later this year to address more detailed questions about the ongoing operations of a QOF, including whether a QOF can buy and sell assets over its lifetime.
The proposed regulations provide clarity with respect to some aspects of the new QOZ tax incentive including the types of gains that may qualify for deferral, the time by which amounts must be invested in QOFs, and the manner in which investors may elect to defer gain. Guidance on which projects will qualify for the new tax incentive are also discussed in the proposed regulations, as well as some general rules for electing and maintaining status as a QOF. Needed guidance regarding the operation of QOFs was not addressed in the proposed regulations but is expected to come in future proposed regulations.
For more information please contact your Andersen Tax advisor.