IRS Issues Opportunity Zone Regulations

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A prior Tax Alert discussed the Opportunity Zone program enacted under the Tax Cuts and Jobs Act last December. As it detailed, the multiple benefits of the new program include the deferral of tax on capital gains. On Friday, the IRS issued long-awaited proposed regulations making clear that almost all reportable capital gains qualify for the deferral. The proposals also cover deadlines for investing gains in a Qualified Opportunity Fund (QOF), how investors will elect to defer gain, and rules for the promotors of QOFs. A public hearing is scheduled for January, and additional regulations are expected.


Opportunity Zones were designed to spur investment in distressed communities throughout the US through tax benefits. Over 8,700 communities in all 50 states, the District of Columbia and five US territories were designated this summer as Qualified Opportunity Zones (see the complete list here).


Investing in a Qualified Opportunity Fund

The proposed regulations clarify that almost all capital gains that would otherwise be taxable before Dec. 31, 2026, can qualify for deferral if the gain is reinvested in a QOF within 180 days of the sale. The gain is deferred until the QOF is sold, or December 31, 2026, if not yet sold. The ordinary income portion of a sale, and any sales to related parties, are not eligible. The holding period and other attributes at the time of sale are preserved during the deferral period and taken into account when the gain is later included in income. Only the amount of the gain - not the entire proceeds of the sale - needs to be reinvested. An investor need not live, work, or have a business in an Opportunity Zone to take advantage of the tax benefits.


Capital gains realized by a partnership, S Corp, estate, or trust may be deferred either at the entity level or by its partners, shareholders, or beneficiaries. If an entity recognizes a capital gain and does not reinvest it in a QOF, its owner may do so with respect to its share.


Investors who hold their QOF investment for at least 10 years may qualify to exempt any gain on the fund when it is sold (losses on fund sales will be recognized). The potential gain on QOF sales is separate from the original deferred gain, which will be recognized by December 31, 2026 regardless. However, investors who hold the fund for enough time will receive a reduction of 10% (five years) or 15% (seven years) on the deferred gain. Also, if an entire QOF investment is sold and the funds reinvested in a different QOF, the tax on the original gain remains deferred.


Creating a Qualified Opportunity Fund

A QOF must be an entity taxed as a partnership or corporation and organized in any state, DC, or a US territory for the purpose of investing in Qualified Opportunity Zone property. A QOF must hold at least 90% of its assets in Qualified Opportunity Zone property. On Friday, the IRS released drafts of Form 8996 and its instructions, which investment vehicles will use to self-certify as a QOF. Form 8996 will also be used by a taxpayer to elect deferral of a capital gain.


Further information on Opportunity Zones may be found on the IRS's Frequently Asked Questions page. Please contact your LM Cohen professional if you have any questions about the new Opportunity Zone tax incentive or other aspects of the tax law. All our prior Tax Cuts and Jobs Act Alerts are available on the Updates page of our website.


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