An Opportunity Fund investment must make sense for the specific situation.
CCBJ: Tell us about the Qualified Opportunity Zones, a provision of the Tax Cuts and Jobs Act of 2017.
Stephanie Hines: The Qualified Opportunity Zone provision was designed to promote local economic development, promising to provide economic growth to distressed areas across the country and U.S territories. The provision has potential to be a win-win situation for both investors and the communities that have been designated as Qualified Opportunity Zones.
How are you advising clients on the best ways to take advantage of it?
We are definitely speaking about this topic on a consistent basis and are working with our clients to ensure that their investment into a Qualified Opportunity Fund makes sense for their specific situation. Our discussions consider the current deferred and potential exclusion of tax on capital gains, as well as understanding that in order to maximize the benefits, there are required holding periods. If our client’s interest is in forming a fund, we are advising on fund structures and how to adhere to the guidelines of qualifying as an Opportunity Fund under the recently released proposed regulations, with the understanding that additional guidance is expected.
What are the three tax benefits of investing in the Qualified Opportunity Zones?
The three tax benefits of investing in Qualified Opportunity Zones are 1) temporary deferral of tax on capital gains 2) elimination of up to 15 percent of the tax on the deferred capital gain and 3) potential exclusion from tax on the gain generated from the appreciation of investments within the Qualified Opportunity Fund.
The provision has potential to be a win-win situation for both investors and communities.
How are Qualified Opportunity Zones and Qualified Opportunity Businesses defined?
The IRS defines a Qualified Opportunity Zone as an economically distressed community identified by the respective states. Identified zones have been certified and, qualifying investments within each zone, have potential to receive preferential tax treatment on certain capital gains.
A Qualified Opportunity Business is a trade or business in which substantially all of the tangible property is owned or leased in Qualified Opportunity Zone Business Property and at least 50 percent of the gross income is derived from the active conduct of the trade or business within the Qualified Opportunity Zone. It is important to note that there are certain “sin” businesses (golf course, country club, gambling facilities, or any store where the principal business relates to the sale of off-premise alcohol consumption) that are excluded from the definition of a Qualified Opportunity Business.
Can you give us an example or scenario as to how this type of investment could play out?
Let’s say that, on August 1, 2018, you invest capital gain of $500,000 in a Qualified Opportunity Fund (QOF). Assuming that you still hold the investment in the QOF on December 31, 2026, which is the seven- (7-) year holding period required to qualify for the 15 percent exclusion on the deferred capital gain, you would recognize $425,000 of capital gain (85 percent of the originally invested $500,000 of capital gain). If you sell your interest after December 31, 2026, and prior to August 1, 2028,you will recognize the gain to the extent it exceeds the original investment of $500,000, as the 10-year required holding period to exclude capital gain on appreciation was not met. However, if you sell your interest on or after August 1, 2028, exceeding the 10-year required holding period, you will make an election to make the FMV the original basis and will not recognize gain on the appreciation of the original investment.
Stephanie Hines is a partner with EisnerAmper in its personal wealth advisors group and she heads up the firm's Qualified Opportunity Funds practice. She has more than 15 years of tax compliance and consulting experience. Reach her at [email protected].
Published January 3, 2019.