New IRS guidelines for Opportunity Zones are making a great deal, even better. It’s a program that provides three outstanding benefits for investors who put money into Qualified Opportunity Zones, and with the latest guidance, investors are ready to put their plans into overdrive. (1)
As we’ve described in previous podcasts and webinars, the Opportunity Zone program is designed to inspire investment in thousands of economically distressed areas across the country, including Puerto Rico and other US territories. The goal is to stimulate the local economy with long-term commitments to capital improvements and job creation. In return, investors will enjoy some amazing federal tax benefits.
This isn’t a brand new concept. Anderson Law Firm attorney Clint Coons on of our recent webinars said, “We oftentimes use the tax code to incentivize investment in certain areas. Remember the Gozone was one of those where they wanted people to go into certain areas that were hard hit by a hurricane and spur investment there to help rebuild it so tax incentives were provided. This is another extension of that. By creating these areas, we are looking to stimulate growth there.”
Review of Opportunity Zone Basics
Opportunity Zones were first introduced as part of the new tax code last year, although the program grew out of an effort during the Obama Administration, according to CPA Ryan Schellhous of IndigoSpire Advisors. It apparently got shelved, and was reintroduced during the writing of the tax reform package last year. Ryan told us that the basic rules for the program were added to the tax reform legislation at the last minute.
Here’s a review of those rules and investor benefits:
- Use money from any kind of capital gains including real estate, stocks, gold, art, and cryptocurrency.
- Within 180 days of that sale, place those gains into a Qualified Opportunity Fund that’s organized as an LLC or corporation for the purpose of Opportunity Zone investment.
- Defer any tax on those initial gains until you dispose of the Opportunity Zone investment.
- Receive a 10% reduction of the initially deferred gain if you hold the Opportunity Zone investment for 5 to 7 years.
- Receive a 15% reduction of the initially deferred gain if you hold the Opportunity Zone investment for more than 7 years.
- And here’s the best part: Receive complete 100% forgiveness of the gains on your new Opportunity Zone investment if you keep your money in the fund for at least 10 years.
- There are more than 8,000 Qualified Opportunity Zones to choose from.
- The deadline to invest is December 31, 2026.
IRS Clarifies Details on Opportunity Zones
So, what’s new?
The IRS released a 74-page document that helps shape this new program. (2) It helps clarify a lot of the details on how the program works, but these are still not the final rules. They are currently up for public comment, with final rules expected after that. Ryan says, “They’ll take general comments on the implementation of those proposed regulations and then publish something at the beginning of the year.”
The new details do shine a much brighter light on how the program will operate and what investors need to know — so much so that many investors are moving forward with their plans now. Here’s what we are learning:
- As long as the 180-day test is met, Investors will be able to defer gains realized in one year even if the investment in a Qualified Opportunity Fund occurs in the following year.
- Money from one capital gain transaction can be divided and placed into multiple funds.
- It appears that investors will also be able to switch their funds from one Opportunity Zone to another without a penalty. That detail hasn’t been totally clarified, however. The rules say the switch must be made “within a reasonable period” without specifying an exact time frame.
- Funds must be set up as a corporation or a partnership. That includes LLCs so long as they are treated like a partnership or a corporation and are not single-member LLCs.
- Tax deferral on the original gain begins immediately, from the day the gains are placed in the funds. Tax deferral is elective so file forms correctly in the year of the gain.
- At least 90% of the money in a fund must be invested into a business or land development. The 90% rule must also pass a compliance test twice a year.
- If you are investing in a business, and not property, 70% of the tangible assets of that business must be within the boundaries of the Opportunity Zone.
- Those 90/70% rules could, in some cases, result in a fund holding just 63% of the Opportunity Zone assets. Treasury officials are apparently okay with that.
- Investors who buy existing real estate must meet a substantial improvement requirement. That’s defined as an amount of money equal to or greater than the value of the existing property, minus the value of the land. Investors would need to figure out how to separate those two values, most likely with the help of an appraiser or cost segregation report.
- Investors can also put money into something that is brand new, with no substantial improvement requirement. According to Ryan, “You can buy something brand-new if its original use is with the owner of the qualified opportunity fund.”
- Opportunity Zone designations will last for just ten years, but investors can hold on to their investments within Qualified Opportunity Funds through the year 2038 without losing any of the tax deferral benefits.
Just to review one of my favorite parts of this program: You not only defer the gains on a current investment sale, you can put that money to use and get a discount on those gains, plus you can completely eliminate the gains on your new investment if you hold on to it for ten years. If you investment wisely now, in a project with the potential for big gains over ten years, the financial windfall could be substantial.
There’s a lot of enthusiasm for this program and many investors are analyzing their options. As Ryan told me, “I think there’s going to be a lot of diamonds in the rough, and low-hanging fruit so to speak.” He said, “There’s going to be some great opportunities… to find places across the street from the path of progress, but inside an Opportunity Zone.”
Ryan Shellhaus will be answering questions on Ozones at our upcoming live event. We’ll also be unveiling some of our plan of attack, this weekend in San Mateo on Saturday, and Los Angeles on Sunday. (3)
(2) IRS Document