On October 19, 2018, the Internal Revenue Service released proposed regulations under Internal Revenue Code Subchapter Z – Opportunity Zones, which was added by the 2017 tax reform legislation and enacted on December 22.
Earlier this year, governors of each state were allowed to identify 25 percent of their states’ low-income census tracts as Qualified Opportunity Zones (QOZs). (Puerto Rico was allowed to identify all of its low-income census tracts as QOZs).
Through the Opportunity Zone Program, an investor is able to receive significant tax benefits that include: (1) a tax deferral for capital gains invested in a qualified opportunity fund; (2) forgiveness of up to 15 percent of the tax on the invested capital gain in the qualified opportunity fund where the investment is held for seven years; and (3) potential step-up in basis to fair market value and elimination of capital gains tax when disposing of a qualified opportunity fund investment, if the investment is held for 10 years or more.
The program is expected to infuse long-term capital through various investment vehicles into low-income communities, which is designed to promote economic growth.
The proposed regulations provide clarification on a number of questions posed since the creation of the program, including the following:
What type of capital gains qualify for deferral? Both short-term and long-term capital gains may be rolled into a QOZ.
Can partners and S-corporation shareholders elect to roll capital gains allocated to them on a K-1 into a QOZ? The new regulations allow the partnership or its partners to elect deferral. Similar rules are also applied to other pass-through entities such as estates, trusts and their beneficiaries, and S-corporations and their shareholders.
What is the “substantially all” test? The proposed regulations provide if at least 70 percent of the tangible business property owned or leased by a trade or business is a QOZ business property, the “substantially all” requirement regarding tangible business property is met providing other requirements are met as well.
How is the “substantial improvement” for a building measured? The proposed regulations provide if the “tangible property” is a building, the “substantial improvement” is solely measured on the basis of the building and does not include the underlying land.
How does a QOZ Fund self-certify? The IRS released Form 8996, which the QOZ Fund must use to self-certify as a Qualified Opportunity Fund.
What is “original use”? Separate from the proposed regulations, the IRS and the Department of the Treasury also released Rev. Rul. 2018-29, which provides guidance for taxpayers on the “original use” requirement for land purchased after Dec. 31, 2017 in QOZs.