August 27, 2018
Opportunity Zones were established in the US last year under the Tax Cuts and Jobs Act. An Opportunity Zone is a geographic area where government is seeking to stimulate private capital investment through tax incentives. This new community development program encourages long-term investments in low-income urban and rural communities nationwide. All 50 state governors have already nominated areas of their respective states for inclusion. The objective of the federal legislation is to encourage capital investment that will bring new jobs and economic vitality to these areas.
The investment opportunities in the Opportunity Zones will be through qualified “Opportunity Funds”, which are investment vehicles organized as corporations or partnerships with the specific purpose of investing in Opportunity Zone assets. These investment vehicles must hold at least 90 percent of their assets in qualifying “property” such as an operating business, equipment or real estate. To confirm an investment in a qualified Opportunity Fund, an eligible taxpayer self certifies by completing an IRS form which is submitted with their federal tax return.
There are several specific tax incentives for investors. First, an investor can defer a capital gain if they roll the proceeds within 180-days into a Qualified Opportunity Fund. Investors can defer these gains until the earlier of the date the Opportunity Zone asset is sold or exchanged, or December 31, 2026 which is over 8 years. Not only is there a deferral, but in certain cases 10-15% of the original gain can be waived provided the Opportunity Fund is held for more than 5-7 years. Most importantly, if the Opportunity Zone asset is held for at least 10 years, the investor can increase the Opportunity Fund cost basis to fair market value (no gain) on the date of sale or exchange and only pay 85% of the original capital gain (first gain) that was deferred prior to rolling the proceeds into the Opportunity Zone asset. As you can see, this community development program could be very beneficial not only for the Opportunity Zone but for the investor.
The Opportunity Zones are mostly in rural areas, but certain urban areas have also been included. In fact, the top 10 Opportunity Zones are in Oakland, Los Angeles, San Jose, San Diego, Seattle, Portland, Phoenix, Nashville, Atlanta, and New York City. For Atlanta, the Zones include the areas of Bankhead, Grove Park and English Avenue.
This new legislation could be a boom for all kinds of investors, provided the right opportunities present themselves. If a significant real property gain was invested in an Opportunity Zone, and held for more than ten years, much of the earnings would be sheltered through accelerated depreciation. Typically, this would result in a negative cost basis situation, but, in this case, the cost basis increases to fair market value at sale or exchange, and thus the capital gain is eliminated. Knowing these Opportunity Zones will be available for the next several years, we encourage you to consider the possible opportunities, and related tax incentives, in consultation with your tax adviser.
Gary B. Martin, CFA