The Tax Cuts and Jobs Act of 2017 (TCJA), enacted on December 22, 2017, includes a provision that provides tax benefits to investors that develop in Qualified Opportunity Zones (QOZs), which were created to stimulate economic development and job creation in distressed communities.
Part I of this seven-part series on QOZs provides an overview of the enactment of the TCJA, and defines QOZs, Qualified Opportunity Funds (QOFs), and Qualified Opportunity Zone Property (QOZP).
Enactment of TCJA
TCJA is tax legislation that affects individuals, businesses, and tax-exempt and governmental entities in a number of areas. For businesses, TCJA includes a miscellaneous provision that, until now, has garnered little attention. The provision, referred to as the Federal Opportunity Zone Program (the “Program”), allows taxpayers to defer payment of federal tax on capital gains from the sale of property if those gains are rolled into a QOF that invests 90% of its assets in businesses located or property used in a designated distressed community. Distressed communities are low-income areas with little economic stability that are disconnected from the growth taking place in other communities. For communities to qualify, the governors of each state had to submit for approval the areas they wished to receive the opportunity zone designation. Unlike previous efforts to encourage economic development in low-income communities, the Program takes a free-market approach that is not directly dependent on federal subsidies. There is no guaranty that an “opportunity zone” designation will attract investment into a particular community. Instead, developers and others involved in the management of private investment funds will generally determine where funds will be invested and the type of projects to be developed. The IRS is the authorized agency implementing the Program, now codified as Section 1400Z-1 and 1400Z-2 of the Internal Revenue Code.
QOZ, QOF, and QOZP Defined
QOZs are low-income census tracts that have been certified by the U.S. Department of the Treasury. To qualify as a QOZ, the tract must be designated as a low-income community under Section 45D(e),
- with a poverty rate of at least 20%, or
- with a median family income that does not exceed 80% of area median income, or
- contiguous with a designated low-income community and the median family income does not exceed 125% of the median family income of the contiguous designated low-income community.
Investments in these economically distressed areas, under certain conditions, may be eligible for preferential tax treatment on capital gains tax liabilities. Click here to access a list of QOZs. A nationwide map of QOZs can be found here.
QOFs, set up as partnerships or corporations, are vehicles for investing is QOZs. QOFs must hold 90% of its assets in businesses located or property used in a designated distressed community. To be eligible for the tax benefits associated with investing in QOZs, investors must roll capital gains from prior investments into a QOF within 180 of realizing the gain.
QOZP includes Qualified Opportunity Zone Business Property (QOZBP) and stock or partnership interests in a Qualified Opportunity Business (QOZB) in which substantially all of the tangible property is QOZBP. At least 50% of the QOZB’s total gross income must be derived from an active conduct of a qualified business. For real estate, QOZP must generally be new construction or “substantially improved,” meaning rehabilitation costs must exceed acquisition costs over 30 months following acquisition. QOZP does not include investments in golf or country clubs, racetracks and gambling facilities, suntan facilities, massage parlors or liquor stores. In addition, a QOF may not invest in mortgage pools or merely debt investments.
Part II of this series will outline the benefits of investing in QOZs and QOFs, including the Temporary Deferral Election and Permanent Exclusion Election, and will discuss the potential advantages of investing in a QOF as an alternative to investing in a 1031 Exchange.
Mr. Siglin focuses his practice on a broad range of business law matters involving corporate structuring, joint ventures, bond financing, syndication of equity, contract negotiation, regulation and compliance, tax credits, property tax exemptions, and real estate acquisition and development. He represents developers, lenders, investors, syndicators, real estate investment trusts, and other businesses and public sector entities. Mr. Siglin is experienced with utilizing federal and state Low-Income Housing Tax Credits (LIHTC) and tax-exempt bond financing to structure transactions; advising on debt and equity terms; negotiating development agreements and construction contracts; assisting with zoning and permitting; advising on compliance issues; counseling on state and local tax incentives; resolving complex tax issues; and providing wide-ranging federal and state tax advice.
Mr. Siglin served as an attorney advisor for the U.S. Department of Housing and Urban Development in Washington, D.C. for four years before entering private practice. He can be reached at firstname.lastname@example.org or 602.262.5842.