The "Tax Cuts and Jobs Act" ("TCJA") passed by Congress in December 2017 included a new incentive designed to encourage investment in economically distressed geographic areas designated as Qualified Opportunity Zones ("QOZ"). Approximately 8,800 areas in the United States and U.S. territories have been designated as QOZs. These areas will retain the QOZ designation for 10 years.
The TCJA added Internal Revenue Code Sections 1400Z-1 and 1400Z-2 which allow taxpayers to defer or exclude capital gains that are invested in QOZ property. In October 2018, the Treasury Department issued Proposed Regulations that provide guidance on the requirements taxpayers must satisfy in order to comply with the QOZ rules.
The deferral of capital gains is available to individuals, corporations, partnerships, trusts, estates and certain other entities that reinvest those gains into a Qualified Opportunity Fund ("QOF"). A QOF is a partnership or corporation organized for the purpose of investing in QOZ property that holds at least 90% of its assets in QOZ property. Form 8996 should be filed by these entities to establish initial certification and to report annual compliance with the asset-based requirement. The investment in a QOF must be an equity interest and may not be a debt instrument.
Capital gain can be deferred if reinvested into a QOF within a 180-day period beginning on the date the gain would be recognized for federal income tax purposes without regard to these deferral provisions. Only the capital gain, and not the entire proceeds attributable to a sale, is eligible for deferral. The reinvested capital gain used to fund the investment in the QOF may be deferred until the earlier of the date of the sale of the QOF investment or December 31, 2026. Taxpayers make the election to defer recognition of capital gain reinvested in a QOF by filing Form 8949 with the tax return for the year in which the gain would be recognized without regard to these deferral provisions.
Taxpayers increase their basis in the QOF investment by the amount of the deferred gain that is eventually recognized. In addition, taxpayers may make a permanent exclusion election that allows the post-acquisition gain attributable to a QOF investment to be excluded from gross income if the QOF investment is held for at least ten years.
The Proposed Regulations were effective beginning on October 19, 2018. Following a public comment period, a public hearing regarding these regulations is scheduled for January 10, 2019. Taxpayers generally may rely on the Proposed Regulations until they are finalized by the Treasury Department.
The Qualified Opportunity Zone provisions provide a unique investment and planning opportunity for taxpayers that generate capital gain income. If you have or are considering undertaking a capital gain transaction or if you have any questions or require any additional information regarding the QOZ provisions, please do not hesitate to contact your Whitley Penn tax advisor.