By Olivia Piluso and Michael Iakovou
Introduction of Qualified Opportunity Zone Investments
Qualified Opportunity Zones (“QOZ”) are low-income communities which are designated by either the Governor or the Secretary of Treasury. QOZ’s are designed to stimulate economic development and promote job creation. The Qualified Opportunity Zone program was originally created by the Tax Cuts and Jobs Act. The goal of this program is to give investors preferential capital gains treatment so that they invest in low-income and under-developed communities.
Capital gains arise during a sale or exchange of an asset which results in a monetary gain. Under this program, any investor that sells appreciated assets can defer paying capital gains tax by reinvesting their gains in a Qualified Opportunity Fund (“QOF”). Therefore, to qualify for the QOZ program, an investor needs to invest in a QOF. An investor who invests in a QOF will receive preferential treatment of capital gains, including (1) temporary tax deferral; (2) avoidance of additional capital gains taxes; and (3) step up in basis; in this context, basis is the amount of a taxpayer’s investment in property. Therefore, a step up in basis – also referred to as “stepped up basis” –is when an asset acquired in a transaction is of a higher market value than when the original owner purchased the asset.
Flow Chart of a Qualified Opportunity Zone Investment
First, an investor must realize capital gains from the sale or exchange of a property. The investor must invest cash or property into an equity interest of a QOF within 180 days of realizing the gain.
In order to qualify for a Qualified Opportunity Fund the following criteria must be met:
- must be a domestic entity but not a single member LLC;
- must be formed for the purpose of investing in a QOZ;
- must elect to be treated as a QOF as of 2018 or later; and
- at least 90% of the assets must be a QOZ property, which is based on semiannual testing dates.
If there is a newly issued corporate stock or partnership interest in an entity that conducts Qualified Opportunity Zone Business (“QOB”), then the QOB must meet the following criteria:
- 50% of the gross income is from the active conduct of a trade or business in the QOZ;
- at least 70% of its tangible property is QOZ Business Property;
- at least 40% of its intangible property is used in the active conduct of a trade or business in the QOZ;
- the Qualified Opportunity Business does not operate or lease more than a de minimis amount of property to a “sin” business – a business involved in, or associated with, an activity that has been deemed unethical or immoral, usually relating to alcohol, tobacco, gambling, sex-related industries, and weapons manufacturers – listed in the statute; and
- less than 5% of the average unadjusted basis of its property is held in nonqualified financial property, subject to working capital safe harbor. Working capital safe harbor is when cash is not treated as a non-qualified financial property if (i) a QOF has a written plan and schedule to invest cash within 31 months or (ii) working capital is spent in substantial compliance with plan, subject to delay for government action and 24-month extension if in a federal disaster area.
If purchased or leased tangible property is used in a Qualified Opportunity Zone, then it is considered a Qualified Opportunity Zone Business Property. A Qualified Opportunity Zone Business Property is split into purchased tangible property and leased tangible property.
Purchased tangible property is property that must be purchased from an unrelated party after 2017, and 70% of the property must be in a Qualified Opportunity Zone during 90% of the Qualified Opportunity Zone’s holding period of the property. The land qualifies as a zone business property if it is used in a trade or business not held for investment purposes.
Leased Tangible Property is when a lease – at market rate – must be entered into after 2017, may be between related parties, and 70% of the use of the leased property must be in a QOZ during 90% of the lease term. Furthermore, there must be no plan, intent or expectation that lessee will purchase the real property for less than the fair market value.
Qualified Opportunity Zone Tax Benefits Timeline
Once the sale or exchange of the property occurs, then capital gain is realized. The deadline to reinvest capital gains in a Qualified Opportunity Fund is 180 days from the sale date. After five (5) years from the Qualified Opportunity Fund Investment Date, the tax basis in investment increases by 10% of the capital gain amount. After seven (7) years from the Qualified Opportunity Fund Investment Date, the tax basis increases by an additional 5% of the capital gain amount. If the Qualified Opportunity Fund has been held for at least ten (10) years, then the investor can step up the tax basis to the fair market value of interest on the date sold or exchanged.
For more information on any aspects of qualified opportunity zone investments covered above, or for specific advice on your particular situation, reach out to our knowledgeable transactional attorneys here at KI Legal.
 If a pre-existing entity elects to be a QOF then only the assets acquired after 2017 counts towards 90% of the test; investments received six months before a testing date may be excluded from calculations if it is held in cash, cash equivalents or short-term debt in interim; and sale proceeds from a QOZ property can be considered as a QOZ property within 12 months if held in cash, cash equivalent or short term debt in interim
*PRIOR RESULTS DO NOT GUARANTEE A SIMILAR OUTCOME*
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