Opportunity Zones Update: Exploring Tax Benefits for Real Estate Investors

In today's ever-changing economic landscape, real estate investors are constantly seeking opportunities to maximize their gains while minimizing tax liabilities. One such opportunity that has gained significant attention is the Opportunity Zone Tax Incentive. Introduced as part of the Tax Cuts and Jobs Act of 2017, this incentive offers tax breaks to real estate investors who make long-term investments in distressed communities, known as Qualified Opportunity Zones (QOZ). In this article, we will delve into the intricacies of the Opportunity Zone program and the tax benefits it provides.

How the Opportunity Zone Program Works

After selling an appreciated asset, an investor generally has 180 days to move capital gains into a Qualified Opportunity Fund (QOF). A QOF is an investment vehicle that holds at least 90 percent of its assets in a Qualified Opportunity Zone Property (QOZP), which typically represents a stock or partnership interest in, or a direct investment in, a Qualified Opportunity Zone Business Property (QOZBP).

There are three primary tax benefits for investing capital gains into a QOF:

  1. Temporary Deferral on Initial Capital Gains Tax Payment: The capital gains tax owed on the reinvested capital gains is deferred until the QOF investment is sold or exchanged, or until December 31, 2026, whichever comes first.

  2. Partial Exclusion of Initial Capital Gains Tax Liability: If the QOF investment is held for at least five years, there is a 10 percent exclusion of the deferred capital gain.

  3. Elimination of Future Capital Gains: If the QOF investment is held for at least 10 years, the investor has the potential to eliminate any tax owed on the appreciation of the QOF investment if the QOF investment is subsequently sold.

Key Takeaways from Final Regulations

The program's proposed regulations initially created uncertainties and questions regarding its implementation. However, after receiving feedback from the public, the U.S. Department of Treasury and Internal Revenue Service issued final regulations, providing much-needed clarity. Here are some key takeaways:

Eligible Gain

As a general rule, the program only allows deferral of capital gains that are subject to United States federal income tax. Ordinary income, such as money sitting in a savings account, does not qualify. The final regulations outline the type of gains eligible for deferral when reinvested into a QOF within a 180-day reinvestment period.

Inclusion Events

Any gain arising from an inclusion event, such as the termination or change in classification of a QOF's status, is eligible for deferral into a new QOF. A full list of events and additional rules can be found in the final regulations.

"Sin Business" Narrowly Permitted

The final regulations allow a Qualified Opportunity Zone Business (QOZB) to lease up to 5 percent of its property to prohibited "sin businesses." However, a QOZB may not engage directly in any of such sin businesses.

Original Use of Tangible Property

Original use commences when a QOF or QOZB places into service property in a QOZ for purposes of depreciation or amortization. The final regulations include exceptions for self-constructed property, vacant property, brownfield sites, and leased property.

Substantial Improvement Test

The final regulations modified the substantial improvement testing, allowing aggregation of property and buildings for the test. This simplifies the process for investors.

Safe Harbors

The final regulations offer additional rules and expansions of previous safe harbors, including those related to gross income, working capital, and QOF 90 percent testing.

10-Year Exit

Investors holding QOF investments for at least 10 years have the opportunity to exclude all gain from the sale of QOF assets, offering a significant tax advantage.

Conclusion

Investing in Opportunity Zones is not just about seeking tax benefits. It's also about contributing to the revitalization of historically low-income communities. To determine if this program is right for you, it's crucial to consult with investment and tax professionals and thoroughly understand the final regulations. When you're ready to move forward, Old Republic Title is here to assist you with your title and escrow needs.

For more information about the Opportunity Zone program, visit the U.S. Treasury Department's Opportunity Zone Resources web page.