A provision of the 2017 Tax Cuts and Jobs Act was the Investing in Opportunity Act, which allowed for the creation of Qualified Opportunity Funds (QOFs). In June 2019, the Atlanta Business Chronicle reported that the city had seen a flurry of activity in some of Atlanta’s 26 Opportunity Zones, including in the historic Fairlie-Poplar neighborhood and the West End Mall. Curbed Atlanta reported in January that the plan to develop the West End Mall into a mixed-use hub featuring offices, shops, eateries and homes has attracted investors and is moving forward. According to the real estate data service, Reonomy, since November 2017, 52 commercial and industrial properties have sold in Atlanta Opportunity Zones, funneling a total of $78 million in new capital to those areas.
As we explained previously, this gave investors a possible triple tax break: temporary deferral of tax on capital gains if they are invested in QOFs; a potential 10% reduction on those gains if they are held for at least five years in the fund; and permanent exclusion of tax on future appreciation inside the fund if held for at least 10 years.
QOFs enable investors to take advantage of the tax breaks by putting money into designated Qualified Opportunity Zones (QOZs). That investment must be made within 180 days of a sale or exchange that gives rise to capital gains.
In December 2019, the IRS finalized regulations about investment in QOZs. Among the important points:
Section 1231 assets
- Internal Revenue Code Section 1231 addresses the tax treatment of gains and losses of property used in a trade or business and held over one year. On the last day of a taxpayer’s tax reporting year, their gains and losses from the sale of Section 1231 assets are netted to determine if the taxpayer has a qualified loss or gain under the Section 1231 rule. Previously, a Section 1231 gain was allowed only after netting against Section 1231 losses, including any carryforwards from the past five years, and this calculation could only be done at year-end. The final regulations allow the gross Section 1231 gains to be included when the gain is recognized instead of having to wait until year-end. This allows for significant additional gains to be eligible for the QOZ benefits throughout the year in many cases.
- Previously, vacant buildings in QOZs could only satisfy the original use test if they had sat vacant for five years. The final regulations state that the one-year rule applies if the building was vacant before the Code Section applied (therefore vacant at least one year before 12/31/2017). If it became vacant after that time, then a three-year waiting rule applies.
- The final rule allows all qualifying property used in the same trade or business to be grouped together for the substantial improvement test, or where funds are used to improve the functionality of non-original use assets in the same or contiguous QOZ. The previous rules were unclear about aggregation. Two or more buildings may be aggregated for this test.
- The final regulations state that property not completed during the 30-month substantial improvement period will qualify as long as the original intent was to complete within the required time frame. This is important for the QOF or Qualified Opportunity Zone Business (QOZB) that may not fall under the working capital safe harbor approach. The final regulations provide that for QOFs and QOZBs, tangible property purchased, leased or improved by a trade or business that is undergoing the substantial improvement process but has not been placed in service or used in a trade or business by the QOF or QOZB is treated as used in a trade or business and satisfies the 30-month substantial improvement period with respect to that property.
- The final rules provide for a new 62-month safe harbor, as long as additional cash is invested in the QOZB and each investment independently satisfies the working capital safe harbor rules. The previous rules only allowed a 31-month safe harbor for the original investments. In any event, the maximum allowable safe harbor is 62 months no matter how many additional investments occur.
Capital Gain Exclusion
- The sale of QOZB property resulting in capital gain treatment is allowed to be excluded under the final regulations, if held for the requisite 10-year period. Because the sale of an equity interest, which is often a closely-held, non-marketable security, is usually more difficult than the sale of the underlying assets in the open market, the new rules allow for both to be excluded. Previously only the sale of the QOZ interest itself would have qualified.
There are many additional nuances to the final regulations that go above and beyond this article and these key points. Smith and Howard has been working with many businesses to help them understand the provisions of the Investing in Opportunity Act. To find out how your business can leverage the investment potential of qualified opportunity funds and qualified opportunity zones, please contact Chris Conrad or a member of our tax team.
Atlanta Business Chronicle, Jun 21, 2019 – https://www.bizjournals.com/atlanta/news/2019/06/21/atlanta-sees-flurry-of-activity-in-opportunity.html
Curbed Atlanta, January 21, 2020 – https://atlanta.curbed.com/2020/1/21/21074841/west-end-mall-atlanta-gravel-beltline-development-close