Little Known Tax Change Prompting Big Buzz

by: Smith and Howard

August 15, 2018

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It’s been almost eight months since the Tax Cuts and Jobs Act was signed into law. There’s been no shortage of analysis about its downstream effects, but one of the bill’s most important features has not received the attention it deserves. It’s an opportunity to defer taxes, invest, and potentially reap new benefits that can bring fresh growth to some of our under-served communities. The Investing in Opportunity Act allows for the creation of “Qualified Opportunity Funds,” or “QO-Funds” to serve as vehicles for unprecedented community revitalization through the deferral and potential exclusion of capital gains.

“A lot of people aren’t aware of this yet,” said Chris Conrad, Senior Manager with Smith and Howard, “but we are starting to see some traction. People have a lot of questions and we want to help get them answers.”

Forbes calls this new provision of the tax code a “triple play tax break” because it provides investors three ways to realize benefits from capital gains. First, it allows for deferral of taxes on 2018 capital gains invested in QO-Funds until the earlier sale of the fund interest or 2026 (but doesn’t require full investment of all gains). Second, it provides for a potential 10% reduction on those gains if they are held for at least five years in the fund and an additional 5% reduction if held at least seven years. Finally, it provides for the exclusion of any future appreciation after investment in the fund via tax-free growth, like a Roth IRA, as long as it is held for 10 years.  The last piece is where a lot of potential investors’ eyes light up.

“There’s no cap on the amount that can be invested,” Conrad said, “just a sunset. It all goes away after December 31, 2026.”

It’s all about the QO-Zones

Nationwide, some 8,700 “Qualified Opportunity Zones,” or QO-Zones, have been designated by states. Qualified opportunity zones have a poverty rate of 20% or higher or a median household income that is less than 80% of the surrounding area. To take advantage of the tax breaks, investors may put money into the designated QO-Zones only through Qualified Opportunity Funds. That investment must be made within 180 days of realizing their capital gains.

The fund may be a domestic corporation or partnership. Investors receive stock or an interest in the fund, which invests directly in QO-Zone business property, which must be tangible property and thus no investments in intellectual property will qualify.  According to the Georgia Department of Community Affairs, 260 Opportunity Zones stretching across 83 counties have been named in Georgia. They’re located in both urban and rural areas and will hold their designations for 10 years.

“Some of these zones aren’t that far away from places people are already doing business,” said Conrad. “They include Chamblee, places close to Atlantic Station and Georgia Tech, and areas toward the airport.” (An interactive map of designated QO-Zones in Georgia and more information from the Georgia Dept. of Community Affairs can be found here).

QO-Zone investments will have a wide variety of purposes and appearances. They will provide the capital to invest in new real estate developments, build or rebuild stores and offices, start new businesses, and spark community revival along the way. At least that’s the goal.

“This could potentially revive a neighborhood or city center,” Conrad said. “An investor can defer their tax now and potentially get a tremendous amount of tax-free gain if they hit a home run.” Conrad adds that some businesses are excluded from eligibility in the fund. “No golf courses or country clubs, and the ‘sin businesses’ are kicked out.”

The fine print

Funds must abide by some stringent rules, including that substantially all the fund’s assets must be located in the zone, the fund must receive at least 50% of their gross receipts from active trades or business within the QO-Zone, and that no “shell corporations” with only an address in the zone are allowed. A physical presence with a real stake in the impoverished area is required.

But what if the scenarios for rosy outcomes don’t materialize?

“Obviously there’s a flip side,” said Conrad. “It’s not just the tax incentive that’s involved. If something doesn’t go well, you’ll get those losses, but there is potential risk at losing your investment and still paying tax on the gains down the road. There are concerns about gentrification, raising the prices to where the local residents can’t afford it and forcing them to go somewhere else. That’s top of mind.”

The IRS has promised more information about the fine details of this tax opportunity in the summer of 2018. With September in sight, and while we wait for those clarifications to drop, Conrad recommends we “get busy now.”

“If you want to get the basic increases of five and ten percent, be ready to invest by 2019. There are still a lot of questions and we can’t get investments off the ground until they’re answered, but we’re staying on top of it.”

To learn more about opportunity funds, contact Chris Conrad  or any Smith and Howard tax professional at 404-874-6244 or fill out the contact form below. 

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