The U.S. Treasury recently released guidance about opportunity zones established under last year's Tax Cuts and Jobs Act. An opportunity zone is an economically distressed community where new investments may be eligible for preferential tax treatment, according to the Internal Revenue Service. They were created to attract investment capital into areas that need it most. In return, investors are incentivized with tax benefits, varying based on the amount of time the capital remains invested in a qualified opportunity zone.
Developers are taking advantage of the opportunity zones to build hotels in areas where it might not have been feasible before.
CBRE recently broke down what U.S. investors need to know about these changes. Here are highlights from its report as well as from the IRS.
The Criteria
Governors in each state made recommendations for areas to be certified as QOZs. The first set of opportunity zones was designated on April 9, 2018, and covered 18 states. Now, all 50 states, the District of Columbia and five U.S. territories are covered, according to the IRS.
Of the census tracts in each state, 25 percent can be designated as opportunity zones, according to CBRE. The area must have at least a 20-percent poverty rate to qualify, and median income cannot exceed 80 percent of metro or state level. The designation of these zones remains through the end of 2028.
A list of QOZs can be found on the IRS website by clicking here (PDF).
To be a QOZ business, 50 percent of gross income needs to come from active conduct of business in an opportunity zone, according to CBRE. An opportunity fund can invest in an opportunity zone business directly or through a subsidiary. The verbiage states that “substantially all,” at least 70 percent, of tangible business assets need to be used in an opportunity zone. CBRE notes that most business will qualify, with golf courses, country clubs and gambling establishments being exceptions.
A QOZ business property must be a tangible property used in business, according to CBRE. This property must have been purchased after 2017 to qualify, and the original use must begin with the certified opportunity zone entity. Additionally, improvements equal to the cost of the building acquisition must be made within a 30-month period.
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Investors do not need to live in an opportunity zone to take advantage of the benefits, according to the IRS. All they need to do is invest in a recognized qualified opportunity fund and defer the tax on that gain. To become a qualified opportunity fund, Form 8996 needs to be filed with federal income taxes. A limited liability company can organize as a qualified opportunity fund, according to the IRS.
The Benefits
Under these new rules, investors can defer taxes on capital gains until 2026, and an unlimited amount of capital gains can be reinvested into an opportunity fund. Capital must be placed in an opportunity fund within 180 days, according to CBRE’s report.
Investments upheld for at least five years by the end of 2026 can qualify for a reduction of 10 percent of deferred capital gains tax liability for the original capital gain.
“If the gain has been invested in an opportunity fund for seven years by the end of 2026, the tax liability on the original gain is reduced by 15 percent. Consequently, in order to take advantage of at least some of these benefits, capital gains must be reinvested by the end of 2021,” the report notes.
Looking beyond these five- and seven-year periods, gains from investments become tax free after at least 10 years, but this doesn’t include the original gain invested in the QOZ and applies to assets held until 2047.