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Tax Incentives for Federal Opportunity Zones Clarified

by Tom Branham, Washington D.C., May 2019

 

Analysts believe 2019 will be a banner year for real estate investors wanting to take advantage of the new Federal Opportunity Zones tax incentive created by the 2017 Tax Cuts and Jobs Act. Treasury Secretary Steven Mnuchin estimates that private businesses will invest $100 billion in Opportunity Zones this year.

 

The latest proposed regulations provide guidance under new a section of the Internal Revenue Code relating to gains that may be deferred as a result of a taxpayer’s investment in a Qualified Opportunity Fund (QOF), as well as special rules for an investment in a QOF held by a taxpayer for at least 10 years.

 

Who Qualifies?

 

Prior to the second set of regulations, no one really knew how businesses like startups headquartered in designated opportunity zones would benefit from the federal program.

 

The newly-released guidelines clarify that a business funded by a qualified opportunity fund and located in an opportunity zone can benefit if it meets one of three safe harbors:

 

1.

 

The management and operations are based in the designated zones.

2.

 

Half the company’s services are within the area.

3.

 

At least 50% of the hours that employees or contractors work are spent within the opportunity zone.

 

Reinvestment Rule

 

In the first set of regulations, the government mentioned there would be some type of mechanism allowing investors to recycle capital upon sale of a designated opportunity zone investment.

 

Qualified opportunity funds will now have a one-year grace period to sell assets and reinvest the proceeds into another opportunity zone investment.

 

Determining the Zone

 

The federal government received a lot of questions concerning what happens if a property, like a retail complex, straddles the area between an opportunity zone and a neighboring non-opportunity zone.

 

Officials cleared this up by saying if the majority of a property (based on square footage) is located within a qualified opportunity zone compared to the amount of its property outside the zone and it is contiguous to the real property inside the zone, then all the property qualifies.

 

Substantial Improvement Provision

 

Prior to the second set of regulations, investors who acquired property in an opportunity zone would be required to meet a substantial improvement provision by providing upgrades to the property.

 

Under the new regulations, a building or other structure that has been vacant prior to being purchased by a qualified opportunity fund will satisfy the original use requirement so an investor will not need to meet the substantial improvement provision.

 

No Triple Net Leases

 

The regulations required that businesses taking advantage of the opportunity zone program be active. The regulations clearly state: “The ownership and operation (including leasing) of real property is the active conduct of a trade or business. Merely entering into a triple-net-lease with respect to real property owned by a taxpayer is not the active conduct of a trade or business.”

 

Additional Public Comment Sought

 

The Treasury Department and the IRS are again soliciting comments and suggestions from the public on the proposed guidelines. A hearing is currently scheduled for July 9 and the guidelines are expected to be finalized later this summer.