You may have heard about many of the Tax Cuts and Jobs Act (TCJA) provisions in the news, however Qualified Opportunity Zones (QOZs) have managed to stay out of the spotlight. QOZs were created to provide tax incentives to taxpayers who invest in distressed communities. These QOZs are high-poverty, low-income population census tracts.
After the passage of the TCJA, the Governors of every state sent their census tract nominations to the Treasury Department for QOZ designation. As of June 2018, the Treasury Department designated QOZs in all 50 states. There are over 8,000 QOZs nationwide, with 103 located in Arkansas.
QOZ Funds
QOZs allow taxpayers the ability to defer capital gain from the sale of real or personal property. To qualify for capital gain deferral, taxpayers must invest their capital gain in a QOZ Fund no later than 180 days from the date of the sale. The sale must not be to a related party.
The QOZ Fund is a partnership or corporation created to hold at least 90% of its assets in QOZ property and files a self-certification form with the IRS each year. The QOZ Fund must either purchase new property inside the zone, or substantially improve existing property inside the zone.
Advantages of the QOZ Program
The attractive advantages of the QOZ program are:
- Deferral of capital gain
- Capital gain invested in a QOZ Fund is deferred until the earlier of: the date the investment is sold, or December 31, 2026.
- Partial forgiveness of capital gain by means of
a basis increases
- Capital gain invested in a QOZ Fund is partially forgiven if certain holding periods are met. If the investment is held in the QOZ Fund for at least five years, then 10% of the gain is forgiven by increasing the taxpayer’s basis by 10%. If it is held for at least 7 years, an additional 5% of the gain is forgiven by increasing the taxpayer’s basis by another 5%.
- Forgiveness of additional future gains by way of
a basis increase
- If the capital gain is invested in a QOZ Fund for more than 10 years, then the taxpayer’s basis in their QOZ Fund investment will equal the fair market value on the date of sale.
A QOZ Example
An example of the mechanics of this can be illustrated as follows:
A taxpayer sells appreciated Fortune 500 stock on July 15, 2018 for a capital gain of $400,000. The taxpayer invests the $400,000 in a QOZ fund on September 30, 2018 (within the 180 day timeframe). The QOZ fund purchases a commercial building in a designated QOZ on October 20, 2018. The QOZ fund substantially improves the building within 30 months after purchase and then the QOZ fund sells the commercial building in January 2030 for a substantial gain. The tax impact to the taxpayer would be as follows:
- Tax year 2018: No income is recognized. The taxpayer’s basis in the QOZ Fund investment is considered to be $0.
- Tax year 2023: The taxpayer’s basis in the QOZ Fund increases by 10% of their deferred gain, or $40,000.
- Tax year 2025: The taxpayer’s basis in the QOZ Fund increases by an additional 5% of their deferred gain to $60,000.
- Tax year 2026: The taxpayer recognizes their deferred capital gain less their increases in basis. They recognize capital gain income of $340,000.
- Tax year 2030: The taxpayer does not recognize any income because their investment in the QOZ Fund equals the fair market value at the date of sale. Essentially there is no tax on the appreciation in the investment.
Arkansas Opportunity Zones
Arkansas currently has 103 Opportunity Zones as designated by the U.S. Department of the Treasury. For a map of the zones, visit the ArcGIS site here.
For more information regarding Qualified Opportunity Zones, please contact Landmark Tax Manager Mark Greco at 479-636-4461.