The buzz around Opportunity Zones is likely to get some fresh momentum now that investors and sponsors have some long-awaited answers to some lingering questions. On December 19th, the Treasury Department and IRS released final regulations that provide greater clarity to maneuvering Opportunity Zone investments.
The Tax Cuts and Jobs Act created tax incentives for Opportunity Zones as a means to attract more private capital investment into economically-distressed communities. Ultimately, the new tax program has led to the creation of some 8,700 Qualified Opportunity Zones (QOZs) around the country and hundreds of Opportunity Zone Funds (QOFs) that are making direct investments in businesses and/or property located within those designated areas.
The carrot on the end of the stick for taxpayers is the ability to defer capital gains on the disposition of assets, such as investment real estate, stocks, art or other property, by rolling proceeds into an Opportunity Zone investment. Program participants who invest their realized capital gains in a QOF within 180 days of realizing them can defer payment of taxes until April 2027 on investments held through December 31, 2026. As an added incentive to promote long-term investment, all capital gains derived through the investment in the opportunity zone itself are tax-free if they are held for at least 10 years.
As with any new tax rule, it was immediately followed by a flurry of questions to pin down some of the ambiguity of what was allowed and what wasn’t. The Treasury Department and IRS aim to address those questions in its final rules, which includes a 544-page report for those who want to read the fine print, or a condensed 5-page FAQ for those who prefer a more streamlined view. Below, we have pulled out some highlights that we have culled from the IRS documents, as well as other article reviews such as the Miami Herald and the Motley Fool.
Highlights of new IRS rules for sponsors
- For developers, the final regulations establish a working capital “safe harbor” that gives them up to 62 months to complete a project from the time when the money is first invested.
- QOFs can sell out of individual properties without having to sell the entire fund.
- A developer can use the construction of a new building to contribute to the improvement of an opportunity zone property where there is already an existing building.
- The final regulations reduce the five-year vacancy requirement in the proposed regulations to a one-year vacancy requirement, as long as the property was vacant for at least one-year prior to the QOZ being designated and remains vacant through the date of purchase.
- Related to brownfield development sites, the final regulations specify that they will take into account the remediation of contaminated land as part of the consideration of whether the land has been significantly improved.
- In regard to property that straddles census tracts, both a square footage test and an unadjusted cost test will be used to determine if a project is primarily in a QOZ. In addition, the tests will be used to determine if parcels or tracts of land will be considered contiguous if they possess common boundaries and would be contiguous if not for the interposition of a road, railroad, stream, etc. Importantly, the final regulations also extend the straddle rules to QOFs and Qualified Opportunity Zone businesses (QOBs) with respect to the 70-percent use test.
- The final rules provide that self-constructed property can count for purposes of the QOF’s 90-percent asset test and the QOZB’s 70-percent asset test and is valued at the purchase price as of the date when physical work of a significant nature begins.
- The 180-day time period for investing gains achieved by selling business assets (including real estate) now begins on the sale date rather than at the end of the year in which the assets were sold.
- The final regulations provide that nonresident alien individuals and foreign corporations may make Opportunity Zone investments with capital gains that are effectively connected to a U.S. trade or business. This includes capital gains on real estate assets taxed to nonresidents and foreign corporations under the Foreign Investment in Real Property Tax Act rules.