The Tax Cuts and Jobs Act (TCJA) created qualified opportunity zones (QOZs), a significant new tax incentive, to encourage long-term, private investment in more than 8,700 economically distressed and low-income communities across the country.
A QOZ business is a trade or business in which:
- Substantially all of the tangible business property is QOZ business property.
- At least 50% of the gross income is from the active conduct of the trade or business.
- A substantial portion of intangible property is used in the active conduct of the trade or business.
- Less than 5% of property is nonqualified financial property.
Several types of investments in the QOZ qualify, including commercial real estate development or renovation, a new business opening, and expansion of existing businesses.
QOZ property includes QOZ business property, QOZ stock, and QOZ partnership interests. QOZ stock and QOZ partnership interests must be acquired after December 31, 2017, for cash, and the business must remain a QOZ business for substantially all of the QOF holding period.
If a taxpayer invests capital gains in a qualified opportunity fund (QOF) or QOZ business, the taxpayer may defer recognition of these capital gains until the earlier of (1) disposal of the investment or (2) December 31, 2026. The election to defer the gains is made on Form 8949.
A QOF may allow a taxpayer to completely eliminate certain gains if the QOF interest is held for at least 10 years. Any post-acquisition capital gain on investment in the QOF are excluded from gross income, and the taxpayer’s basis in the property being sold equals the fair market value at the date that the interest is sold or exchanged.
If the taxpayer holds the interest for more than seven but less than 10 years, the taxpayer must only recognize 85% of the deferred gain. If the taxpayer’s interest is held for more than five but less than seven years, the taxpayer must recognize 90% of the deferred gain. If the interest is held for less than five years, the taxpayer must recognize 100% of the deferred gain.
Recent IRS guidance clarifies the “substantially all” requirements for the use and holding period of the tangible business property. 70% or more of the tangible business property must be used in a QOZ, and it must be QOZ property for at least 90% of the holding period.
Proposed regulations cover certain inclusion events such as gift, charitable contributions, abandonments, and corporate/partnership transactions occurring before 2027. The proposed regulations also make clear that a transfer to a disregarded entity (partnership, S corporation, or grantor trust) is not an inclusion event.
If you would like more information about how investing in a QOZ could benefit you, please contact your Blue & Co. advisor.