New Act Creates Tax Incentives for Investors in “Opportunity Zones”February 2018
The federal Tax Cuts and Jobs Act of 2017 (the "Act”) defines Qualified Opportunity (QO) Zones as certain low-income communities that are experiencing uneven economic development, resulting in pockets of disinvestment and unemployment. The Act provides tax incentives for developing QO Zones, provided that the financing mechanisms meet the criteria for a QO Fund, which is a private investment vehicle organized as a partnership or corporation, for the purpose of investing in QO Zone Property. These tax incentives include tax deferral for gains from the sale of property that are reinvested in a QO Fund, a step-up in basis for certain investments, and the potential for permanent exclusion of capital gains from the sale or exchange of an investment in a QO Fund.
What Are the Incentives for Investment in Qualified Opportunity Zones?
The Opportunity Zone program offers investors the following incentives to reinvest certain investment proceeds in a QO Fund:
a. Tax Deferral for Capital Gains Invested in Qualified Opportunity Funds
The QO Zone program allows taxpayers to elect to defer taxation of certain gains due upon a sale or disposition of property to the extent that the gain is reinvested within 180 days in a QO Fund. Any deferred capital gain must be recognized on the earlier of the date on which the taxpayer sells its investment in the QO Fund or December 31, 2026.
b. Step-up in Basis
Taxpayers that elect to defer gain by investing in a QO Fund will initially have a $0 basis in that investment. However, if such reinvestment of deferred gain is maintained in a QO Fund for at least five years, the taxpayer will also receive a step-up in the basis in the QO Fund, equal to 10% of the original deferred gain. If the investment is maintained in the QO Fund for at least seven years, the taxpayer will receive an additional 5% step-up in tax basis.
c. Permanent Exclusion from Taxable Income of Capital Gains
The program also allows taxpayers to elect to permanently exclude from income gains, the sale or exchange of an investment in a QO Fund, provided that the investment in the QO Fund is held for at least 10 years. This exclusion will apply solely to the gains attributable to appreciation after the investment in a QO Fund (i.e., not the original gains deferred in making such investment).
What Areas May Be Designated as Qualified Opportunity Zones?
QO Zones are defined as low-income communities that include (1) population census tracts with a poverty rate of at least 20%, (2) metropolitan area census tracts with median family income of at most 80% of the greater of the metropolitan area median income or statewide median income, or (3) non-metropolitan census tracts with median family income that is at most 80% of statewide median family income (85% for areas in “high migration” rural counties).
For a map of all census tracts eligible for designation as QO Zones, click here.
QO Funds must invest 90% of the pooled capital in QO Zone Property (generally tangible property used in certain QO Zone businesses, or stock or partnership interests in entities engaged in certain QO Zone businesses). QO Funds are a way for US investors to put significant sources of capital to work for economic development and realize attractive capital returns.
Governors of each state are permitted to nominate a certain number of census tracts as QO Zones and submit them to the US Department of the Treasury. The Secretary of the Treasury will then have a 30-day “consideration period” to ultimately designate the census tracts in each state as QO Zones.
The designation of a census tract as a QO Zone will remain in effect from the date of its designation to the end of the 10th calendar year after its designation.
Developments in Missouri
As part of the nomination process, Missouri's Governor, Eric Greitens, has been working closely with the Missouri Department of Economic Development to prioritize and select census tracts for nomination. The Act limits the number of a given state's QO Zones to the greater of 25 eligible census tracts or 25% of the number of eligible census tracts in the given state.
All census tract proposals are due to the Missouri Department of Economic Development by Friday, March 2, 2018. The St. Louis Development Corporation (SLDC) is coordinating the preparation of proposals in the City of St. Louis. The SLDC has recently reached out to various interested members of the St. Louis metropolitan community, including developers, investors, business owners, residents, and others, to prepare and submit summary proposals for suggested QO Zone census tracts in which they are active. The St. Louis Economic Development Partnership has also contacted various stakeholders and municipalities about potential investment in QO Zones.
Final nominations will be submitted by the Governor to the U. S. Department of the Treasury no later than March 21, 2018.
In addition, the Missouri Department of Economic Development is working with the Missouri Department of Revenue to determine state tax benefits and other incentives that may apply.
The Real Estate Practice Group at Lewis Rice frequently works with various investors, developers, projects, fund managers, and third-party financing providers throughout the region. We will continue to monitor the QO Zone program. For more information regarding this program, participation in QO Funds, or forming a QO Fund, please contact a Lewis Rice real estate attorney.