Opportunity Zone Sees New Regulations: Where Do We Stand Now?
Posted: April 23, 2019
"As part of the Tax Cuts and Jobs Act, Congress enacted two companion provisions designed to encourage investment and economic growth in certain low-income communities. First, Sec. 1400Z-1 paved the way for nearly 9,000 such low-income communities to be designated as "qualified opportunity zones" (QOZs). In turn, Sec. 1400Z-2 offers three federal income tax incentives to a taxpayer who invests in a business located within one of these zones: (1) the temporary deferral of capital gains, to the extent the gains are reinvested into a "qualified opportunity fund" (QOF); (2) the partial exclusion of previously deferred gains when certain holding period requirements in a QOF are met; and (3) the permanent exclusion of post-acquisition gains from the sale of an investment in a QOF held longer than 10 years.
While Sec. 1400Z-2 teases a tantalizing menu of tax breaks, the statutory language was, to put it kindly, vague and confusing. As a result, taxpayers were initially uncertain of how to meet the various investment requirements to achieve the promised tax benefits.
On Oct. 19, 2018, the IRS published proposed regulations providing much of the direction taxpayers had been seeking. And while those regulations represented a giant step forward in understanding how to implement an opportunity zone project, many questions remained. Last week, the IRS sought to address many of those questions by publishing a second set of proposed regulations. These regulations provide much needed clarity on conducting an operating business within a QOZ, while also providing additional flexibility for QOFs that wish to purchase raw land, lease property to be used in their business, receive ongoing inflows of invested capital, or dispose of assets and reinvest the proceeds in replacement property. In addition, the latest regulations provide relief for those investors who do not sell their interest in a QOF after ten years, but rather cause the QOF to sell its assets.
This discussion will take a look at the newly-issued proposed regulations from the perspective of the manner in which they address questions raised by the initial round of proposed regulations. First, of course, we'll need to get up to speed on what the statute and the original proposed regulations had to say, so we'll begin by examining what we knew BEFORE last week's release of additional guidance. When we discuss the original guidance, I will not layer on changes made by the newest round of regulations within that discussion; rather, I'll save those changes for the final analysis of only the latest guidance so that we can track the evolution of the opportunity zone rules.
By all means, if you were very comfortable with how opportunity zones worked prior to last Wednesday, then feel free to skip ahead to the section titled "New Proposed Regulations." But if you're in need of a refresher, I'd encourage you to give the entire article a read."