By Matthew Goodfellow, Tax Manager – Harris CPAs
The IRS just released a new set of proposed regulations on April 17, 2019 regarding investments in Opportunity Zones. The newly minted Section 1400Z-2 of the IRC allows for deferral of capital gains if they are subsequently invested in a designated “Opportunity Zone” and these proposed regulations provide additional guidance for taxpayers on how to decipher the code.
We will spare you the nitty-gritty details of this 169-page document and just give you the highlights. Here are the most important clarifications from the new regulations:
- Land and Qualified Opportunity Zone Business Property: In order for property to qualify as Qualified Opportunity Zone Business Property, it must either have its original use begin with the fund, or be “substantially improved” within 30-months of acquisition. The new proposed regulations clarify that while land will never be able to qualify under the original use test, it does not need to be substantially improved in order to qualify as QOZBP. This favorable ruling comes with a few caveats, but generally means that investors can include the cost of land when determining their total qualifying assets for the 90% test if it meets the other qualifications.
- Original Use: The regulations provide that property that has been unused or vacant for an uninterrupted period of at least 5 years may have its original use commence when the fund places it into service after the vacancy period for purposes of the original use test discussed above. They also state that leasehold improvements will satisfy the original use requirement if made by the qualified opportunity fund or qualified opportunity zone business.
- Capital Contributions and the 90% Asset Test: When determining whether the qualified opportunity zone fund meets the 90% asset test, the new regulations stipulate that the fund may exclude any capital contributions made to the fund for 6 months from the date of contribution. These excluded contributions must be held in cash, cash equivalents, or debt instruments with a term of 18 months or less.
- Section 1231 Gains: Due the varying nature of tax treatment for gains and losses resulting from the sale of business use property held for more than one year, the regulations clarify that 180-day period by which the gains must be reinvested begins on the last day of the taxpayer’s taxable year which respect to such Section 1231 gains. The reason for this is that the nature of the 1231 gain cannot be determined until it is netted with all other 1231 gain or loss for the year and any unrecaptured 1231 losses from prior years. Since only capital gains are eligible for deferral by investment in a qualified opportunity zone fund, only net 1231 gains that are not subject to recapture as ordinary income will qualify for deferral.
If you would like to discuss anything related to opportunity zones and what these new regulations might mean for you or your clients, feel free to reach out to me at firstname.lastname@example.org.
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