The Trump Administration enacted the Tax Cuts and Jobs Act (the “TCJA”) on December 22, 2017. It is claimed to be one of the most aggressive tax reforms in history. Not only did it change the tax brackets and taxation of corporate tax incentives, but it also introduced a new innovative tax incentive designed to encourage investment in economically distressed areas throughout the United States.
The “Investing Opportunity Act” (“OZ Program”) is a proposed change to the tax code that will change the way an investor’s capital gain is taxed. A capital gain is a type of tax and occurs when something is sold for more than its acquisition price. Thus, when an investor sells either stock or property it owns for more than it originally purchased the asset for, they received a capital gain which is taxable. Traditionally, investors pay taxes on capital gains as part of their federal income tax. The proposed OZ Program will either allow investors a chance to defer the tax temporarily or completely eliminate the tax altogether.
The OZ Program has designated over 8,000 US census tracts as “Qualified Opportunity Zones” (“QOZs”). Each governor was permitted to select up to 25% of their state’s low-income census tracts (“LIC”), which are designated by the New Markets Tax Credits legislation, as QOZs. LIC’s are defined as “places with poverty rates of at least 20 percent or median family incomes no greater than 80 percent of the surrounding area.” The current designations will be in effect for the next 10 years. It is estimated that more than 31 million Americans live within QOZs.
In the face of a lot of political turmoil, the OZ program is an example of recent bi-partisanship in the United States government. A conversation around OZs has occurred for the past three years. It originally started in 2015-16 between two Senators who don’t necessarily share similar political views: Tim Scott, a Republican from South Carolina, and Cory Booker, a Democrat from New Jersey. Senators Scott and Booker were the main drivers behind the presentation of this legislation to the Senate.
Out of the 300 pages of the TCJA, only three were designated to the OZ Program. On October 19, 2018, the IRS issued regulations answering some critical questions about the legislation. While the regulations are proposed, taxpayers and QOFs may rely on the proposed regulations presuming they apply the rules correctly and reliably. Thus, despite its original status as somewhat of a “sleeper provision,” the OZ amendment to the Tax Code has picked up steam in the real estate development and investment world.
OZs are the latest addition to a string of federal tax incentive initiatives to expand economic development and long-term private investment in distressed communities nationwide. It has been predicted that the OZ Program has the potential to be the largest economic development program in the United States. The Act encourages investments in low income communities by allowing taxpayers 180-days to reinvest capital gains they receive from a sale of certain appreciated assets in a “Qualified Opportunity Zone Fund” (a “QOF”), which is a corporation or partnership organized for the purpose of investing in a QOZ property (a “QOZP”). A QOZP includes any qualified OZ stock, partnership interest, and business property. Reinvesting the capital gains into a QOF will potentially allow taxpayers to: (1) defer capital gain from the sale of the assets; (2) reduce the deferred capital gain; and (3) eliminate future gain arising out of appreciation in the QOF investment.
Overall, the jury is still out on how investors can best take advantage of these opportunity zones. It seems that if you have a deal in one of the designated QOZs then it is worth it to go the extra effort of the election, however, the OZ program doesn’t “make a bad deal good” it instead makes “a good deal better.” The IRS has said it will issue more regulations but has given no timeline on their release. Hopefully, these new regulations will make some of the uncertainties within the legislation clearer and provide an easier path for investors to benefit from this dynamic tax incentive.
Samantha Moench is a second-year law student at Wake Forest University School of law. She holds a Bachelor of Arts in Psychology and a minor in Mass Communications from Washington and Lee University. Upon graduation, she intends to practice real estate transactional law.