2018 Opportunity Zones
The 2017 tax reform passed on December 22 created a new tax incentive program called Opportunity Zones under Internal Revenue Code Subchapter Z. This program is to incentivize investment into certain economically distressed communities based on geographic location. An investor could defer the current tax on a gain, exclude 15% of the deferred gain in later years, and even potentially eliminate tax on the capital gain on the appreciation of a qualified investment when exiting in the future.
New Code §1400Z-1 and §1400Z-2 allow individual and corporate taxpayers to defer an unlimited amount of gains on the sale of any asset by investing the proceeds in an Opportunity Fund within 180 days from the sale of the appreciated stock, property, or asset. Unlike a §1031 like-kind exchange, the code allows the taxpayer to reinvest and defer only the gain, not the total proceeds into a Qualified Opportunity Fund.
An Opportunity Fund is a corporation or partnership that has a minimum of 90% of its assets invested directly or indirectly in businesses located in the designated Opportunity Zones. For a map of Arizona’s Opportunity Zones, click here. An Opportunity Zone Business has to have substantially all of the tangible assets of the business used within an Opportunity Zone, at least 50% of the gross income earned by the business conducted within the Zone, and the business is limited on the amount of investment assets held. The majority of businesses operating within the Zones would qualify with the exception of “sin businesses.”
To further encourage investments in these Zones, the code provides the taxpayer with an increase in their basis if it is held for 5 or more years. After an investment is held for 5 years, their basis is increased by 10% of the deferred gain and after another 2 years it is increased by an additional 5%. This translates to a 10% or 15% permanent forgiveness of initial capital gain if it is held for 5 or 7 years respectively.
The remaining deferred gain would be recognized upon disposal of the investment or as of December 31, 2026, whichever comes first. However, due to the nature of law and politics, the December 31, 2026 gain recognition date always has the potential to be extended. In the event that the fair market value of the property at December 31, 2026 is less than the deferred gain, only the fair market value of the property would have to be realized as a taxable gain.
Lastly, if the investment is held for 10 or more years then §1400Z-2(c) provides that the basis in an Opportunity Fund investment is the fair market value of the investment at the date of sale. This means no tax would be owed on post-acquisition appreciation. If the taxpayer invested more than just deferred gain proceeds, the additional cash from other sources would be treated as a separate investment and would be ineligible for the 10 year capital gain exclusion and 10%/15% basis boosts.
For more information on Opportunity Zones and how they would apply to your individualized investment interests, please contact our office at 520-624-8229.