The Federal Tax Cuts and Jobs Act of 2017 (“TCJA”), which was enacted at the near end of 2017, created the tax concept of opportunity zones.  As a result, States designated tracts by census as “qualified opportunity zones”; However, the census tracts either met the definition being a low-income community or were eligible tracts that were contiguous with other selected low-income community tracts.  In all, there are more than 8,700 qualified opportunity zones located in all 50 states, the District of Columbia, as well as five U.S.  territories.  The opportunity zone program offers taxpayers potential capital gain tax deferrals.

Qualified opportunity zones provide temporary deferral of taxes on earned capital gains. To defer a capital gain (including “net” §1231 gains), a taxpayer has 180 days from the date of the sale or exchange of appreciated property to invest the realized capital gain dollars into a Qualified Opportunity Zone Fund. The fund then invests in Qualified Opportunity Zone Property.  The taxpayer may invest the return of principal as well as the recognized capital gain, but only the portion of the investment attributable to the capital gain will be eligible for the exemption from tax on further appreciation of the Opportunity Zone Investment, as explained below. The Opportunity Zone program allows for the sale of any appreciated assets, such as stock, with a reinvestment of the gain into an Opportunity Zone Fund. There is no requirement to invest in a like-kind property to defer the gain.

Note that a taxpayer who receives a reported capital gain from a flow-through entity, such as a partnership, S-corporation, or a trust/estate, has 180 days from the end of the calendar year to make an investment in a Qualified Opportunity Zone Fund, regardless of how early in the calendar year the entity itself realized its gain.  For example, if a partnership entity realized a capital gain in March, each partner’s 180-day triggering date will be December 31 of the same year and each partner will have until approximately June 28 of the following year to make their Qualified Opportunity Zone investment.

A Qualified Opportunity Zone Fund is any investment vehicle which is organized as a corporation or a partnership for the purpose of investing in qualified opportunity zone property (other than another qualified opportunity fund) that holds at least 90 percent of its assets in qualified opportunity zone property.

Qualified Opportunity Zone Property is used to refer to property that is qualified opportunity zone stock, a qualified opportunity zone partnership interest or a qualified opportunity zone business property acquired after December 31, 2017, used in a trade or business conducted in a Qualified Opportunity Zone or ownership interest in an entity (stock and partnership interests) operating with such tangible property.

An Opportunity Zone Fund investment provides potential tax savings in three ways:

Tax deferral through 2026 – A taxpayer may elect to defer the tax on some or all of a capital gain if, during the 180 day period beginning at the date of sale/exchange, they invest in a qualified opportunity fund. Any taxable gain invested in an Opportunity Zone Fund is not recognized until December 31, 2026, (due with the filing of the 2026 return in 2027) or until the interest in the fund is sold or exchanged, whichever occurs first. In addition, the deferred gain can be further reduced as described below.

Step up in tax basis of 10% or up to 15% of deferred gains – A taxpayer who defers gains through an Opportunity Zone Fund investment receives a 10% step-up in tax basis after five years and additional 5% step-up after seven years. Note that to take full advantage of the 15% step-up in tax basis, the taxpayer must have invested by December 31, 2019. When the tax is triggered at the end of 2026, the taxpayer will have held the investment in the fund for seven years, thereby qualifying for the 15% increase in tax basis.

No tax on appreciation – Remaining in the qualified opportunity fund for at least ten years results in the cost basis of the property being equal to the fair market value on the date of sale/exchange (potential to lower cost basis but does not eliminate the gain recognition event on 12/31/2026).

To entitle a taxpayer to opportunity zone benefit, such taxpayer with capital gains realized in connection with a sale or exchange of property invests those earned capital gains into a qualified opportunity fund.  QOF means any investment vehicle which is organized as a corporation or a partnership for tax purposes for the purpose of investing in qualified opportunity zone property (other than another QOF) that holds at least 90% of its assets in qualified opportunity zone property, determined by the average of the percentage of qualified opportunity zone property.  By investing in a QOF and acquiring, improving and holding appropriate assets (“Qualified Opportunity Fund Property”), it is possible to eliminate capital gains taxes, both from the initial capital gain proceeds that are invested into the Qualified Opportunity Fund Property, and from the appreciation in the Qualified Opportunity Fund Property that is acquired and improved through the QOF.