Qualified Opportunity Funds – New Regulations Released

By Laura Berry, CPA and Gary Gruner, CPA

As a follow-up to our recent blog post, the much-awaited guidance, proposed regulations and Revenue Ruling 2018-29 for Qualified Opportunity Funds (QOFs) were released. Investors and developers have been waiting on the sidelines for clarification to several uncertain parts of the program that was enacted by the Tax Cut Jobs Act in December of 2017. While the guidance released was not as robust as needed, it did shed light on many gray areas and, hopefully, this will help investors and fund managers with the direction needed to jumpstart this exciting program. 

The new Opportunity Zone program offers taxpayers the possibility of three tax incentives, by investing in certain “low-income communities” through Opportunity Zone Funds. The investor benefits are:

  • Temporary deferral of gains (up to eight years);
  • Reduction of deferred gain (up to a 15-percent reduction); and
  • Permanent exclusion on Opportunity Fund gains.

The Oct. 12, 2018 guidance consists of 74 pages of proposed regulations, a revenue ruling and draft of Form 8996 used to certify QOFs.

Below are important points taken from the guidance issued on Section 1400Z-1 and Section 1400Z-2:

Capital Gains: The proposed regulations provide that a gain is eligible for deferral if it is treated as a capital gain for Federal income tax purposes. Eligible gains, therefore, generally include capital gain from an actual, or deemed, sale or exchange, or any other gain that is required to be included in an eligible taxpayer’s computation of capital gain.

This capital gain refers to the original investment made into the Qualified Opportunity Fund that is subject to the 180-day rule. 

Gains from Pass-Through: The proposed regulations provide rules that permit a partnership to elect deferral under section 1400Z-2 and, to the extent that the partnership does not elect deferral, provide rules that allow a partner to do so. Consistent with the general rule for the beginning of the 180-day period, the partner’s 180-day period generally begins on the last day of the partnership’s taxable year, because that is the day on which the partner would be required to recognize the gain if it is not deferred. The proposed regulations state that rules analogous to the rules provided for partnerships and partners apply to other pass-through entities (including S corporations, decedents’ estates, and trusts) and to their shareholders and beneficiaries.

This capital gain refers to the original investment made into the Qualified Opportunity Fund that is subject to the 180-day rule.

Eligible Taxpayer: An eligible taxpayer is a person that may recognize gains for purposes of Federal income tax accounting. Thus, eligible taxpayers include individuals; C corporations, including regulated investment companies (RICs) and real estate investment trusts (REITs); partnerships; S corporations; trusts and estates. An eligible taxpayer may elect to defer recognition of one or more eligible gains in accordance with the requirements of section 1400Z-2.

How to Elect Deferral of Capital Gains: It is currently anticipated that taxpayers will make deferral elections on Form 8949, which will be attached to their Federal income tax returns for the taxable year in which the gain would have been recognized if it had not been deferred. Form instructions to this effect are expected to be released very shortly after these proposed regulations are published.

Certification of an Entity as a QOF (Form 8996) – It is expected that taxpayers will use Form 8996, Qualified Opportunity Fund, both for initial self-certification and for annual reporting of compliance with the 90-Percent Asset Test in section 1400Z-2(d)(1). It is expected that the Form 8996 would be attached to the taxpayer’s Federal income tax return for the relevant tax years. The IRS expects to release this form contemporaneous with the release of these proposed regulations.

Additionally, summarized below is an important point taken from the Revenue Rule 2018-29.

Land and Building: The measurement for substantial improvement is applied to the adjusted basis of the building excluding the land. There is no requirement for the QOF to separately improve the land. 

For example, if an eligible taxpayer plans to defer $5 million of eligible capital gains by buying an existing property ($4M FMV building and $1M FMV land) located in an Opportunity Zone, only the amount allocated to the building is used in the substantial improvement calculation. The eligible taxpayer would need to improve the building by at least $4 million, bringing the basis of the building to at least $8 million.

This is an exciting time for taxpayers to serve as an investment vehicle to assist with a tax-free opportunity while helping struggling communities with much-needed economic development and financial opportunity across America―some which are right in your back yard.  Windham Brannon is eager to answer any questions you may have or provide the assistance you many need with your Opportunity Zone investment. 

More information about the latest business insights on COVID-19Click Here