Public law no. 115-97, better known by its common, monosyllabic name, Tax Cuts and Jobs Act of 2017 (“TCJA”) will have consequences for “place making.” There has been established “Opportunity Zones” that provide an investment vehicle to shelter capital gains if there is a purchase of properties and operation of businesses in communities that are economically disadvantaged.
It is something like the more well-known and more popular “1031 Exchanges” (named for the provision in the Internal Revenue Code allowing free-exchanges of real property), but it is different. Like all tax provisions, application is complicated. For the purpose of “Zonelaw” readers, this article is to put you on notice that this possibility exists and that investors should take a look at investing in areas that might be otherwise overlooked. Patient capital will now find two rewards: a tax advantage and an investment in an emerging neighborhood. So, give the future Bronx, Brooklyn, Wynwood or Design District a hard look. You might be quite surprised on your return after receiving these tax advantages.
The tax gambit works this way: Once you realize capital gain from a prior transaction, you have 180 days from the date of sale to invest the gain in an “Opportunity Zone Fund.” These are being referred to as “OZ funds.” This will give you three benefits: (a) you will receive a temporary tax deferral on the gain from the completed transaction; (b) if you hold the investment for certain time period prescribed in the TCJA, your amount of tax will ultimately be reduced, with benefits of this reduction beginning with a five (5) year holding period; and (c) if you hold your OZ Fund interest for ten years or more, you will not owe capital gains tax on the ultimate disposition of that OZ Fund interest.
Of course the TCJA is just hot off the presses in terms of Federal tax acts. Much more needs to be gleaned from rules, regulations and real world applications that will soon be forthcoming. For example, it looks as if this vehicle would work if you sold real property on a “flip” and had a gain that did not qualify for capital gains treatment. The Treasury Department’s regulations will likely provide guidance.
OZ Funds are created to hold these special investments. This seems a bit cumbersome but it is how the TCJA wants the investments aggregated. These investments have to be a “Qualified Opportunity Zone Business” and a Qualified Opportunity Zone Business can be located only in a properly designated Qualified Opportunity Zones. There is a requirement that the OZ fund must derive at least 50% of total gross income from the active conduct of business in an Opportunity Zone.
There is a procedure for establishing Qualified Opportunity Zones and it is quite complicated. For the purposes of this article, you should know that the Governors of each state choose a portion of their State’s census tracts that are shown to be economically disadvantaged and these become the zones. Not all disadvantages areas will qualify. A map has been established for the State of the Florida. Other states are in various phases of the designation and all designations must be completed shortly.
Thereafter, OZ Funds are free to invest in variety of business, such as commercial real estate. This could be accomplished through project agreements with private developers. An OZ Fund could then look through the Code for other tax advantages, like new market tax credits, Historic Tax Credits or Low-Income Housing Tax Credits and become the vehicle that is something we may all remember: a tax advantaged real estate investment. Until we get appropriate advise, all of this remains speculation but it is all a possibility.
According to a Treasury statement, the government is planning to provide temporary rules regarding sometime around June 30, 2018. Final regulations will take some time. Stay tuned. It could be a heck of a tax ride for emerging neighborhoods and another reason to be involved in the next MIMO, Northwood or LULA.