The 2017 Tax Cuts and Jobs Act (2017 Tax Act) provides an investment vehicle that allows you to defer paying tax on capital gains realized from the sale of capital assets. This investment vehicle is a Qualified Opportunity Fund (QOF). The opportunity zone program was created to encourage taxpayers to invest in business activities that bring economic growth to economically distressed areas. Our team can develop tax strategies to defer paying tax on capital gains realized from the sale of capital assets.
Qualified Opportunity Zone properties are invested into through Qualified Opportunity Funds. To qualify for tax deferral benefits, investors must place the capital gains into a Qualified Opportunity Fund within 180 days of realizing the gain. These benefits apply to individuals as well as corporations and flow-through entities. There is no limit to the amount of capital gains that can be deferred by reinvestment into a Qualified Opportunity Fund.
There are various levels of tax benefits that can be achieved under these rules, depending on the timing of the investment in a Qualified Opportunity Fund. These tax benefits include:
- Gain deferral: Gain from the sale of assets reinvested in a Qualified Opportunity Zone Fund are deferred until the earlier of (a) sale of the interest in the QOF or (b) Dec. 31, 2026.
- Gain elimination: Depending on how long an investment in a QOF is held, you may be able to permanently eliminate part of the gain. If the investment is held for 5 years, 10% of the deferred gain is eliminated. If the QOF investment is held for 7 years, then 15% of the original gain is eliminated from taxable income.
- Tax elimination on appreciation: If you hold the investment for at least 10 years, you can step-up the basis of the Qualified Opportunity Fund investment to the fair market value on the date you dispose of it; therefore, no tax would apply to gain on the sale of the investment.
Qualified Opportunity Funds are also required to report the EIN of each business in which the QOF has an ownership interest and the value of the investment using Form 8996. It also requires QOFs to report the value and census tract location of qualified business property it owns or leases directly.
Example Engagement: Opportunity Zone Tax Deferral
A long standing hospitality owner/operator acquired a previously owned hotel located in a qualifying opportunity zone. The client did not acquire the property with an intention of qualifying the property as tax deferral for capital gains. However, it was brought to the owner’s attention that several of his investors could benefit from the tax deferral of gains by qualifying his LLC as a Qualified Opportunity Zone Fund (QOF). We educated the owner on the relative costs and benefits of QOF and bonus depreciation. As part of most hospitality acquisitions, the new owner conducts property improvement programs (PiP). Thanks to recent tax legislation, the PiP expenditures, as well as a substantial portion of the cost of the acquired building were deductible over the first 2 or 3 years of operating the property. This left the owner with a decision on whether to qualify the property as a QOF or take advantage of the rapid write off of acquisition and improvement costs.
CCA worked with the owner/operator assisting in negotiations with the seller for purchase price allocation beneficial to the two tax strategies, as well as with counsel to provide for language in the LLC operating agreement to support either of the tax strategies as appropriate. In addition, CCA was able to leverage their 30 years of cost segregation expertise to the analysis. The owner/operator was able to present the property to his investor group, allowing the potential investors to identify which of the two strategies benefited them.