What you need to know about Qualified Opportunity Funds

To become a Qualified Opportunity Fund and invest in eligible property located in an Opportunity Zone, you should self-certify. (In other words, no approval or action by the IRS is required.) To self-certify, you must complete a form (to be released in the summer of 2018) and attach that form to your federal income tax return for the taxable year.

There are a few important things to note about Opportunity Funds:

Qualified Opportunity Zone business property is tangible property used in the business that is located in the opportunity zone purchased by the qualified Opportunity Zone fund after 12/31/17.
The Opportunity Fund must hold at least 90% of its assets in qualified Opportunity Zone property. This is determined by the average percentage of qualified Opportunity Zone property held on the last day of the 6th month and the last day of the tax year. If the fund fails to meet this test, you will be subject to penalties.
If the tangible property ceases to be qualified Opportunity Zone business property, then it will continue to be treated as qualified Opportunity Zone business property for the lesser of 1) Five years after the date on which it ceased to be qualified or 2) the date on which it is no longer held by the qualified Opportunity Zone business.

As mentioned, a taxpayer can sell any property (capital asset or other) and any amount of that gain that is invested by the taxpayer to a Qualified Opportunity Fund shall be excluded from gross income in the year of exchange (during the 180-day period that begins on the date of such sale or exchange). There is no dollar limit on the amount of gain that can be deferred under the temporary deferral election, but just one temporary deferral election can be made.

Example #1: Let’s assume Mr. Smith sells property and realizes a gain of $500,000 on January 15, 2020. On February 15, 2020 (within the 180-day window) Mr. Smith invests $400,000 of the $500,000 gain in the QOF and Mr. Smith makes the temporary deferral election. A few weeks later, Mr. Smith invests the remaining $100,000 of the gain in the same QOF. The $100,000 is ineligible for a temporary deferral election because Mr. Smith already met the one-election limitation.

Example #2: What if the facts are the same as in the above example except that Mr. Smith initially invested the entire $500,000 gain and an additional $200,000 from his savings account into the QOF? Since the investment exceeded his $500,000 gain on sale, the investment is treated as two separate investments into the fund. The $500,000 investment is subject to the temporary deferral election. The other investment of $200,000 is not eligible for deferral, even if it is all invested into the QOF on the same day.

The one-sale-limitation might also apply to a taxpayer who sold property on an installment basis and made a temporary deferral election applicable to gain recognized in the year of sale. In that case, the one-election-limitation might prevent that taxpayer from making a second temporary deferral election with respect to the gain recognized from installment payments received in tax years after the initial temporary deferral election. Why? Because the two elections would relate to gain from the same sale, similar to example #2 above.

In summary, here are the major benefits of investing in a Qualified Opportunity Fund:

Gain deferral – All gains invested in the QOF may be deferred in the year the temporary deferral election is made.
Permanent tax exclusion of 15% taxable gain for investments held five years – Investments held in the QOF for at least five years will receive a basis increase equal to 10%.
Permanent tax exclusion of 15% taxable gain for investments held seven years – Investment held in the QOF for at least seven years will receive an additional basis increase of 5%, for a total increase of 15%.
Permanent tax exclusion of 100% of taxable gain – Any investment, under which the deferral election was made, held by the taxpayer for at least 10 years will receive a basis increase to be equal to the fair market value of the investment on the date the investment is sold. Under this section, all rolled over deferred gain and earnings while in the QOF would be eliminated and therefore tax-free.

A few things you should know about this investment:

It expires December 31, 2026, and no gain deferrals will be available after this date.
Gains will be picked up into income at the earlier of the date the investment is sold or December 31, 2026.
Therefore, on December 31, 2026, 85% of the original deferred gain will be recognized.
However, you will recognize the lesser of the original gain or the fair market value at that date. This gives you the benefit if the investment decreases in value.
The appreciation on the investment will not be recognized until asset is sold and if that appreciated asset is held 10 years, it will have a step up to the FMV and be tax-free.
Planning Opportunity – need to plan for this recognition event and the cash flow needed to pay tax at this date.

Over the next few months, the Treasury Department and the Internal Revenue Service will be providing further details, including additional legal guidance, on this new incentive. Check out the IRS’s published resources on Opportunity Zones at https://www.cdfifund.gov/Pages/Opportunity-Zones.aspx

Must-Knows About Qualified Opportunity Funds

The Tax Cuts and Jobs Act, enacted on Dec. 22, 2017, established new tax codes that provide significant tax deferral opportunities for recently realized capital gains when they are invested in a Qualified Opportunity Fund (QOF or O Fund) for at least five years. There are still many unanswered questions about how exactly this will work in practice, and investors are waiting on soon-to-be-released Treasury Department regulations for guidance. But there is substantial interest on the part of large private client banks, hedge funds and ultrahigh-net-worth individuals.

Investing In Qualified Opportunity Zones

Russ Alan Prince
iLeadership Strategy
I write about the creation and management of exceptional wealth.

The new tax law created a new investment vehicle called “ qualified opportunity funds” that have tax advantages. The rationale for the tax benefits is to direct resources to low-income communities – “qualified opportunity zones.” Each state nominates communities as qualified opportunity. Qualified opportunity zones can be found by going here.

“A qualified opportunity fund is an investment vehicle that can be organized as a corporation or a partnership that holds at least 90% of its assets in qualified opportunity zones,” says John Bowen, cofounder of BSW Inner Circle and author of Elite Wealth Planning: Lessons from the Super Rich. “From the date of sale of an appreciated asset, the investor has 180 days to invest in a qualified opportunity fund. The investor receives either stock or an interest in the fund.”

According to Edward Renn, an internationally acclaimed tax lawyer at WithersBergman, “There are a number of tax incentives of qualified opportunity funds including (1) the deferral of capital gains taxes from the sale of appreciated assets until the earlier of December 31, 2026 or the disposition of the qualified opportunity fund, (2) possibly lowering of the capital gains tax up to 15% because of an increase in the basis of the appreciated assets used to buy the fund interest, (3) possibly eliminating capital gains due on the appreciation in a qualified opportunity fund if it is held for 10 years or longer.”

Example: Sale of a Business

John sold a business for a $12 million capital gain in June of 2018. John located three properties in two Qualified Opportunity Zones with a total purchase price of $12 million. John formed a limited partnership as his Qualified Opportunity Fund and his attorney made sure the partnership agreement contained appropriate language to be treated as a Qualified Opportunity Fund.

If John holds the Qualified Opportunity Fund until December 31, 2026 instead of paying $671,000 in federal tax by April 15, 2019, $570,000 of tax will be due by April 15, 2027.

The tax reduction is attributable to the 10% basis bump after holding the Qualified Opportunity Fund for five years and an additional 5% basis bump for holding the Qualified Opportunity Zone for seven years.

If John waits at least ten years to sell the three properties consisting of the Qualified Opportunity Fund investments, any gain on the properties will escape tax.

John gets eight years of federal tax deferral, a reduction of 15% on the deferred gain, and tax-free proceeds on the sale of the Qualified Opportunity Zone property.

I am president of R.A. Prince & Associates, Inc. I consult with family offices, the ultra-wealthy and select professionals.