The Opportunity Zones Program: Potential for Capital Gains Deferral or Elimination

With the 2017 tax reconciliation reform (Tax Cuts and Job Acts) comes a new tax incentive program aimed at promoting investments in certain economically distressed communities across the country.

How does it work?

An investor may elect to exclude capital gains from gross income to the extent the gains are invested in a Qualified Opportunity Fund (QOF). A QOF is any corporation or partnership organized for the purpose of investing at least 90% of its assets in a Qualified Opportunity Zone property.

To qualify for deferral, gains must be invested within 180 days from the date of sale.  All or part of the deferred gain is includible in taxable income when the taxpayer sells the QOF investment or on December 31, 2026, whichever occurs first. Click here for example.

What are the tax benefits associated with participating in this program?

The Opportunity Zones program offers up to three potential tax benefits for investing in low-income communities through a QOF:

  1. Temporary Gain Deferral
    • Tax deferral on capital gain until the earlier of the QOF disposal or 12/31/2026*
  2. Step-up in Basis, which reduces the Gain Recognized
    • Tax exclusion on up to 15% of the original deferred gain from non-zone investments invested into a zone by 12/31/2019 and held for 7 years or until 12/31/2026
      1.  Basis increased to 10% of deferred gain after 5 years
      2. Basis increased to 15% of deferred gain after 7 years
  3. Gain Exclusion above Original Deferred Gain Amount
    • 100% gain exclusion on zone investments after 10 years
*There is some ambiguity in the law as to whether the 12/31/26 date should be stated as 7 years, instead of an actual date, in the event that investment occurs before 12/31/19.
What about a QOF investment made post 12/31/19?

Additional guidance is needed from the IRS to determine how the step-up in basis of the original gain might apply to gain rolled over in 2020 or later.  Currently, the deferred gain is triggered no later than 12/31/2026, which would mean that the rollover into a zone-investment must be no later than 12/31/19 to exclude 15% and no later than 12/31/21 to be eligible to exclude 10% of the original deferred gain.

Will CA conform to the Opportunity Zones gain deferral and exclusion?

Although CA will have designated Opportunity Zones for investment, CA does not conform to the Federal tax bill for gain deferral/exclusion at this time.

We are happy to discuss any questions you may have and will keep you updated as new developments progress related to this opportunity.