Critical New Insights on Proposed Opportunity Zone Regulations NOVEMBER 7, 2018

Transcription

1 Critical New Insights on Proposed Opportunity Zone Regulations NOVEMBER 7, 2018

2 To Receive CPE Credit Participate in entire webinar Answer polls when they are provided If you are viewing this webinar in a group Complete group attendance form with Your printed name, signature & address All group attendance sheets must be submitted to training@bkd.com within 24 hours of live webinar Answer polls when they are provided If all eligibility requirements are met, each participant will be ed their CPE certificates within 15 business days of live webinar

3 INTRODUCTIONS Derek Smith, CPA Partner Michael Hill, CPA Director

4 WHAT WE LL COVER TODAY Upon completion of this program, participants will be able to Explain the qualified opportunity zone (OZ) Discuss what we learned from proposed regulations & what we expect from additional guidance Identify planning opportunities

5 Qualified Opportunity Zones Qualified opportunity (QO) Zones: low-income census tracts identified by states Fund: corporation or partnership that invests in QO zone property Not limited to real estate Businesses with substantially all of tangible property owned or leased in QO zone Cannot be golf course, country club, gaming, etc.

6 Qualified Opportunity Zones Temporary deferral of gain 180-day reinvestment of gain directly in fund Deferral ends on earlier of date of next sale, or 2026 Percentage of deferred gain recognized depends on holding period < 5 years: 100% > 5 but < 7 years: 90% > 7 years: 85% Permanent exclusion of gain on sale of QO fund Appreciation in the investment 10-year hold requirement

7 Qualified Opportunity Zones

8 GAIN DEFERRAL What gains can be deferred? Proposed regulations provide that only capital gain is eligible for deferral Must stem from an actual, or deemed, sale or exchange with unrelated party Related person threshold is 20%, instead of 50% Must be realized & included in computation of capital gain by taxpayer Need further guidance on 1231 gains (net loss is ordinary while overall gain is capital) Section 1256 gains

9 GAIN DEFERRAL Who can defer a gain? Eligible taxpayers Person that may recognize gains for federal income tax purposes (includes C corps, REITs, RICs) Pass-through entities such as partnerships, S corps, decedent's estates & trusts Owners or beneficiaries are eligible if gain not deferred at pass-through level Taxpayers cannot invest in OZ property directly; must invest through QOFs

10 REINVESTMENT PERIOD 180-day reinvestment period Gain (or portion of gain) must be reinvested in QOF within 180 days of sale/deemed sale Proposed regulations clarify 180-day period begins on date gain is recognized for federal income tax purposes 180-day reinvestment period begins at end of passthrough entity s taxable year Optional: owner may elect to use day gain was recognized by entity to start the 180-day period 180-day window for 1256 capital gains begins on last day of taxable year

11 REINVESTMENT PERIOD Example: partnership investments On January 1, 2019, Partnership P realizes $100K capital gain & decides not to elect to defer Two of five partners want to defer their allocable portions of that gain Partner 1 invests $20K in QOF on February 2020 Investment falls within 180-day window under general rule (window begins on last day of partnership s year-end) Partner 2 invests $20K in QOF on February 2019 Investment falls within 180-day window under elective rule (partner elects to use date of sale to start 180-day period)

12 REINVESTMENT PERIOD REITs & RICs 180-day period starts when capital gain dividends are paid For undistributed capital gains, 180-day period begins at end of taxable year

13 Treatment of deferral over the years When deferral expires, if held for five years, taxpayers receive basis step-up equal to 10% of deferred gain If held for seven years, taxpayers receive additional 5% basis adjustment (reduction of gain) Reporting of deferred gain retains character of original gain Taxpayers may also elect to permanently exclude gain related to QOF appreciation after a 10-year holding period 10-YEAR BASIS ADJUSTMENT RULES

14 Expiration of zone designations is December 31, year holding period Expiration of zone designations will not impact time frame for making basis adjustment election Additional 10-year window Proposed regulations provide taxpayer has until December 31, 2047, to make election 10-YEAR BASIS ADJUSTMENT RULES

15 Rules for a QOF Entity treated as a corporation or partnership for federal income tax purposes eligible to selfcertify as using Form 8996 Preferred interest or special allocations Cannot be debt instrument Can be used as collateral for loan Partners share of liabilities ( 752(a)) is not treated as additional investment (mixed fund) & does not increase qualified investment Pre-existing entities may qualify by satisfying requirements under 1400Z-2(d) Note: existing tangible property will not qualify for the 90% test FUND ENTITY REQUIREMENTS

16 Self-certify as a QOF Form 8996 attached to federal income tax return for applicable year(s) Entity may choose to identify taxable year & first month of that year to be treated as QOF Failure to specify: treated as qualified on first month of entity's tax year Initial testing dates FUND ENTITY REQUIREMENTS

17 Example: initial testing dates Corporation formed in February, but elects April first month as QOF Investments before April do not qualify for deferral Testing periods are end of September & end of December (first 6-month period of taxable year of the period in which it was a QOF & end of year FUND ENTITY REQUIREMENTS

18 ASSET TESTS 90% asset test Initial test (6 months) & annually at year-end Must be used when QOF invests in tangible assets The QOF may use asset values that are reported for applicable financial statement (AFS) purposes AFS includes those filed with federal agency other than IRS, e.g., SEC or audited financial statements If financial statements are not prepared, QOF required to use unadjusted cost basis of its assets

19 ASSET TESTS Opportunity zone businesses Substantially all of the businesses assets must be OZ business property Substantially all defined for this purpose under the proposed regulations as 70% 50% of OZ business total gross income must be from active conduct of trade or business Applicable financial statement rule also applies here as well 5% zone taxpayer rules

20 SUBSTANTIAL IMPROVEMENT REQUIREMENT & LAND Substantial improvement requirement with respect to purchased building located in OZ Additions to basis of property acquired by the QOF must exceed an amount equal to the adjusted basis of property at beginning of 30-month period When measuring substantial improvement for an acquired building, cost of land ignored

21 SUBSTANTIAL IMPROVEMENT REQUIREMENT & LAND Example: substantial improvement requirement Z Partnership acquires building & land for $1M. Cost allocated to land is $200K & building is $800K Required minimum improvements to meet substantial improvement requirement is $800K

22 WORKING CAPITAL SAFE HARBOR Invest contributed funds in sufficient time 90% test must be met six months from beginning of creation of QOF Safe harbor provided by proposed regulations states property can be held by QOF as working capital for period up to 31 months Must be a written plan identifying financial property to be considered working capital Must be written schedule of how & when property will be used QOF must comply with written plans & schedule

23 WORKING CAPITAL SAFE HARBOR Example: working capital safe harbor Taxpayer realized $10M gain & reinvested in QOF within 180-day period QOF immediately purchased OZ land with intent to construct building QOF had written plans to acquire land & construct building $1M of the $10M reinvested was dedicated to purchase of land Plans provided for construction within 30 months QOF had no other gross income during 31-month period

24 WHAT QUESTIONS REMAIN Additional guidance What happens if a QOF fails 90% test What could cause decertification Clarification of 1231 gain issues Rules regarding reinvestment of OZ property by OZ Fund

25 WHAT QUESTIONS REMAIN Additional resources BKD's Tax Reform Resource Center Article: "Opportunity Zone Guidance Issued by IRS (by Derek Smith & Michael Hill) One-page summary: Qualified Opportunity Zones Under the Tax Cuts and Jobs Act Simply Tax podcast: Episode 41: What s a Qualified Opportunity Zone?

26 Questions?

27 CONTINUING PROFESSIONAL EDUCATION (CPE) CREDITS BKD, LLP is registered with the National Association of State Boards of Accountancy (NASBA) as a sponsor of continuing professional education on the National Registry of CPE Sponsors. State boards of accountancy have final authority on the acceptance of individual courses for CPE credit. Complaints regarding registered sponsors may be submitted to the National Registry of CPE Sponsors through its website: The information contained in these slides is presented by professionals for your information only & is not to be considered as legal advice. Applying specific information to your situation requires careful consideration of facts & circumstances. Consult your BKD advisor or legal counsel before acting on any matters covered

28 CPE CREDIT CPE credit may be awarded upon verification of participant attendance For questions, concerns or comments regarding CPE credit, please the BKD Learning & Development Department at

29 Thank You! Derek Smith, CPA Michael Hill, CPA