Investing in Opportunity Zones

Transcription

1 Investing in Opportunity Zones for the 2018 Defense Communities National Summit Gregory Clements Partner, Dover Novogradac & Company LLP

2 Taxpayers can get capital gains tax deferral (& more) for making timely investments in Qualified Opportunity Funds (QOFs) which invest in Qualified Opportunity Zone Property

3 3 Tax Incentive Benefits Gain Deferral Partial forgiveness Forgiveness of additional gains

4 Period of Deferral The period of capital gain tax deferral ends upon the earlier of: Dec. 31, 2026, or EARLIER SALE

5 Amount Recognized THE LESSER OF: 1. Amount of gain deferred or 2. The fair market value of investment in QOF interest MINUS: Taxpayer s basis in the QOF interest Note: The taxpayer s basis in the Opportunity Fund is initially deemed to be zero.

6 Partial Forgiveness and Forgiveness of Additional Gains Basis is equal to Fair Market Value SALE INVESTMENT Basis increased by 10% of the deferred gain Basis increased by 5% of the deferred gain Forgiveness of gains on appreciation of investment Requires an election Up to 90% taxed Up to 85% taxed HELD FOR 5 YEARS HELD FOR 7 YEARS HELD FOR 10 YEARS

7 Sample Investment Jan. 2, 2018 Taxpayer enters into a sale that generates $1M of capital gain June 30, 2018 (Within 180 days), Taxpayer contributes entire $1M of capital gain to a Qualified Opportunity Fund Taxpayer is deemed to have a $0 basis in its QOF investment QOF Invests the $1MM in Qualified Opportunity Zone Property

8 Sample Investment June 30, 2023 (After 5 years), Taxpayer s basis in investment in QOF increases from $0 to $100k June 30, 2025 (After 7 years), Taxpayer s basis in investment in QOF increases from $100k to $150k Dec. 31, 2026 $850K of the 1MM of deferred capital gains are taxed and the basis in QOF investment increases to $1MM. June 30, 2028 (after 10 years), Taxpayer sells its investment for $2.0MM. Basis in the investment is deemed to be FMV. The effect is no tax on appreciation in investment

9 10.00% 9.00% 8.00% 7.00% 6.00% 5.00% 4.00% 3.00% 2.00% 1.00% 0.00% Opportunity Zone Incremental Benefit Standard After Tax IRR Total IRR 9.08% 8.08% 7.95% 7.71% 6.00% 6.00% 6.00% 6.00% 5 Year 7 Year 12/31/ Year 23.8% Tax Rate 5 Year 7 Year 12/31/ Year Standard After Tax IRR 6.00% 6.00% 6.00% 6.00% Incremental OZ Benefit 2.08% 1.95% 1.71% 3.08% OZ Investment IRR 8.08% 7.95% 7.71% 9.08% Percentage Increase 35% 32% 29% 51%

10 State Tax Implications Opportunity Zone benefits increase if states conform to the Federal Law Some states piggy-back off of the current Federal Law but could decouple from OZs New York decided not to decouple Hawaii decided to decouple North Carolina released a draft bill that would decouple Some states do not conform to Federal Law but could add OZs at the state level Colorado is considering a bill to add the OZ benefit at the state level Some states do not have a state income tax (e.g. Alaska, Florida, Nevada, South Dakota, Texas, Washington, and Wyoming). State Tax Implications of an single OZ transaction may include multiple states State where original gain was realized State (s) where the opportunity fund has nexus Some states are tying other State incentives to opportunity zones Missouri proposed increased cap for state historic credits for properties in OZs California introduced a bill to exempt projects in OZs from the CA Environmental Quality Act

11 Eligible Areas Where are the Opportunity Zones?

12 Opportunity Zones Population Census Tract that is in a low-income community 37% of the United States What is a low-income community? Same definition for New Markets Tax Credits Based upon Poverty Rate (over 20%) or Median Family Income (under 80%) Contiguous tracts (must not exceed over 15% of MFI of the contiguous LIC tract)

13 74,001 Census Tracts

14 31,680 LICs - 9,453 Contiguous Tracts Cross State Census Tracts Contiguous tracts Low-income community

15 Qualified Opportunity Zones Initial deadline was March 21, could be extended to April 20. Treasury designated OZs in all states.

16 Designated Opportunity Zones as of June 14 Opportunity Zones Low-income community

17 Puerto Rico Opportunity Zones

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19 Designated Opportunity Zones and Promise Zones

20 Qualified Opportunity Zones CDFI Fund Opportunity Zones Mapping Tool:

21 Qualified Opportunity Zones QOZs remain in effect for 10 years following designation.

22 Qualified Opportunity Fund

23 Qualified Opportunity Fund - Purpose An investment vehicle organized as a corporation or a partnership for the purpose of investing in Qualified Opportunity Zone Property (QOZP).

24 Qualified Opportunity Fund Assets Test Must hold at least 90% of assets in QOZP, determined by the average of the percentage of QOZP held on: The last day of the first six month period of the fund s taxable year, and The last day of the fund s taxable year June 30th December 31st JAN FEB MAR APR MAY JUN JUL AUG SEPT OCT NOV DEC

25 Certification Process An eligible taxpayer self-certifies to become a certified qualified opportunity fund. No approval or action by the IRS is required. A taxpayer merely completes a form (which will be released in the summer of 2018) and attaches that form to the taxpayer s federal income tax return for the taxable year. The return must be filed timely, taking extensions into account.

26 Qualified Opportunity Fund Noncompliance Penalty Failure to meet 90% investment standard Per month penalty for failing to meet 90% test x % shortfall underpayment rate penalty No penalty if it is shown failure is due to reasonable cause (Federal short-term rate plus 3%) currently 5.34%

27 What is Qualified Opportunity Zone Property Qualified Opportunity Zone Property (QOZP) Qualified Opportunity Zone Partnership Interest Qualified Opportunity Zone Stock Qualified Opportunity Zone Business Property

28 Qualified Opportunity Zone Stock and Partnership Interests The investment must be acquired after December 31, 2017 in exchange for cash; Must be a qualified opportunity zone business, or is being organized for the purpose of being a qualified opportunity zone business; Must remain a qualified opportunity zone business for substantially all of the qualified opportunity fund s holding period

29 Qualified Opportunity Zone Businesses (QOZB) for Indirect Investments A trade or business in which substantially all of the tangible property owned or leased by the taxpayer is qualified opportunity zone business property (QOZBP) and: At least 50% of income derived from Active Conduct Substantial portion of intangible property used in active conduct of business < 5 percent unadjusted basis of property is nonqualified financial property

30 QOZB: Excluded Businesses Can t be a Sin Business A private or commercial golf course, country club, massage parlor, hot tub facility, suntan facility, racetrack or other facility used for gambling, or any store the principal business of which is the sale of alcoholic beverages for consumption off premises.

31 Qualified Opportunity Zone Business Property (QOZBP) for Direct and Indirect Investments Tangible property used in a trade or business Acquired by purchase from an unrelated party (20% standard) after December 31, 2017 During substantially all of holding period, substantially all the use is in a QOZ Original use in the QOZ commences with the taxpayer OR Taxpayer substantially improves the property during any 30-month period after acquisition, additions to basis exceed an amount equal to the adjusted basis of such property at the beginning of such period

32 Comparison of Requirements by Direct and Indirect Investment by Opportunity Fund Requirement Direct Investment Indirect Investment Percentage of O Fund s assets that must be invested in qualified opportunity zone business property Percentage of O Fund s assets that must be invested in stock or partnership interests Percentage of O Fund s assets that may be held in cash or other liquid investments Percentage of O Fund s assets that may be held in intangible property 90% N/A N/A 90% 10% (together with intangible property) 10% (together with cash) 5% plus reasonable working capital Unlimited, but intangible property must be used in trade or business Percentage of O Fund s assets that must be invested in tangible property 90% No minimum Percentage of gross income that must be derived from O Zone None 50% Ineligible Businesses None Sin Businesses

33 Readily Identifiable Investment Types in Opportunity Zones Commercial Real Estate Development and Renovation in Opportunity Zones Opening New Businesses in Opportunity Zones Expansion of Existing Businesses into Opportunity Zones Large Expansions of Businesses already within Opportunity Zones

34 LIHTC Combining with Other Tax Incentives Opportunity Zone NMTC HTC RETC

35 Recommendations for Guidance on OZs Guidance on whether a taxpayer can benefit from the 10 year holding period election to increase investment basis to fair market value when opportunity fund property is sold before a taxpayer sells his/her investment. Guidance is needed on the definition of the active conduct of a business for purposes of a qualified opportunity zone business. Guidance is needed on whether an established low-income community business can qualify as a qualified opportunity zone business Guidance is needed on the meaning of sale or exchange for the purpose of the end of the deferral period. Whether an LLC qualifies as an Opportunity Fund Law states that a Opportunity Fund must be organized as a partnership or corporation

36 Investing in Opportunity Zones for the 2018 NALHFA Annual Conference Gregory Clements Partner, Dover Novogradac & Company LLP