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Greenbaum, Rowe, Smith & Davis LLP Client Alert

On October 17, 2018, the Internal Revenue Service released proposed regulations and commentary concerning the opportunity zone program, a key component of the 2017 Tax Cuts and Jobs Act (TCJA). The opportunity zone program is intended to encourage long-term capital investments into select low-income communities through the use of a new type of investment vehicle known as a Qualified Opportunity Fund (QOF). This Client Alert presents an overview of the opportunity zone program, QOFs, and the IRS’s recently proposed regulations.

What Are Opportunity Zones? 

Under the TCJA, eligible opportunity zones must be low-income census tracts with a poverty rate of 20% or a median family income of up to 80% of the area median.  There are currently 169 census tracts (located in 75 municipalities) designated as opportunity zones in New Jersey, the maximum number permitted in the state under the TCJA.   Accordingly, the opportunity zone program constitutes a significant incentive tool to further encourage redevelopment opportunities throughout the state at eligible locations.

What Constitutes a Qualified Opportunity Fund? 

QOFs are investment vehicles organized as a corporation or partnership for the purpose of investing in qualified opportunity zone property (other than another QOF).  At least 90% of a QOF’s assets must be invested in qualified opportunity zone property.  In addition to direct ownership of real estate located in opportunity zones, qualified opportunity zone properties may include other “qualified opportunity zone business property” and equity interests in a “qualified opportunity zone business.”

To constitute a “qualified opportunity zone business property,” the property must be used in an opportunity zone along with new capital to “substantially improve” same so long as (1) the property was acquired by purchase after December 31, 2017; (2) the original use of the property in the opportunity zone commences with the QOF, or the QOF substantially improves the property; and (3) substantially all of the use of the property occurred in a qualified opportunity zone during the QOF’s holding period for the property.

For a trade or business to qualify as a “qualified opportunity zone business,” substantially all (i.e., 70% per proposed regulations) of the tangible property owned or leased by the business entity must constitute qualified opportunity zone property.  Moreover, the entity must be a “qualified opportunity zone business” both (1) when the QOF acquires its equity interest in the entity and (2) during substantially all of the QOF’s holding period for that business.

Under the opportunity zone program, capital gains invested in a QOF are deferred until the sooner of the date the investment is sold or exchanged, or on December 31, 2026. This allows investors to roll their capital gains into a QOF with no up-front tax penalty.  Moreover, qualified taxpayers may also exclude (1) 10% of the deferred gain from inclusion in income if the investments are held in a QOF for longer than 5 years, (2) 15% of the deferred gain from inclusion in income if the investments in a QOF are held longer than 7 years, and (3) the entire post-acquisition gain if the qualifying investment is held in the QOF for 10 years or more.  

What Do the Proposed IRS Regulations Do? 

The proposed opportunity zone regulations provide: (1) taxpayer requirements in order to defer the recognition of gains through QOF investments; (2) rules permitting corporations/ partnerships to self-certify as QOFs and (3) requirements for corporations/partnerships to qualify as a QOF.  The proposed regulations also address the “substantial-improvement requirements” with respect to buildings purchased in qualified opportunity zones.  

Key opportunity zone issues addressed in the proposed regulations include:

The IRS is currently soliciting comments on the proposed opportunity zone regulations.  Moreover, additional proposed regulations will be forthcoming from the IRS in the near future.  We will continue to monitor and advise as the IRS promulgates further guidance and finalizes its opportunity zone regulations. 

Please contact the author of this Alert, Matthew J. Schiller, with any questions concerning opportunity zones in New Jersey.