The Treasury provided an early holiday gift to investors in December by releasing the final Opportunity Zone Program regulations. With few exceptions, in our opinion, the final regulations are taxpayer friendly and add much needed clarity to several important issues.
The final regulations are over 500 pages. This summary provides what we view as the key highlights from an investor perspective. There are several clarifying points for fund managers tied to the administration of the funds as well as additional flexibility in what qualifies for investment within a Qualified Opportunity Fund (“QOF”) that are beyond the scope of this summary. If you would like to discuss the final regulations in more detail, or have any questions, please reach out to us at Platform Ventures ([email protected]).
Key highlights for Investors from the Final Opportunity Zone Regulations Summary:
10-year Tax Benefifit is Available for Asset Sales
As a quick refresher, if an investor holds its QOF interest for at least 10 years, there is no federal income tax on the gain realized by the investor at the sale of the QOF investment. The 10-year tax benefit, as drafted in the proposed regulations, required an investor to sell its ownership interest in the QOF as opposed to selling the assets. This made the exit from real estate assets held in a multi-asset fund tricky because it assumed a buyer would need to buy an interest in an existing entity versus a typical asset sale. The exit permitted under the proposed regulations was not seen as ideal for buyers, as there was concern in the marketplace about possible discounts due to the added layer of complexity at exit versus a typical asset sale. The final regulations, however, now permit investors to elect the 10-year tax benefit on any gain allocated to them from a sale or exchange of property by either the QOF or the Qualified Opportunity Zone Business (“QOZB”), which opens the door to typical asset sales versus entity end of the 10-year investment period.
Section 1231 Gains Flexibility
The proposed regulations required investors to net Section 1231 gains and losses (i.e. net gains and losses generated from the sale of real property used in a business) as of the last day of the investor’s taxable year (typically December 31st). Under the proposed regulations, investors were only able to invest the net Section 1231 gain within 180 days from the end of the taxable year. The final regulations allow Section 1231 gain investment in a QOF by permitting an investor to invest gross Section 1231 gains as eligible gain into a QOF without regard to Section 1231 losses. Further, Section 1231 gains are now subject to the same timing rules as other capital gains. In other words, an investor no longer needs to wait until the end of his taxable year to determine his eligible Section 1231 gains. Investors have the option to invest within 180 days of the realized Section 1231 gross gain. The gross Section 1231 gain, however, cannot be subject to recapture from personal property that would be treated as ordinary income. We believe, the change in the final regulations is beneficial for investors as it not only increases the amount of gain they may invest in QOFs, but also allows investors to take an ordinary tax deduction for their Section 1231 loss in the current year while concurrently deferring tax on their Section 1231 gain.
Flexibility for Investors that Experience an Inclusion Event that May Otherwise Generate a Taxable Gain
If an investor experiences an inclusion event (i.e. an event where the investor receives a distribution of property with a FMV in excess of the taxpayer’s basis) before the end of 2026 either from the full sale of the investor’s entire QOF interest or a partial disposition of the QOF investment, the deferred gain will be realized and taxed dollar for dollar. However, under the final regulations, the investor can reinvest the deferred gain created by the inclusion event as eligible gain within 180 days from the date of the inclusion event. The holding period for the investor resets to begin on the date of the reinvestment into a QOF and can remain eligible for the 10-year tax free benefit and possibly the 10% step-up in basis benefit (if the inclusion event occurs prior to December 31, 2021). Under the proposed regulations, the option for a second deferral had applied only when a taxpayer sold its entire interest in the QOF.
REIT Capital Gain Dividends
The final regulations also provide that an investor seeking to invest the capital gain dividends received from a REIT or RIC investment can now elect an investment period that is:
i) 180 days from the close of the shareholder’s tax year in which the capital gain dividend would otherwise be taxed, or
ii) 180 days from when the shareholder receives the capital gain dividend from a REIT or RIC.
The provision adds flexibility; however, investors should remember the total amount of capital gain dividends that are eligible for the QOF investment and the subsequent tax benefits are still capped at the total amount of capital gain dividends reported or designated by the REIT or RIC during the shareholder’s taxable year. REIT or RIC investors may want to confirm the amount of capital gain dividends designated for the year prior to making an eligible opportunity zone investment.
The final regulations provided some flexibility when investing gains generated from installment sales (i.e. a sale with multiple payments). The final regulations made clear that installment sales can either i) recognize and measure the 180-day period all in the year of the sale, using a December 31st start date; or ii) make qualifying investments over the years that the gain is recognized. Further, the final regulations also confirmed that taxpayers who had installment sales before the opportunity zone rules became law in December of 2017 can still receive opportunity zone treatment for gains to be recognized on the installment method in later years.
Foreign Investors/Nonresident Investment
The final regulations provide that nonresident alien individuals and foreign corporations may make Opportunity Zone investments with capital gains that are effectively connected to a U.S. trade or business. This includes capital gains on real estate assets taxed to nonresident alien individuals and foreign corporations under the Foreign Investment in Real Property Tax Act rules.
Overall, we are pleased to see the release of the final regulations and believe the Treasury provided some very investor-friendly clarifications. If you would like to discuss the final regulations in more detail or have any questions please reach out to us at Platform Ventures ([email protected]).
Platform Ventures and its affiliates do not provide tax, legal, accounting, or investment advice. This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, tax, legal, accounting, or investment advice. You should consult your own tax, legal, accounting, and investment advisors before engaging in any transaction as an investment in a Qualified Opportunity Fund is highly illiquid and may include substantial risks. A decision to invest in real estate or other assets should be made only after a careful review of the relevant offering materials, including consideration of the risks related to the investment.