The recently enacted Tax Cuts and Jobs Act (“TCJA”) introduced two tax saving opportunities. One option permits a taxpayer to defer gain from the sale of property that is reinvested in an investment in a Qualified Opportunity Fund (“QO Fund”). The second option permits the taxpayer to permanently exclude gain from the sale or exchange of the taxpayer’s investment in the QO Fund. These options can provide substantial tax benefits for a taxpayer who can comply with the detailed and complex QO Fund requirements.
Designation of a Qualified Opportunity Zone (“QO Zone”). Under the TCJA, a state’s chief executive officer (generally the governor) had the opportunity to nominate certain census tracts that are low-income communities as QO Zones. The IRS then reviewed and certified the nominated tracts. The list of designated QO Zones can be found at Opportunity Zones Resources and in Federal Register at IRB Notice 2018-48.
Qualified Opportunity Fund (“QO Fund”). A QO Fund is an investment vehicle organized as a corporation or a partnership for the purpose of investing in a QO Zone. To become a QO Fund, an eligible corporation or partnership self-certifies by filing IRS Form 8996 with its federal income tax return. An LLC that chooses to be treated as a corporation or a partnership for federal income tax purposes may be a QO Fund. The QO Fund’s tax return with Form 8996 must be filed timely, taking extensions into account. QO Fund has to meet many requirements, including that substantially all of the QO Fund’s business property is used in a QO Zone. A penalty can apply to the QO Fund if it fails to meet the 90% requirement.
Temporary Gain Deferral. If a taxpayer invests gains from the sale or exchange of property (“Property Sale”) with an unrelated person in a QO Fund within the 180-day period beginning on the date of the sale or exchange, the taxpayer can elect to defer part or all of the gain from the Property Sale. The taxpayer makes the election to defer gain when filing his or her return for the year in which the gain would have been recognized if not deferred. The election is made by completing and attaching IRS Form 8949 to the taxpayer’s return.
Amending Returns to Elect Deferral. If a taxpayer made a Property Sale in a prior open year and failed to make the deferral election, the taxpayer may amend the return for that year and elect deferral on the gain on Property Sale by attaching IRS Form 8949 to the taxpayer’s amended return.
Recognition of Deferred Gain. A taxpayer defers the gain from the Property Sale until the later of the date on which the investment is sold or exchanged, or December 31, 2026. At that time, the taxpayer includes the excess of: (1) the gain on sale of the investment over the lesser of the amount of deferred Property Sale gain or the fair market value of the investment as determined on that date over (2) the taxpayer’s basis in the investment.
Basis in the Investment. A taxpayer’s basis in the investment is zero unless any of the following increases apply: (a) 10% of the deferred Property Sale gain if the investment is held for five years, (b) 5% of the deferred Property Sale gain if the investment is held for seven years; and (c) any deferred Property Sale gain recognized at the end of the deferral period.
Permanent Gain Exclusion. A taxpayer can elect to exclude any post-acquisition capital gains on an investment in a QO Fund if the investment in the QO Fund has been held for ten years.
When Elections Cannot be Made. A taxpayer cannot make an election to defer or exclude gain if there is already an election in effect with respect to the same sale or exchange. Also, a taxpayer cannot make a temporary deferral election with respect to any sale or exchange after December 31, 2026.
It is anticipated that the Treasury Department and the IRS will be providing further details, including additional legal guidance, on this new tax benefit. If you would like more information about deferring gain on sale or investing in a QO Fund, please contact one of our tax and business attorneys at 937-223-1130 or Jsenney@pselaw.com