AnOpportunity Zone is a designation and investment program created by the Tax Cuts and Jobs Act of 2017 allowing for certain investments in lower income areas to have tax advantages. The purpose of this program is to put capital to work that would otherwise be locked up due to the asset holder's unwillingness to trigger a capital gains tax.[1]
The first Opportunity Zones were designated in April 2018.[4] There are 8,764 Opportunity Zones in the 50 states, and five U.S. possessions, including American Samoa, Guam, Northern Mariana Islands, Puerto Rico, and the Virgin Islands.[5]
Not all Opportunity Zones are in low income communities. Per Internal Revenue Code Section 1400Z-1(e), up to five percent of the Opportunity Zones in each state can be non-low income tracts contiguous to low-income tracts.[6] In December 2019, Treasury issued final regulatory guidance on Qualified Opportunity Fund investing.[7]
To qualify, the Opportunity Fund must invest more than 90% of its assets in a Qualified Opportunity Zone Property located in an Opportunity Zone.[8] The property must be original use, or meet the definition of substantial improvement, meaning that the adjusted basis in the property must be doubled after purchase.[9]Capital gain taxes are deferred for investments reinvested into investments in these zones and, if the investment is held for ten years, all capital gains on the new investment are waived. Despite the tax benefits and broad bipartisan support,[10] the Opportunity Zones policy has its critics.[3] Opportunity Zones are census tracts nominated by state authorities and certified by the IRS. A total of 8,764 census tracts have been so designated.[11]
An investor who triggers an eligible gain (including capital gains and qualified 1231 gains) may reinvest the capital gain in a Qualified Opportunity Fund within 180 days in order to receive Opportunity Zone tax benefits.[8]
There are four major tax benefits available to U.S. taxpayers who timely reinvest eligible gains into Qualified Opportunity Funds that comply with the Opportunity Zone statute and IRS regulatory guidance.[12]
For tax reporting purposes, the eligible gain is deferred until December 31, 2026.
The tax liability on the reinvested eligible gains is reduced, through a basis step-up of either 10 or 15 percent. Note: The 15% benefit expired after December 31, 2019. The 10% benefit expired after December 31, 2021. Investments in QOFs made after December 31, 2021 no longer receive this benefit.
The tax liability resulting from the sale of the Qualified Opportunity Fund is eliminated, through a step-up to fair market value upon disposition, so long as the Qualified Opportunity Fund has been held for a period of at least 10 years.
There is no depreciation recapture upon the sale of depreciated Qualified Opportunity Zone Property.
In order to report the investment to the IRS, the taxpayer needs to file IRS Form 8997 annually.[13]
Prior to the law creating Opportunity Zones, an investor could defer capital gains taxes only through a like-kind exchange, i.e., by trading one asset with another asset in the same asset class by using a Section 1031 exchange.[1][14] Opportunity Zones are similar, but there are several key differences.[15] One such difference is that an Opportunity Zone does not require a like-kind exchange. Instead, by investing in a Qualified Opportunity Fund, an investor can defer any eligible gain (either capital gains or qualified 1231 gains) arising from the transaction of a property in any asset class (e.g., stocks, privately held business, real estate, collectibles, etc.).[1][14]
