In an article for Accounting Today published recently, Bennett Thrasher partner Trey Webb offered insight on the second round of Internal Revenue Service (IRS)-proposed regulations on Qualified Opportunity Zones (QOZs), which were originally included in the Tax Cuts and Jobs Act. QOZs seek to attract investment in designated low-income communities through tax incentives in an effort to encourage economic growth and job creation in the area. While the newest round of regulations may be extensive, they have some distinct advantages for businesses investing in QOZs.
“If a taxpayer has capital gain and makes an investment in a QOZ Fund, they can defer that gain up to the amount of the investment in the fund. So if they have $100,000 gain and they make that investment in the QO fund, they can defer the recognition of that gain until the earlier of the date it is sold or exchanged, or Dec. 31, 2016. If I hold that investment for five years, I get a step-up in basis – a permanent exclusion – of 10 percent of that gain,” Trey explains. “So if I hold the $100,000 for five years, I can exclude $10,000 from tax. And if I hold it for an additional two years, for a total of seven years, I can permanently exclude an additional 5 percent, so that I will only recognize $85,000 of gain. But if I hold the investment for three more years, or for 10 or more years, and it grows to $125,000, I never have to recognize gain on the $25,000 gain on the initial investment in the fund.”
Trey mentions that the second set of proposed regulations clarified some provisions from the first round, modified some others and “provided additional guidance based on comments the IRS received and those made in the public hearing.” He explains that one of the challenges from the first round of regulations surrounded the disposal of assets after a taxpayer holds them for more than 10 years and whether they could exclude gain on the sale of these properties. As clarified in the new round of regulations, taxpayers can now exclude the gain on the sale of these properties and can dispose of them individually.
Another concern regarding the first round of regulations was that 50 percent of a business’s gross income of the QOF had to derive from activity in that zone. “There was concern that this requirement would prevent a lot of businesses other than real estate, retail or restaurants from qualifying as being actively conducted in the QOZ — for example, a startup internet company that is selling to a worldwide customer base.” However, the IRS added safe harbors to clarify this requirement.
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