Opportunity Funds are a new class of investment vehicles that aim to responsibly drive much-needed capital into rural and low-income urban communities. Opportunity Funds will activate passive holdings by connecting investors to investment opportunities located in newly designated Opportunity Zones.
This concept – originally introduced in the Investing in Opportunity Act (IIOA) – is the first new community development tax incentive program introduced since the Clinton Administration. The program will allow U.S. investors to receive a temporary tax deferral and other tax benefits when they reinvest unrealized capital gains into O Funds for a minimum of five years. Today, trillions of dollars in unrealized capital gains are held in stocks and mutual funds alone. This capital could soon be invested in Oz Opportunity Fund to uplift local economies throughout the nation.
The Tax Cuts and Jobs Act (TCJA) was passed into law at the end of 2017 and made changes that affect all kinds of taxes – individual, corporate, partnership and other “passthrough” business entities, estate, and even tax-exempt organizations. Most changes from the Tax Cuts and Jobs Act took effect on January 1, 2018 and are slated to sunset after December 31, 2025. However, there are a few provisions from the new tax law that have a 2019 effective date and some are retroactive.
Taxpayers realizes capital gain from a capital gain triggering event (e.g., taxpayer sells corporate stock).
The capital gain must stem from a sale or exchange with an unrelated party that occurred within the previous 180 days.
Taxpayers can not invest in Opportunity Zone Property directly. All investments must be made through Opportunity Funds.
Must be tangible property, such as real estate or equipment, acquired from an unrelated party after December 31, 2017.
During “substantially all” of the Opportunity Fund’s holding period of the property, the property must be used within an Opportunity Zone.
Either the “original use” of the property in the Opportunity Zone must be with the Opportunity Fund or the Opportunity Fund must “substantially improve” the property within 30 months.
Must be stock or a partnership interest in a domestic company, acquired with cash after December 31, 2017.
Upon acquisition and during “substantially all” of the Opportunity Fund’s holding period of the investment, the company must be considered an Opportunity Zone Business.
“Substantially all” of the business’s owned or leased tangible property must meet the requirements for Opportunity Zone Business Property.
At least 50% of the business’s total gross income must be derived from the “active conduct” of the business.
A “substantial portion” of the business’s intangible property must be used in the “active conduct” of the business.
Less than 5% of the average bases of the business’s property is attributable to nonqualified financial property (e.g., stocks).
The business cannot be a “sin business,” such as a country club, hot tub facility, racetrack, or liquor store.
The title of IRC Section 1400Z-2 is, “Special Rules for Capital Gains Invested in Opportunity Zones,” but the body of IRC Section 1400Z-2 refers to “gain” without the word “capital” or other qualifications.
The legislative history indicated that eligible gain may have been limited to long-term capital gain.
The statute does not specify what types of “gain” a taxpayer can invest into an Opportunity Fund in order to receive tax benefits.
The proposed regulations clarify that gain is eligible if it is “treated as a capital gain for Federal income tax purposes.”
"Form 8949: Sales and Other Dispositions of Capital Assets" is an Internal Revenue Service (IRS) form used by individuals, partnerships, corporations, trusts and estates to report capital gains and losses from investment. Taxpayers must use the form to report short- and long-term capital gains and losses from sales or investment exchanges.
Individuals must use the form to report the following:
IRC Section 1400Z-2 states that an Opportunity Fund must hold “at least 90% of its assets in qualified Opportunity Zone Property,” tested by averaging the percentage of Opportunity Zone Property held in the Opportunity Fund at the end of the first six-month period and the last day of the tax year.
In an Opportunity Fund’s first year, the first test date for the 90% asset test will be the end of the first six months in the tax year that the entity is an Opportunity Fund and the second test date will be the last day of the tax year. If an Opportunity Fund is created in the second half of its tax year, the only test date will be the last day of the tax year. The Opportunity Fund will need to annually report its compliance with the 90% asset test.
IRC Section 1400Z-2 provides that an Opportunity Fund must have 90% of its assets invested in Opportunity Zone Property. IRC Sections 1400Z-2 and 1397(b) provide that in order for corporate stock or a partnership interest in a business to constitute Opportunity Zone Property, the business is limited in the amount of “nonqualified financing property” that it can hold, with an exception for “reasonable amounts of working capital.” However, neither statute defines “reasonable amounts of working capital.”
Opportunity Zones are an economic development tool—that is, they are designed to spur economic development and job creation in distressed communities.
A Qualified Opportunity Fund is an investment vehicle that is set up as either a partnership or corporation for investing in eligible property that is located in a Qualified Opportunity Zone.
Opportunity Zones are designed to spur economic development by providing tax benefits to investors. First, investors can defer tax on any prior gains invested in a Qualified Opportunity Fund (QOF) until the earlier of the date on which the investment in a QOF is sold or exchanged, or December 31, 2026. If the QOF investment is held for longer than 5 years, there is a 10% exclusion of the deferred gain. If held for more than 7 years, the 10% becomes 15%. Second, if the investor holds the investment in the Opportunity Fund for at least ten years, the investor is eligible for an increase in basis of the QOF investment equal to its fair market value on the date that the QOF investment is sold or exchanged.