On October 22, 2018, the IRS issued proposed regulations relating to the deferral of gain under IRC §1400Z-2 for investments in qualified opportunity zones (“QOZ”). The provision allows taxpayers to elect to defer capital gains that are invested in a qualified opportunity fund (“QOF”) within 180 days after the sale or exchange triggering the gain. Qualified Opportunity Funds must hold at least 90% of their assets in QOZ Property, and make “substantial improvements” to the purchased property. For additional details on QOZs, please see our original blog post on the subject here.
The proposed regulations cover several important topics, and help clarify questions related to:
Topics Related to Investors
- The types of gain that investors can defer.
- Eligible taxpayers that can elect to defer gains.
- Eligible investments.
- Treatment of land and buildings (important for the “substantial improvement” requirement).
- The deadlines for investing corresponding amounts of gain in a QOF.
- The manner in which investors elect to defer gain.
Topics Related to Qualified Opportunity Funds
- How a corporation or partnership self-certifies as a QOF.
- The valuation of QOF assets.
- The operations of QOZ businesses.
Gain Eligible for Deferral
The proposed regulations clarify that only capital gains are eligible for deferral. Ordinary gains and gains from sales to related parties are not eligible. A taxpayer may use the gain from a single sale to reinvest in multiple QOZs/QOFs within the 180-day investment period. The tax attributes of the deferred gain are preserved during the deferral period and taken into account when the gain is later recognized.
The proposed regulations provide special rules for determining the beginning of the 180-day period if the capital gain is a result of a “deemed” sale and there is no statutory language providing a specific date for the deemed sale.
Only taxpayers that would typically recognize capital gains can elect to defer the gain. These include:
- C-Corporations (including RICs and REITs)
- Certain other pass-through entities, including common trust funds, qualified settlement funds, disputed ownership funds, and other entities taxable under Reg. §1.468B
If a partnership has capital gains and does not elect to defer under §1400Z-2, a partner may choose to separately invest in QOZs/QOFs and defer their distributive share of gain outside the partnership.
Qualified investments only include equity interests in a QOF. Preferred stock and partnership interests with special allocations qualify as equity interests. Debt instruments and deemed contributions of money as a result of a partner’s assumption of partnership liabilities or increase in a share of partnership liabilities do not qualify. A qualified investment may be used as collateral for a loan.
Taxpayers may sell or exchange an interest in one QOF and reinvest in another QOF in order to defer tax on the previously deferred gain. The taxpayer, however, must sell or exchange the entire initial investment.
Treatment of Land and Buildings
As previously mentioned, QOFs must hold at least 90% of their assets in QOZ Property, and make “substantial improvements” to the purchased property. The “substantial improvement” test is met only if: During any 30-month period beginning after the date of acquisition of such tangible property, additions to basis with respect to such tangible property in the hands of the QOF exceed an amount equal to the adjusted basis of such tangible property at the beginning of such 30-month period in the hands of the QOF.
In determining the basis of the tangible property for purposes of the “substantial improvements” test, the proposed regulations clarify that the basis of land purchased along with a building in a QOZ is not taken into account in determining whether a building is substantially improved.
Additional regulations are expected to be issued to address several more questions and topics. A public hearing is scheduled for January 10, 2019. Contact your HLB Gross Collins, P.C. representative if you have questions or would like additional information.
- Jonathan Milhalter, CPA