In October 2018, additional guidance was released for the Opportunity Zone program which went into effect earlier in the year on January 1, 2018. It helped clarify key issues that were not covered in the original legislation. Here is a quick synopsis of the main elements revealed by the new guidance and how investors will be affected by Atlanta Opportunity Zone taxes.
Capital Gains Qualifying For Investment
In the original legislation, a broad statement was made regarding capital gains that are associated with the Opportunity Zone program. The new guidance makes it more clear. It states the tax deferral eligibility for the following gains:
- Long-term capital gains
- Short-term capital gains
- Section 1231 gains
Both section 1250 and 1245 gains are not capital in nature and don't qualify. However, it should be noted that since short-term capital gains still maintain a character of being ordinary income, they should be taxed and treated as ordinary income rates.
Required Tax Forms
Initial legislation required that the investment of eligible capital gains is only allowed to be put into a Qualified Opportunity Fund (QOF), and the time period for this has to be within 180 days after recognizing the gain. The regulations states that investors will report this to that IRS by using Tax Form 8949, which is also used for sales of capital assets.
Instructions and an updated form are expected, which will probably include fields for the following:
- Amount of realized gain
- Date placed into the QOF
- Name of the QOF
Our Atlanta Opportunity Zone CPAs will be able to clarify this once any new updates are released.
The legislation allows the gains to be invested at either the partnership level or individual partner level when the investment is made by a pass-through entity such as a partnership, the 180 day period must begin on the date that the gain is recognized. If made by an individual partner, there are two choices in which the 180 day period will begin:
- On the same date that the gain was recognized by the partnership
- On the ending day of the taxable year for the partnership
Reasonable Working Capital Definitions
A QOF must have at least 90 percent of its assets in QOZ property. The calculation comes from the average amount of the percentage of Qualified Opportunity Zone property that's held in the fund, which is measured:
- On the taxable years last day of the fund
- On the ending day of the first six months for the taxable year
Proposed regulations will allow the inclusion of working capital as QOZ property in order to meet the 90 percent test. However, the following must apply as well:
- Amounts are required to be designated for substantial improvement, construction or acquisition of tangible property
- Working capital funds must be spent within 31 months of receipt
- Must have a detailed written plan regarding the purpose for the working capital
This is a critical clarification, which provides a way for a QOF to greatly improve a property without the risk of failing the criteria of the 90 percent test.
Land Exclusion Criteria
Originally, to be recognized as QOZ property, any improvements made must exceed an amount that's equal to that of the adjusted basis of properties during the 30 month time period, which begins after the acquisition date. This was narrowed down in the proposed regulations to only encompass the adjusted basis of pre-existing buildings. It was also stated that in areas where a building is already located, there's no requirement to separately improve the land.
This clarification was crucial in regards to major cities like New York or Los Angeles where a large expense is often associated with the land when real estate renovations are completed.
Certification and Reporting
Self-certification of a QOF must be made to the IRS, which states eligibility for beneficial tax treatment. This certification should be made on IRS Form 8996. It requires a QOF to show that their organization's purpose for existing is to invest in QOZ property. It will also include information that will allow for the 90 percent test calculation and list any noncompliance penalties.
Tax-Free Gain Clarification
The main incentive for Atlanta investors who are taking advantage of the benefits that the Atlanta Opportunity Zone program has to offer is that their taxes on appreciation are exempt if they hold the investment for 10 years. In the proposed regulations, the IRS clarified a few unknowns. Appreciation for an investment made in an Opportunity Zone will stay tax-free for a period of about 30 years as the exemption date and on December 31, 2047.
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