Russell Stein
When President Donald Trump signed into law the Tax Cuts and Jobs Act late last year, it created the most significant changes the U.S. federal income tax laws have seen in over three decades. Real estate developers and investors may want to pay particular attention to the Opportunity Zone tax incentive program enacted as part of that legislation. This tax incentive is aimed at increasing economic development in low-income communities while giving investors the opportunity for significant tax savings.
The Opportunity Zone tax incentive program provides three potential tax savings opportunities for taxpayers who make an applicable election on their tax returns.
First, it provides immediate deferral of gain if proceeds from the sale of property (including stocks and real estate) are invested in a Qualified Opportunity Fund within a given time period. Second, it provides permanent exclusion of up to 15 percent of the deferred gain from taxation if the investment is held for at least seven years. Third, it can provide exclusion from taxation on any appreciation in the fund if the investment is held for at least 10 years prior to sale.
A Qualified Opportunity Fund is an investment entity organized as a domestic corporation or partnership that invests in businesses or properties located in a qualified opportunity zone – a low-income area designated by the governor of a state and approved by the U.S. Department of Treasury. A Qualified Opportunity Fund has to invest at least 90 percent of its assets in qualified opportunity zone businesses – generally any trade or business in which substantially all of the tangible property owned or leased by the business is in a qualified opportunity zone. There is no size requirement for the fund; it can hold a single investment or multiple investments, however certain businesses such as golf courses, gambling facilities and package stores are ineligible investments even if they are operated within an opportunity zone.
Gain Deferral and Exclusion
Investors making the applicable tax election will recognize the deferred gain in income on the earlier of the date the investment is sold or Dec. 31, 2026. If the investment in the fund is held for at least seven years, the investor can exclude 15 percent of the deferred gain from taxation when the investment is sold.
If the investment in the fund appreciates, the investor has the opportunity to exclude 100 percent of the appreciation from taxation if the investment is held for at least 10 years. This 100 percent exclusion only applies to the appreciation in the value of the investment since any deferred gain will be recognized by Dec. 31, 2026, even if the investment is not sold.
This is one example of how the tax incentive could work:
An investor sells tech stock on April 15, 2018, for a $500,000 capital gain. This investor would ordinarily have to pay taxes on the $500,000 capital gain. However, she finds a building in a qualified opportunity zone that she wants to buy and rehabilitate and, along with other investors, forms a limited partnership as a Qualified Opportunity Fund. She invests her $500,000 in the fund to purchase the property.
If she holds onto the investment until April 16, 2025, and then sells it for $800,000, she would only have to pay taxes on a $725,000 gain, excluding 15 percent ($75,000) of the original deferred gain from taxation. However, if she holds onto her interest until April 16, 2028, and then sells it for $800,000, she would only have had to pay taxes on a $425,000 gain at the end of 2026 (85 percent of the original deferred capital gain would be recognized automatically if she still holds the property on Dec. 31, 2026) and the remaining $375,000 in appreciation would be tax-free (assuming the income tax code does not change before then).
Massachusetts’ Qualified Opportunity Zones
In Massachusetts, there are 138 areas designated as Qualified Opportunity Zones, including areas in Boston, Brocton, Cambridge, Fall River, Framingham, Lowell, New Bedford, Quincy, Springfield and Worcester. It is intended that the opportunity zones will benefit the designated communities by providing an incentive for new businesses to be established or property redeveloped.
Investors and developers should keep the opportunity zone tax incentive in mind when they are considering projects where they can reinvest in a property or business. This is just a highlight of some of the main requirements of the opportunity zone tax incentive. Prior to creating or investing in a Qualified Opportunity Fund an investor should become familiar with all of the requirements and any further guidance the IRS may issue once the program becomes more established.
Russell Stein is of counsel with Partridge Snow & Hahn LLP. He may be reached at rstein@psh.com.
