Posted by Joseph Zimmerl:

Under the 2017 Tax Cuts and Jobs Act, Opportunity Zones were added to the tax code under Internal Revenue Code section 1400Z-2.  The designation of a community as Opportunity Zone means the community is economically distressed and entitles certain investments made in those communities to preferential tax treatment.  Several communities in the Central Valley including some in Fresno, Madera, and Kings county have already be selected as Opportunity Zones.

Only investments in a Qualified Opportunity Fund (“QOF”) qualifies for this preferential tax treatment. 90% of a QOF’s assets must be businesses or property in an Opportunity Zone.   The rules governing creation of QOFs must be strictly adhered to and may be difficult to maneuver.  However, Opportunity Zones still provides businesses in those communities with a great opportunity to receive additional capital.   

            Investment in Opportunity Zones can provide taxpayers with the following two tax benefits:   

1.      Deferment of Gains: Investors can defer the capital gains of a sale by investing in a QOF until the investor sells or exchanges his investment in the QOF or December 31, 2026.  In addition, if the investor retains his QOF investment for five years 10% of the deferred capital gain will be permanently excluded and if the investment is held for seven years an additional 5% of deferred capital gain is excluded; for a total exclusion of 15%.

  –          Ex. 1 T sells 300 acres of property in 2019 and realizes $1,000,000 in capital gain on the sale.  T invests $1,000,000 in a QOF.  The $1,000,000 in capital gain is deferred until T sells or exchanges the QOF investment or December 31, 2026.

–          Ex. 2 Same facts as Ex. 1.  T holds onto the QOF investment for 7 years or until 2026.  T will realize only 85% or $850,000 of the deferred gain from the 2019 sale.   The remaining $150,000 is permanently excluded from recognition.

 2.      Exclusion of Capital Gain:  If an investor invests in a QOF and retains his or her investment in the QOF for 10 years, his or her basis in the investment will be equal to the fair market value of the investment at ten years.

 –          Ex. 3  P invests $3,000,000 in a QOF (none of the cash is from a deferred gain from a sale) and retains the investment for 10 years. After 10 years, the value of P’s investment is $6,000,000.  If P then sells the QOF investment at year 10, P will have to pay zero capital gains, despite realizing a gain of $3,000,000.