New Rules Define How Much Real Estate Must Be Inside Zones to Get Tax Breaks
APRIL 17, 2019|MARK HESCHMEYER
This story was updated with additional guidelines.
The Internal Revenue Service released its long-awaited second round of regulations on investing in areas designated as economically distressed under the federal Opportunity Zone program, with the new rules providing greater flexibility for leased properties.
Under the law, any physical property used by a business qualifies if it was bought after Dec. 31, 2017. The new regulations extend the tax benefits to businesses operating in some real estate that is leased.
The Opportunity Zone law, which took effect last year, allows the deferral of all or part of a capital gain that is invested into a Qualified Opportunity Fund. The gain is deferred until the investment is sold or exchanged or Dec. 31, 2026, whichever is earlier. If the investment is held for at least 10 years, investors may be able to permanently exclude the gain from the sale or exchange of the investment.
“Who would have thought this was going to be so successful,” President Donald Trump said in announcing the rules. “Nobody thought it was going to catch on like it's going on.”
He added that the program is “anticipated to spur $100 billion in private capital investment.”
The new guidelines provide details on aspects of rules that have gone unspecified since the law took effect. They offer two new criteria that must be satisfied to qualify: At least 70 percent of the leased physical property must be in a qualified opportunity zone for at least 90 percent of the time the business leases it.
The guidance also notes for the first time that there are situations where deferred gains may become taxable if investors transfer their interest in a qualified opportunity fund, an investment pool used for buying properties in the zones.
For example, if the transfer is done by gift the deferred gain may become taxable. However, inheritance by a surviving spouse is not a taxable transfer. Neither is a transfer, upon death, of an ownership interest in a qualified opportunity fund to an estate or a revocable trust that becomes irrevocable upon death.
"Hopefully there should be enough guidance that came out today that people are now ready to invest," Treasury Secretary Steve Mnuchin said in discussing the new regulations. "It may not be for every single investment type that we've provided clarity, but we've provided clarity for an awful lot."
Craig Bernstein, principal of OPZ Bernstein, a Washington, D.C.-based opportunity fund seeking to raise $500 million, said he was surprised by how favorable the new regulations are toward businesses.
"There is no question Treasury continued to take a liberal stance in interpreting the underlying law that was passed in 2017," he said.
Mnuchin specifically touted the new guidelines’ treatment of the law that required 50% of a businesses’ gross income to come from within an opportunity zone. According to the new guidelines, that 50% rule can now be measured as relating to 50% of hours of work performed or 50% of the amount paid for services in an opportunity zone, or if 50% of the management or operation of the business in a zone is necessary to generate 50% of gross income.
Those new regulations were welcomed by Zale Tabakman, president of Local Grown Salads. After the announcement the head of the Toronto-based agriculture and technology company said the guidelines are favorable as Local Grown Salads raises $60 million for an opportunity fund to invest in self-contained farming units in the eastern United States. Those products are sold to commercial, restaurant and retail customers outside of opportunity zones.
Accountants, lawyers and opportunity funds have begun combing through the 169 pages of new guidelines. The Treasury Department and the IRS emphasized that they are continuing to request comments on the guidelines.
There were some indications from the Treasury Department recently that a third round of guidelines could be issued in the third or fourth quarter of this year.
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