How Real Estate Investors Can benefit from Qualified Opportunities Zones under Trump Tax Plan
One of the real estate tax shelters created under the Trump tax reform is the tax deferral and reduced tax rate by investing on the program Qualified Opportunities Zones (QOZ), also enacted under the same tax reform. QOZ were created to encourage long-term investment in low-income urban and rural communities to re-invest their unrealized capital gains into Opportunity Funds that are dedicated to investing in QOZ designated by the Governor of each U.S. state and approved by the The U.S. Treasury. According to The New York Times, there are 8,800 approved QOZ in the U.S.
A Qualified Opportunity Fund (QOF) is an investment vehicle that is set up as either a partnership, an LLC or corporation for investing at least 90% of its assets in eligible property that is located in a QOZ. If you are interested in forming a QOF, there is a list of designated zones, click here for the designated zones list that the fund must invest in, in order to qualify for the tax shelter. The same list applies for investors willing to buy an interest in the fund and benefit from the tax shelter. Click here for more QOZ resources.
To become a QOF you just need to invest in a QOZ and elect QOF classification with the IRS by filing form 8996 at the filing of the return detailing the assets invested in the QOZ.
Amazon is one of the first tech beneficiaries of investing in a QOZ in NY, according to The New York Times, after the announcement that one of its two headquarters will be located in Long Island City.
The potential of capital investment is $6 Trillion according to Barron’s. The mechanics for an investor is very simple:
- You have a current investment in the stock or real estate market and sell it. You don’t have to pay taxes on the capital gain if within 180 days (similar to a 1031 exchange) you invest into a QOF. After 7 years if the interest in the QOF is sold, you will pay capital gain tax on 85% of the original capital gain only, meaning 15% of the original capital gain will be excluded from taxes.
- In addition, there is a permanent exclusion from capital gain tax from the sale or exchange of an investment in a QOF if the investment is held for at least 10 years. This exclusion only applies to gains accrued after an investment in an Opportunity Fund.
- Original: $1M capital gain from the sale of an asset
- Investment: QOF
- After 7 years: capital gain tax payable on 85% of the original $1M capital gain (1)
- After 10 years: any capital gain created from the QOF investment is completely tax free.
There are very specific requirements for QOF to getting the tax benefit:
- All of the property must be within the QOZ during the holding period.
- QOF businesses must derive 50% of its gross income from active business in a QOZ.
- Within 30 months the QOF provides substantial investments equal to the purchase basis of the building (land is irrelevant) to qualify as a QOF.
There are exceptions to QOF investments:
- Any sin business is not acceptable
- Country club or golf course, not acceptable
- Liquor store, not acceptable
- Massage parlor, not acceptable
- Racetrack or any gambling venue, not acceptable
- Hot tubs or tanning, not acceptable
Investors willing to form QOFs need also become certified with the IRS at the filing of QOF tax return. QOFs, as mentioned above, can be organized as and LLC or as a Corporation. Click here for more IRS Q&A.
For 2018, taxpayers who invested in QOFs (to benefit from the tax shelter) need to elect the gain deferral when filing their tax return in 2019.
For those taxpayers who invested in QOFs in 2017 and want to take advantage of the tax deferral, you can file an amended tax return and claim a reimbursement.
Contact us for more info about tax strategies for Real Estate Investments.
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