Opportunities for You in Opportunity Zones

By at 27 July, 2018, 4:31 pm

Small Business Insider: Business Success Strategies

By Barbara Weltman-

The Tax Cuts and Jobs Act created new tax incentives in “qualified opportunity zones” (QOZs, or Opportunity Zones). These are areas designated by a state (and approved by the IRS) as economically-distressed communities for which the new tax incentives apply. The tax incentives are designed to spur investments in these areas, which in turn, should help these areas to prosper. What opportunities do Opportunity Zones present to you?

Opportunities for Investors

A taxpayer—an individual or business—can elect to defer gain from the sale or exchange of any property to an unrelated party if the gain is reinvested in a qualified opportunity zone within 180 days. So an investor can be located anywhere and need not be in an Opportunity Zone. And the property sold for which deferral of gain is sought can be located anywhere and need not be in an Opportunity Zone.

The amount of the gain excludable from gross income is the amount invested in a qualified opportunity fund. The fund is a corporation or partnership organized for this purpose and which holds at least 90% of its assets in qualified Opportunity Zone property (an interest in a corporation, partnership, or other business within the zone).

This deferral election runs from 2018 through 2026. However, deferral doesn’t go on forever. The deferred gain is recognized when the investment in the fund is sold, or on December 31, 2026, whichever is earlier.

If an investor is holding an interest in the fund on December 31, 2026, then the gain recognized can be minimized by a special increase in basis. Usually, in figuring the amount of deferred gain, basis is zero (so that you effectively pay tax on the amount of the initial gain deferred). However, if the investment is held at least five years but less than seven years, then basis is increased by 10% of the original gain that was deferred. If the investment is held at least seven years, then basis is increased by an additional 5% of the original gain that was deferred.

If the investment in the fund is held at least 10 years (which is beyond the December 31, 2026, deferral recognition date), then on a future sale, the taxpayer can elect to treat the fair market value of the investment on the date of sale as the taxpayer’s basis in the investment. Thus, if the date of sale value of the taxpayer’s interest in the fund is greater than the initial investment, any gain on the appreciation becomes tax free if the election is made.

And if the value of the shares in the fund has declined on the date of sale, or December 31, 2026 as compared with the value when the investment was made, then gain that must be recognized from the original deferral is determined by the share’s fair market value on the applicable date.

Opportunities for Business Owners

In the past, certain economically-challenged areas enabled businesses operating there to obtain tax breaks. For example, with empowerment zones, a business could take a tax credit for certain hiring there. The breaks for empowerment zones expired at the end of 2017.

Now, businesses in Opportunity Zones are the recipients of capital invested by special funds, described earlier.  So if you own a corporation located within an Opportunity Zone and you need capital (and an Opportunity Zone fund wants to invest in you), you can issue stock to the fund and receive cash in exchange. This dilutes your ownership interest but you receive a needed infusion of cash that you can use as you see fit (unless the fund places restrictions on use); the tax law does not dictate what you do with the money.

Is your business eligible for such investments? Substantially all of the tangible property owned or leased by you must be within an Opportunity Zone. And it must meet the requirements for an enterprise zone business.  Qualified opportunity funds are barred from investing in certain types of businesses (e.g., golf courses and country clubs, massage parlors, tanning salons, race tracks used for gambling, and wine and liquor stores, as well as certain financial companies).

A business owner who sells his or her business located anywhere may take advantage of the opportunities for investors described earlier to defer tax on the gain. In other words, if you have a big gain on the sale of your business, instead of paying tax on your gain now, you can defer gain recognition to the future (and a reduced amount at that). There are no dollar limits on the deferral election.

The Current State of Play

The IRS has approved the designation of Opportunity Zones in all 50 states, the District of Columbia, and the five U.S. possessions. These zones, which account for about 8,700 census tracts, retain their designation for 10 years. You can click on a map to see these zones.

The IRS has yet to certify any qualified opportunity funds, which must be done before investors can begin to utilize tax breaks. Once this is done, then investors will need to look at prospectuses and decide whether to proceed (tax breaks aren’t the only reason to put money into an investment). And business owners will need to decide whether to accept investments if they are offered.

Read additional interesting information about Opportunity Zones from the Economic Innovation Group: Opportunity Zones: The Map Comes Into Focus

Barbara Weltman is a member of SBE Council’s advisory board, and has been a premier consultant for small businesses of every kind for over twenty years. She’s the founder of Big Ideas for Small Business® and has written numerous books on small business operations, including J.K. Lasser’s Small Business Taxes, Complete Idiot’s Guide to Starting a Home-Based Business, and The Rational Guide to Building Small Business Credit. Follow Barbara on Twitter  @BarbaraWeltman

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