Unpacking The Complex Opportunity Zone Tax Program
Established through the tax reform law of 2017, federal Opportunity Zones are a new development program designed to drive long-term private investments to low-income communities.
The law allowed governors in each state to designate low-income census tracts as Opportunity Zones that offer federal tax incentives for certain types of investments within those designated areas. In Louisiana, Gov. John Bel Edwards designated 150 tracts as Opportunity Zones, including several in the Baton Rouge region.
The new tax law provides investors an opportunity to defer and partially eliminate tax on capital gains income that is reinvested in an Opportunity Zone, while completely eliminating taxes on the appreciation of the investment.
Attorney and tax-law specialist Dan Walter of law firm Stone Pigman Walther Wittmann gave an overview of the new Opportunity Zone Program and the laws and regulations that govern it at a recent Tech Park Academy event at the Louisiana Technology Park. Read on for a look at what he shared.
Structure and Timing
The Opportunity Zone Program offers multiple tax benefits to qualified investors. First, investors can defer tax on any prior gains invested in a Qualified Opportunity Fund (QOF) until 2026 or until the investment is sold. Second, if the investor holds the investment in the Opportunity Fund for at least 10 years, the investor can forgive taxes on the appreciation of the investment.
A Qualified Opportunity Fund is an investment vehicle that is set up as either a partnership or corporation for investing in eligible property that is located in an Opportunity Zone.
The entire process, Walter says, must begin with an investor who sells a capital asset and generates capital gain. That person can then reinvest the amount of the gain in a Qualified Opportunity Fund — within 180 days after the sale — to reap the benefits of the OZ incentives.
“There are timing issues involved,” he says. “It’s going to be a little challenging with some of the types of deals people are doing to make sure they fall within the proper time frame — when the money comes in and when it’s deployed.”
Once the investor places the money in the Qualified Opportunity Fund, the next step is for that fund to invest those dollars in either property or in a business that is operating in the zone.
Investing in the Zone
This incentive program is designed to drive long-term investments to low-income communities, but it sets up strict requirements that will likely limit the types of deals that can be facilitated through the program, Walter says.
Central to the program is the Qualified Opportunity Fund, which must be a corporation or a partnership that is organized for the purpose of investing in opportunity zone property. The fund must hold at least 90 percent of its assets in Opportunity Zone property. “Generally speaking it’s probably best to have a new entity,” Walter says.
Walter says the most common type of Opportunity Zone property is a tangible business property, which must be newly acquired — in 2018 or later — from an unrelated party. This can include buildings, land and equipment.
The second type of property that a fund can own is equity in a business that is operating in the zone. That equity interest must also be acquired in 2018 or later, directly from the entity for cash.
But Walter says given the restrictions in the law and the lingering uncertainty surrounding the regulations that govern how it will be applied, the most common Opportunity Zone projects are likely going to be shovel-ready real estate deals.
A typical example, he says, would involve a couple of investors who generated a capital gain from the sale of an asset, then put those dollars into a Qualified Opportunity Fund. The fund would take that money and find a third-party developer who is planning on developing a piece of property. They would then create, perhaps together, a new OZ business, which in turn would purchase and develop the property in the Opportunity Zone.
“This is clearly the least-risky way to use opportunity zones right now,” he says. “Because of the way the statute is written, because of the initial guidance that we got and because of the fact that a lot of these incentives historically were designed for real estate, people are generally pretty comfortable about using them” in this way.
Tech Park Academy is a monthly seminar hosted by the Louisiana Technology Park. We strive to bring you talented, knowledgeable professionals who have invaluable information to share. These events are accompanied by a catered lunch, which is included in the ticket price of $10.