Congress made several significant changes to the individual income tax when it passed the Tax Cuts and Jobs Act of 2017.
The creation of the Opportunity Zone program is among these changes. This law, codified in the Internal Revenue Code, creates tax breaks and incentives for those who invest their money into designated “opportunity” zones. In short, the Opportunity Zone program is an economic development tool designed to spur economic development and job creation in distressed communities.
An Opportunity Zone is a designated economically-distressed area where new investments, under certain conditions, may be eligible for preferential tax treatment. Our local officials in Chelan and Douglas counties proactively sought the designation of a large number of properties within each of the counties as Opportunity Zones, which requests were ultimately approved by Gov. Inslee among a total of 139 census tracts approved as Opportunity Zones in 36 counties within Washington. You can find these properties through the mapping feature at commerce.wa.gov/growing-the-economy/opportunity-zones/.
In order to invest within an Opportunity Zone and qualify for these new tax breaks, an investor must first form a Qualified Opportunity Fund (“QOF”), which can be either a partnership (including limited liability companies) or a corporation. This fund is the vehicle which then makes the investments in the eligible property located in an Opportunity Zone. The tax benefits for these investments are reminiscent of the benefits associated with 1031 exchanges, but with the potential for even more advantageous tax breaks.
Investors into Opportunity Zones can defer tax on prior capital gains invested into a QOF until the earlier of the date on which the investment in the QOF is sold, or Dec. 31, 2026.
- If the QOF is held for longer than five years, there is a 10 percent exclusion on the deferred gain.
- If the QOF is held for longer than seven years, there is an additional 5 percent (for a total of 15 percent) exclusion on capital gain.
- If the investor holds the investment in the QOF for at least ten years, the investor is eligible for an increase in basis of the QOF investment equal to its fair market value — meaning that there would be no capital gains tax levied at all.
In order to take advantage of the deferral, there are a few requirements.
- The 180-Day Window. The investment into the QOF must be made within 180 days of the sale of other property. An investor cannot utilize the Opportunity Zone program if they already have the cash and simply want to invest. There has to be a triggering sale of property with capital gains and then a reinvestment of those funds within the 180-day window.
- The Fund. The fund has to be set up in accordance with the Internal Revenue Code and the recently released proposed regulations. As noted above, the fund can be a partnership tax entity or a corporation. The QOF must designate a fund manager.
- The Investment. The QOF must use at least 90 percent of the funds it receives to invest in qualifying property within an Opportunity Zone. The investment must improve existing property and/or consist of a new build. The investment can also be made into a new or existing business that is located within an Opportunity Zone.
- The Dec. 31, 2026 Window. The capital gains exclusion incentives are based on the length of time that the investment is held and time-capped as of the end of 2026. An investor can still invest in 2019 in order to hit the seven-year window of time for exclusion of capital gains.
The tax breaks associated with the investment into Opportunity Zones could have a lasting impact on many taxpayers. An investor does not need to create their own fund and there are many funds all over the country, which are currently formed and trying to raise capital. If you are a property or business owner that has been considering a sale that would trigger capital gains, now may be a great time to sell and reinvest those funds into a QOF fund. On the flip side, if you are a property or business owner located in an Opportunity Zone, you should consider leveraging these tax incentives to get new investors. The Opportunity Zone regulations are complex. Investors considering the Opportunity Zone Program should consult with their attorney and tax advisor to ensure full compliance with the rules and regulations in order to achieve the maximum tax benefits contemplated under the Act.
Lindsey J. Weidenbach and Michelle A. Green are partners at Jeffers, Danielson, Sonn & Aylward, P.S. who practice in many areas of law including real estate. If you have any questions about this article or another real estate matter email to LindseyW@jdsalaw.com, MichelleG@jdsalaw.com or call JDSA Law at 662-3685.