By Anthony Diosdi
The Tax Cuts and Jobs Act enacted Sections 1400Z-1 and 1400Z-2 as a temporary provision to the Internal Revenue Code. These code sections were enacted to encourage private sector investment in certain lower-income communities designated as qualified opportunity zones (“QOZs”). An eligible investor, with significant capital gains can invest in a Qualified Opportunity Vehicle (“QOV”) as a way to minimize the tax burden on such gains when certain requirements are met. QOVs are corporations or partnerships (domestic or foreign) established for the purpose of making equity investments in business, real estate, and business assets in a QOZ.
There are three potential tax benefits available to eligible investors who invest in QOZs.
First, U.S. income tax on capital gains reinvested into a QOV by an eligible investor is deferred until such taxpayer sells or exchanges the taxpayer’s interest in the entity, or until December 31, 2026, whichever comes first. Once the eligible investor includes the gain from the QOV in his or her taxable income, the gain from the QOV included has the same attributes in the taxable year of inclusion that it would have had if tax on the gain had not been deferred. See Prop Reg. Section 1.1400Z-2(a)-1(b)(5).
Second, the eligible investor’s investment in a QOV starts at zero and is increased for gain included in gross income from the sale of the investor’s interest in the QOV. If the eligible investor investment in the QOV is held for at least five years, there is a basis increase which is intended to exempt ten percent of the deferred gain from being subject to federal income tax. See IRC Section 1400Z-2(b)(2)(B)(iii). If held for seven years, there is an additional basis increase which is intended to exempt a total of fifteen percent of the deferred gain from being subject to U.S. income tax. See IRC Section 1400z-2(b)(2)(B)(iv). An eligible investor would have to make an investment in a QOV prior to December 31, 2019 to take advantage of the ten percent basis adjustment and by December 31, 2021 to take advantage of the fifteen percent basis adjustment.
Finally, in the case of an investment held for at least ten years, an eligible taxpayer can elect for a basis adjustment that is meant to exempt one hundred percent of the post-acquired gain on investment in a QOV from U.S. income taxation. See IRC Section 1400Z-2(c). Any deferred taxable gain invested in a QOV remains subject to federal income tax. However, it is subject to a reduced taxable gain. This reduction depends on how long the QOV investment was held prior to the disposition of the investment in the QOV.
In order to obtain any of the above-referenced benefits, the taxpayer must be an eligible taxpayer. An eligible taxpayer is a person that may recognize gains for purposes of federal income tax accounting. Thus, eligible taxpayers include individuals; “C” corporations; partnerships; subchapter “S” corporations; and trusts and estates.
Diosdi Ching & Liu, LLP represents clients in a wide variety of domestic and international tax planning and tax controversy cases.
Anthony Diosdi is a partner and attorney at Diosdi Ching & Liu, LLP, located in San Francisco, California. Diosdi Ching & Liu, LLP also has offices in Pleasanton, California and Fort Lauderdale, Florida. Anthony Diosdi represents clients in federal tax controversy matters and federal white-collar criminal defense throughout the United States. Anthony Diosdi may be reached at 415.318.3990 or by email: adiosdi@sftaxcounsel.com.
This article is not legal or tax advice. If you are in need of legal or tax advice, you should immediately consult a licensed attorney.