In this article we will present information regarding an important tax incentive provision in the Tax Cuts and Jobs Act that specifically impact real estate investors, developers and other professionals who serve within the sector. We believe that there are noteworthy changes that you need to be aware of and which should prompt a deeper discussion.

Understanding the Tax Incentive Provision

Under the new law, a real estate investor may elect to defer the gain from the sale of a property, if he invests such gain in a Qualified Opportunity Fund within 180 days of such disposition.

A Qualified Opportunity Fund is an investment vehicle organized as a corporation or a partnership which invests at least 90% of its assets in Qualified Opportunity Zone Property.

Qualified Opportunity Zone Property “QOP” includes tangible property within an Opportunity Zone, including multifamily, office, retail, land for development, and multi-use, including both new construction and existing facilities or businesses, subject to an improvement requirement for existing facilities or businesses. QOP also includes investments in partnerships and corporations which derives most of its income from such property.

While the deferral provision operates similar to an IRC section 1031 like-kind exchange, the QOZ concept may actually be more beneficial. QOZ requires reinvestment of the recognized gain. Whereas, Section 1031 exchange requires reinvestment of the entire net proceeds from a sale. Under QOZ regulations, the deferral period ends the earlier of when taxpayer sells its investment in the Qualified Opportunity Fund, or December 31, 2026, at which time the taxpayer must include the amount of the gain (or a portion of the gain) in its gross income.

Deferral and Abatement of Existing Gains

In addition to the immediate deferral incentive, in year five of an investment, an investor will receive a 10 percent step-up in basis on the initial deferred investment with an additional 5 percent step-up in basis in year seven of the investment. In December 2026 the deferral period ends and the investor must generally recognize gain on the excess of:

a) the lesser of

  1. the initial deferred investment or
  2. the fair market value of the Opportunity Fund investment,

b) over the investor’s basis in the Opportunity Fund investment, which shall be zero prior to year five.

In short, investors may defer existing capital gains until December 2026, and in 2026 investors may be able to reduce their gains up to 15 percent of the originally deferred gain.

Potential for Tax Free Treatment

Furthermore, if an investment of existing capital gains is held for 10 or more years in an Opportunity Zone Fund, the appreciation on the initial investment would not be subject to taxation at disposition or sale of the Fund interest. For example, if $10 million of capital gain is invested in a Fund that invests in eligible Qualified Opportunity Zone Property and the investment appreciates to $60 million over a 10-year investment horizon, the $50 million of appreciation would be tax free to the investor at disposition or sale of the interest in the Opportunity Zone Fund.

Understanding the Opportunity Zone Fund

Governors of each state have submitted their OZ designations to the U.S. Treasury Department for certification, and Treasury has published regulations to guide the program, including rules for certifying Opportunity Funds and for ongoing compliance and reporting.

Investors will benefit most in OZ financing when the underlying assets, real property or business investment, are subject to rapid 10-year appreciation. This new tax incentive program will provide significant planning opportunities for many investors. It is intended to generate additional long-term investment in areas most needing redevelopment and business growth.   Optimally, this program will provide for:

· Short and long term capital gains deferral

· Substantial step up in tax basis

· Tax abatement of all post-investment appreciation

Continued Clarification of the New Provision and its Impact

Much guidance and regulatory clarification is expected in coming months to flesh out this promising incentive program. However, with additional federal and state tax credits and incentive programs, the new tax law is expected to generate additional opportunities for capital investment in low-income areas. These include the New Market Tax Credit, EB-5, and Economic Redevelopment and Growth tax credit programs,

In light of this, businesses and investors must plan accordingly to take advantage of the possible funding and investment opportunities that are expected to result from the Opportunity Zone program.

Tax professionals at Sobel Co LLC have been tracking these developments and are here to assist you with any question, or planning advice. To get more information, please visit us at SobelCoLLC.com or call Mariana Moghadam at 973-994-9494.