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BREAKING: New IRS Regulations Encourage Tax-Free Investments in Qualified Opportunity Funds

Smart Summary

  • Created by the recent federal tax reform law, Qualified Opportunity Funds offer potentially significant tax advantages to investors.
  • Foreign businesses and investors liable for U.S. federal income taxes may defer payment of capital gains tax by reinvesting the amount of realized, unrecognized capital gain into a Qualified Opportunity Fund within 180 days.
  • New regulations from the IRS provide regulatory certainty for investors by clarifying lingering administrative questions, such as the requirement to “substantially improve” a Qualified Opportunity Zone asset within six months.

The IRS, along with the Treasury Department, has issued an initial set of regulations and guidance on Qualified Opportunity Funds (“QO Funds”) under IRC 1400Z-2, providing a most favorable interpretation of the Congressional statute authorizing tax-free profits for investors in QO Funds.

Opportunity Zones, created by the 2017 Tax Cuts and Jobs Act, were designed to spur investment in certain communities throughout the country through tax benefits. These benefits authorize taxpayers to defer payment of capital gains tax until Dec. 31, 2026, by reinvesting the amount of realized, unrecognized capital gain into a QO Fund. If that investment is held in the QO Fund for 10 years, then the investor will have received a 15% tax break on the initial amount invested, and the investor’s share of profits in the QO Fund will be treated as 100% tax-free. Any taxpayer may form a QO Fund, which is an entity organized as a corporation, partnership, or limited liability company for federal tax purposes.

The proposed IRS regulations provide taxpayer-investors and private equity fund managers with greater certainty in how the statute will be administered. For example, a statutory requirement that a QO Fund must “substantially improve” a Qualified Opportunity Zone asset in six months presented a road block for projects that take more than six months to develop, such as a startup business or a real estate development project. However, the proposed rules clarify that so long as a QO Fund has a plan for a qualifying project within a QO Zone, then the QO Fund will have an additional 30-month period to substantially improve it.

Additionally, the IRS recently issued Revenue Ruling 2018-29, which provides guidance on the “original use” requirement for land purchased after 2017 in Qualified Opportunity Zones. They also released Form 8996, which is used by QO Funds to self-certify as a QO Fund.

Kegler Brown Hill + Ritter advises clients on how to structure QO Funds and QO Zone Businesses. For a deeper discussion of this new investment vehicle, as well as the liability risks, contact a member of our team of QO Fund attorneys by clicking on their name at the top of this article.

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