Qualified opportunity zone funds are a relatively new investment vehicle that was created under the 2017 Tax Cuts and Jobs Act to allow investors to defer and potentially reduce capital gains taxes. The creation of this type of fund is so new, in fact, that the basic rules governing opportunity zone funds are still being written by the IRS. The IRS recently released new guidance on opportunity zone funds that amends and expands upon previous regulations.
Tax Incentives for Businesses
Businesses that are funded by an opportunity zone fund may benefit from tax incentives if it meets at least one of the following conditions:
- At least 50% of all hours worked by employees is done within the bound of the opportunity zone
- At least 50% of the business’s services are within the opportunity zone
- The management/operation of the business is based in the opportunity zone
While previously it was stated that, like a 1031 exchange, investors had 180 days to reinvest proceeds from a previous investment into an opportunity zone fund, the new guidance states that investors have a full year, giving investors more than double the amount of time to find a new investment that fits their needs.
Substantial Improvements Provision
Previous guidance required that new properties must be built or that existing properties acquired by a fund must be “substantially improved,” defined by renovations equal to the initial investment in the property. However, the new guidance introduces an exception to that rule if the property was vacant prior to purchase. Previously vacant properties do not have to be substantially improved in order to qualify.
Properties on the Border of an Opportunity Zone
Previously, there was no clarification as to whether buildings straddling the border of an opportunity zone were considered to be within the bounds, and therefore subject to the benefits of a fund’s investment. The IRS’s new guidance says that, as long as a building has most of its square footage within the bounds of the opportunity zone it can qualify to be included in an opportunity zone fund. Additionally, for a property straddling the border, the square footage outside the zone must be connected with the portion inside the zone as a single building. Properties with multiple buildings that go over zone borders may not qualify.
Inheritance of Investments
Qualified opportunity zone fund investments are now able to be passed on to heirs, which was unclear in previous regulations. This is a significant clarification, as the majority of the tax benefits come after an investment has been held for ten years, which leaves a lot of room for uncertainty for older investors.
Triple Net Leases
Triple net leases, which require a tenant of a leased property to be responsible for all costs associated with a property, including insurance and maintenance, are not allowed in an opportunity zone fund property under the new IRS guidance. The opportunity zone program was designed to stimulate active businesses and property owners, while a triple net lease allows building owners to be hands-off.
Opportunity zones are a potentially huge market for alternative investments and should be carefully considered by advisors and investors looking for alternative investment opportunities. Qualified opportunity zone funds are very much still in the process of being shaped by the federal government. Any and all projects are subject to be affected by possible changes in regulation. All investments in qualified opportunity zone funds are risky, with long hold periods and potential loss of principal. Failure to complete the entire investment term could potentially incur tax related consequences.
Qualified Opportunity Zone Funds join an increasingly popular group of tax-advantaged investments that allow investors to defer or avoid capital gains taxes on the sale of certain investment properties.