Created by Congress as part of the 2017 Tax Cuts and Jobs Act (TCJA), Opportunity Zones were designed to incentivize investment in distressed communities across the country. This provision is the first community development tax incentive enacted since the Clinton Administration. In all, 8,761 communities in all 50 states, the District of Columbia, and the five U.S. territories were designed as qualifies Opportunity Zones.
The Opportunity Zone legislation encourages investors to reinvest unrealized capital gains in Qualified Opportunity Zone Funds (Zone Funds) in exchange for a temporary tax deferral and other tax benefits tied to long-term holdings. With the ability to roll passive holdings of capital into investments in Opportunity Zones, Zone Funds could redirect trillions of dollars of private capital into in distressed urban and rural communities.
The TCJA Opportunity Zone provision has two main tax incentives to encourage investment:
- Allows for the temporary deferral of inclusion in gross income for capital gains that are reinvested into Opportunity Funds.
- Investors can roll existing capital gains into Zone Funds with no up-front tax liability.
- If investors hold their Zone Fund investments for five years, the basis of their original investment is increased by 10 percent. If investors hold for seven years, the basis increases by a further 5 percent.
- Investors can defer their original tax liability until December 31, 2026 at the latest, or until they sell their Zone Fund investments, if earlier.
- Excludes from taxable income capital gains on Zone Fund investments held for at least 10 years. In other words, after settling their original tax bill, patient investors in Zone Funds will face no capital gains taxes on their Opportunity Zone investments.
The Treasury Department and the Internal Revenue Service has issued proposed regulations clarifying that almost all capital gains qualify for deferral. In addition to the proposed regulations, Treasury and the IRS issued an additional piece of guidance to aid taxpayers in participating in the qualified Opportunity Zone incentive. Rev. Rul. 2018-29 provides guidance for taxpayers on the “original use” requirement for land purchased after 2017 in qualified opportunity zones.