Pro­posed reg­u­la­tions help ‘green light’ QOZS

Accounting Today - - Taxpractice - Mark A. Luscombe

Ini­tially, the Qual­i­fied Op­por­tu­nity Zone pro­vi­sions of the Tax Cuts and Jobs Act did not at­tract a great deal of at­ten­tion. With past tax laws of­fer­ing eco­nomic de­vel­op­ment zones and new mar­kets tax cred­its, this just seemed like more of the same.

How­ever, as tax prac­ti­tion­ers started look­ing into the de­tails, they started get­ting very in­ter­ested. The QOZ rules of­fered not just de­fer­ral of gain, sim­i­lar to like-kind ex­changes, but also po­ten­tial for­give­ness of tax on gain. Then in the spring, the states started des­ig­nat­ing their QOZS. There were thou­sands of them, cov­er­ing a sig­nif­i­cant per­cent­age of the coun­try, and in­clud­ing some ar­eas where sig­nif­i­cant in­ter­est in de­vel­op­ment al­ready ex­isted. While like-kind ex­changes were now lim­ited to real prop­erty not held pri­mar­ily for re­sale, the new QOZS were avail­able to both real and per­sonal tan­gi­ble prop­erty. It was not long be­fore QOZS be­came a hot topic.

Still, there was some rea­son for con­cern. The QOZS had some dead­lines that made it look dif­fi­cult to achieve some of the tax for­give­ness. They did not per­mit di­rect in­vest­ment but only through Qual­i­fied Op­por­tu­nity Funds, which raised ad­di­tional ques­tions. As with many new tax pro­vi­sions, there were a lot of def­i­ni­tional ques­tions as well. Many tax­pay­ers and their ad­vi­sors were hold­ing off un­til the In­ter­nal Rev­enue Ser­vice of­fered greater clar­ity, in spite of the fact that some of the dead­lines seemed to push for quick ac­tion. The IRS is­sued pro­posed reg­u­la­tions on Oct. 19, 2018. The reg­u­la­tions on the whole ap­pear very tax­payer-fa­vor­able. They an­swer a num­ber of ques­tions, while leav­ing oth­ers for later guid­ance. Still, the pro­posed reg­u­la­tions, which may be re­lied upon un­til fi­nal reg­u­la­tions are is­sued, ap­pear likely to start mov­ing sig­nif­i­cant sums of money into QOFS and then into QOZS.

QOZS

States may des­ig­nate Qual­i­fied Op­por­tu­nity Zones that are a pop­u­la­tion cen­sus tract that is a low-in­come com­mu­nity. A state may des­ig­nate up to 25 per­cent of such tracts as QOZS, and smaller states may des­ig­nate not less than 25 tracts. Thou­sands of QOZS have been des­ig­nated by the states. The law per­mits cer­tain con­tigu­ous tracts that are not a low-in­come com­mu­nity to be des­ig­nated as part of the QOZ. In ur­ban ar­eas, many ar­eas that are al­ready be­ing gen­tri­fied are ad­ja­cent to low-in­come ar­eas and have been in­cluded as part of a QOZ. The QOZ des­ig­na­tions have helped to at­tract fur­ther in­ter­est in uti­liz­ing QOZS. Un­der cur­rent law, QOZS must be des­ig­nated by 2028.

Qual­i­fied Op­por­tu­nity Funds

The gain from a sale of prop­erty must be trans­ferred to a Qual­i­fied Op­por­tu­nity Fund within 180 days of the sale for de­fer­ral of the gain. The other pro­ceeds from the sale need not be trans­ferred to the QOF but may be. A QOF must be a part­ner­ship or a cor­po­ra­tion. The pro­posed reg­u­la­tions clar­ify that an LLC taxed as a part­ner­ship also qual­i­fies.

A QOF is re­quired to have 90 per­cent of its as­sets held in QOZ prop­erty. The 90 per­cent thresh­old is ba­si­cally tested twice a year. A QOZ busi­ness must have sub­stan­tially all of its as­sets in the QOZ. The pro­posed reg­u­la­tions de­fine “sub­stan­tially all” as at least 70 per­cent. There­fore, com­bin­ing the 90 per­cent and the 70 per­cent, it would be pos­si­ble to have a valid QOF with only 63 per­cent of its as­sets in a QOZ.

The tax savings

Un­der cur­rent law, the de­fer­ral of tax on gain trans­ferred to a QOF lasts un­til the ear­lier of the sale of the prop­erty or Dec. 31, 2026. The 2026 date may have been se­lected for bud­getary rea­sons and it is pos­si­ble that date could get ex­tended by sub­se­quent con­gres­sional ac­tion.

If the prop­erty is held in the QOF for at least five years, up to 10 per­cent of the tax on the de­ferred gain may be for­given. If the prop­erty is held for at least seven years, an ad­di­tional 5 per­cent of the tax on the de­ferred gain may be for­given. How­ever, with a 2026 end date, the gain would have to be placed in the QOZ by 2019 to be able to meet the seven-year dead­line by 2026. Also, if the prop­erty is not sold by 2026, the tax­payer will have to come up with a source to pay the tax due on the de­ferred gain with the 2026 tax re­turn. This obli­ga­tion should be kept in mind when de­cid­ing how to in­vest the pro­ceeds on the sale of the prop­erty other than the de­ferred gain.

If there is ad­di­tional gain in the value of the prop­erty while it is held in the QOZ and the prop­erty is held in the QOZ for at least 10 years, a tax­payer may elect to treat the ba­sis on the date of sale of its in­ter­est in the QOF as the fair mar­ket value of the QOF on the date of its sale, re­sult­ing in non­recog­ni­tion of gain on the ap­pre­ci­a­tion in the QOF. The pro­posed reg­u­la­tions pro­vide that, in spite of the 2028 dead­line for des­ig­nat­ing QOZS, tax­pay­ers have un­til Dec. 31, 2047, to meet the 10-year test.

The po­ten­tial tax savings there­fore in­clude de­fer­ral of tax on the gain to as late as 2026, for­give­ness of up to 15 per­cent of the tax on the gain, and po­ten­tial for­give­ness of tax on any ad­di­tional ap­pre­ci­a­tion in the value of the prop­erty while it is held in the QOF.

The tax forms

The IRS has is­sued a draft QOF self-cer­ti­fi­ca­tion form — Form 8996. The IRS is also ex­pected to have the de­fer­ral elec­tion made on Form 8949.

Other clar­i­fi­ca­tions in the pro­posed regs

The pro­posed reg­u­la­tions clar­ify that ei­ther the part­ner­ship can elect to de­fer gain on the sale of part­ner­ship prop­erty, or, if the part­ner­ship fails to act, each part­ner may elect to de­fer gain on the por­tion of the gain al­lo­cated to that part­ner.

The reg­u­la­tions clar­ify that a QOF can be set up to hold mul­ti­ple prop­er­ties or a sep­a­rate QOF for each prop­erty. The reg­u­la­tions also clar­ify that, if a QOF sells prop­erty in a QOZ be­fore Dec. 31, 2026, it can fur­ther de­fer gain by rein­vest­ing the pro­ceeds in a QOZ.

With re­spect to the treat­ment of land, unim­proved land will not qual­ify. How­ever, with re­spect to im­proved land, it is not nec­es­sary to seg­re­gate the gain as­so­ci­ated with the land from the over­all gain on the sale of the prop­erty. The pro­posed reg­u­la­tions seek ad­di­tional com­ments on a va­ri­ety of ad­di­tional is­sues that will be ad­dressed in sub­se­quent reg­u­la­tions, ex­pected be­fore the end of 2018.

Sum­mary

Qual­i­fied Op­por­tu­nity Zones of­fer the po­ten­tial not only for tax de­fer­ral, like the like-kind ex­change rules, but also the po­ten­tial for at least par­tial for­give­ness of tax on the de­ferred gain and to­tal for­give­ness of tax on the gain while held in the QOZ. The tax ben­e­fits com­bined with the broad scope of avail­able QOZS in the U.S. are likely to make QOZS a very at­trac­tive in­vest­ment al­ter­na­tive.

AT

Mark A. Luscombe, JD, LL.M, CPA, is prin­ci­pal an­a­lyst for Wolters Kluwer Tax & Ac­count­ing.

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