Nine Questions NJ Real Estate Investors Are Asking About Opportunity Zones
The Qualified Opportunity Zone Program offers significant opportunities for real estate investment and development…
The Qualified Opportunity Zone Program offers significant opportunities for real estate investment and development. It is particularly attractive because it has the potential to turn borderline projects in New Jersey’s most distressed communities into viable ones.
Because the program is new and the regulations are still evolving, many businesses are unsure how to reap the program’s sizable tax benefits. In recent months, our attorneys have fielded questions from developers and other investors about the Qualified Opportunity Zone Program. Below are several of the most common questions (and answers).
Where are New Jersey’s Opportunity Zones located?
In total, 169 census tracts in 75 municipalities in New Jersey have been designated as Opportunity Zones. You can find a list of Opportunity Zone census tracts here.
What’s the best way to take advantage of the Opportunity Zone Program?
Businesses can either set up their own Qualified Opportunity Fund or attract investment from an existing Qualified Opportunity Fund. Determining the best option requires careful examination of your business model, investment goals, and ability to meet the program’s strict requirements.
What are the tax benefits of the Opportunity Zone Program?
The key tax benefit is that taxpayers can defer paying federal taxes on capital gains (including those from real estate sales) invested in Qualified Opportunity Funds. The program offers three distinct tax incentives: Reinvested capital gains are deferred from taxation until exit from a Qualified Opportunity Fund or December 31, 2026, whichever comes first; the original capital gains reinvested in Qualified Opportunity Fund investments held for the long term receive a reduction in capital gains tax liability, discounted by 10 percent at the 5-year mark and by an additional 5 percent at the 7-year mark; and any new gains from Qualified Opportunity Fund investments held for at least 10 years are permanently excluded from the capital gains tax.
Who can invest in a Qualified Opportunity Fund?
Any federal taxpayer, including individuals, businesses, and corporations, can invest in a self-certified Qualified Opportunity Fund (provided they otherwise meet the fund’s critera). However, the investments must consist of capital gains reinvested during the 180-day period beginning on the date of the sale or exchange giving rise to the gain. Investments must take the form of an equity interest, including preferred stock or a partnership interest with special allocations. They may not take the form of a debt instrument.
What are the requirements for Opportunity Funds?
Investment vehicles must be organized as a corporation or partnership for the purpose of investing in Qualified Opportunity Zone Property, which may include opportunity zone business property, stock, or partnership interests. Opportunity Funds must also hold at least 90 percent of their assets in Opportunity Zone Property. The Treasury’s proposed regulations further provide that if at least 70 percent of the tangible business property owned or leased by a trade or business is qualified opportunity zone business property, the requirement that “substantially all” of such tangible business property is qualified opportunity zone business property can be satisfied if other requirements are met. If the tangible property is a building, the proposed regulations provide that “substantial improvement” is measured based only on the basis of the building, rather than the underlying land.
What is “qualified opportunity zone property?”
The term is specifically defined as tangible property used in a trade or business of the qualified opportunity fund and located in a qualified opportunity zone if: (i) the original use of such property in the qualified opportunity zone commences with the qualified opportunity fund or, (ii) if the property is used, the qualified opportunity fund, during any 30 month period beginning after the date of the acquisition of such property, incurs costs with respect to such property that exceed the fund’s basis at the start of the 30 month period.
The Treasury’s proposed regulations would further provide that cash and other working capital assets held for up to 31 months can qualify as qualified opportunity zone business property, so long as: the cash and other working capital assets are held for the acquisition, construction and/or substantial improvement of tangible property in an opportunity zone; there is a written plan that identifies the cash and other working capital as held for such purposes; and the cash and other working capital assets are expended in a manner substantially consistent with that plan.
How does a corporation or partnership become certified as a Qualified Opportunity Fund?
To become a Qualified Opportunity Fund, an eligible corporation or partnership self-certifies by filing Form 8996, Qualified Opportunity Fund, with its federal income tax return. Early-release drafts of the form and instructions are now available. To ensure that you satisfy all of the requirements, it is essential to work with an experienced attorney and accountant.
Can partnerships participate?
In the case of a capital gain experienced by a partnership, the rules allow either a partnership or its partners to elect deferral. Similar rules apply to other pass-through entities, such as S corporations and their shareholders, and estates and trusts and their beneficiaries.
Can other federal, state, and local tax incentives be combined with Opportunity Zone investments?
Yes, federal, state, and local tax incentive programs can be used in combination with Opportunity Zone investments, which can further increase the viability of real estate development projects.
Additional Guidance Required
While the U.S. Treasury and IRS published proposed rules in October 2018, the government shutdown slowed progress. As a result, many important issues remain unanswered. Some important questions include: what specific requirements must be satisfied in order for Opportunity Zone businesses to pass the “30 Months Test” and the “70 Percent Test”; what specific factors will be used to determine what constitutes Original Use; and what reporting requirements will be mandated.
Scarinci Hollenbeck will provide updates once additional guidance is released. In the meantime, we encourage investors to contact our Opportunity Zone team, which is comprised of affordable housing, real estate, tax