ABOVE: This view of southern Middle Tennessee shows in red the areas designated as opportunity zones that are in need of reinvestment. A link to a national map is below. //ECONOMIC INNOVATION GROUP
Brentwood-based professional services firm LBMC has teamed with the local office of Cincinnati-based law firm Frost Brown Todd to assess the zones. LBMC shareholder and wealth care advisory division leader Briana Mullenax is working directly with FBT attorney Chris Coffman on the effort.
The Post recently chatted briefly with Mullenax (pictured).
What are opportunity zones and which areas have been designated such in Tennessee?
Opportunity Zones are low-income census tracts nominated by the governor of each state. From these nominations, the U.S. Department of Treasury designated more than 8,700 tracts across the states, territories and the District of Columbia as Qualified Opportunity Zones. The Tax Cuts and Jobs Act of 2017 created significant tax incentives for taxpayers who reinvest capital gains in certain property and businesses located or operating in these zones. The final round of certifications took place in June. In Tennessee, Treasury designated 176 tracts in 75 counties as Qualified Opportunity Zones
An interactive map of the zones can be found here.
What is distinctive about the program?
The legislation was created to incentivize community investment in areas that have been passed over during the recent economic recovery. This is a unique opportunity for investors to join with local community leaders, developers and business owners to make a lasting beneficial impact in communities that are in need of revitalization. While there is certainly potential for investors to realize a return on investment, the heart of this program is a chance to give back to these great communities and their local businesses. The impact on social and economic development are fundamental to this opportunity and should remain a key focus for investors.
What are the tax incentives to a project located in an opportunity zone?
There are three tax incentives for a taxpayer who reinvests capital gains into a Qualified Opportunity Zone Fund (QOZ Fund): a deferral of tax, a step up in basis, and a permanent exclusion of gain on appreciation. The deferral of tax incentive allows the taxpayer to temporarily defer (or temporarily not pay) tax on the original gain event. The tax on the original gain will be due when the investment in the QOZ Fund is sold or in the tax year that includes Dec. 31, 2026, whichever is sooner.
If the investment in the QOZ Fund is held five or seven years, the taxpayer is entitled to a step up in basis that essentially eliminates a portion of the original gain. The step-up in basis is 10 percent if the investment is held five years and 15 percent if the investment is held seven years. Since the original gain will be recognized no later than Dec. 31, 2026, taxpayers must make qualifying investments no later than Dec. 31, 2019, to meet the full seven-year holding period requirement and qualify for the 15 percent step up in basis.
The third tax incentive is what makes investments in QOZ Funds a potential home run. If the investment in the QOZ Fund is held 10 years or longer, any appreciation on the investment in the fund is completely tax free.
Let’s tie this all together. Assume a taxpayer holds securities with a basis of $500,000 and a market value of $1.5 million. The taxpayer liquidates the securities in 2018 generating $1.5 million in cash and a $1 million capital gain. The taxpayer decides to invest the $1 million capital gain into QOZ Fund. In the tax year 2018, the taxpayer pays no tax on the $1 million gain. Let’s assume the taxpayer holds the investment until 2029, at which point they sell the investment in the QOZ Fund for $3 million. In the tax year ending Dec. 31, 2026, the taxpayer recognizes a gain of $850,000 ($1 million less 15 percent basis step up). Remember: Tax on the original gain less the basis step up is due in this year even when the taxpayer continues to hold the investment. In 2029 when the underlying investment in the QOZ Fund is sold, the taxpayer pays no additional tax since they met the 10-year holding requirement.
How long does a taxpayer have to reinvest capital gains into qualified opportunity zone fFunds?
The taxpayer generally has 180 days from the date of sale to identify and make an investment in a QOZ Fund. However, if the original asset that generates the capital gain is held within a partnership or other flow-through entity, the taxpayer has 180 days from the year end of the flow-through entity to identify and make an investment in a QOZ Fund. For most owners of flow-through entities, the start date of the 180 day window will be Dec. 31 giving the taxpayer until June of the following tax year to make a qualifying investment.
Are capital gains eligible for this program?
Only capital gains generated in non-related party transactions are eligible for this program. Ordinary gains from depreciation recapture or ordinary gain from the sale of hot assets do not qualify as gains eligible for the tax incentive. Capital gains from the sale of securities, property, other assets, partnership interests or closely held stock generally qualify, so long as the sale is not between related parties.
What are the regulatory and legal needs to sponsor a project within an opportunity zone?
Taxpayers who wish to form or create an Opportunity Zone Fund can self-certify by filing Form 8996. Organizing documents will need to be amended or created to include a statement of the entity’s purpose of investing in qualified opportunity zone property and the description of the qualified opportunity zone business. The Fund will have to disclose the investment standard calculation, which is the total qualified opportunity zone property over the total assets of the fund. This will be calculated at a six-month interval and at the taxpayers year end.
The two percentages are averaged to come up with a qualified fund average. If the average is less than 90 percent, civil penalties will apply. Meaning, the fund can’t hold cash or other non-qualifying property for extended periods of time and still qualify as a fund. The taxpayer can exclude certain working capital assets if the fund has a written business plan with details on the deployment of funds over a specific period of time. The creation of opportunity zone funds is designed to be less rigid than tax incentives of the past. However, we would strongly recommend speaking with an expert on opportunity zones before rushing out and creating a new fund or investing in a new fund. As with anything new, there can be missteps if taxpayers are not working with subject matter experts.
If an individual already owns in a zone, what can that person take advantage of?
It is possible for taxpayers already operating or owning property in the zones to qualify for the tax incentives but not without expert advice. The regulations contain various restrictions on related party transactions and require a minimum amount of new money be invested in these businesses or property after Dec. 31, 2017. We would recommend taxpayers wishing to qualify for the tax incentives to contact an expert to discuss.