History of Qualified Opportunity Funds
In prior Tips, I discussed Qualified Opportunity Zones (QOZ) and Qualified Opportunity Zone Funds (QOZF). I also updated the original TIP with a few additional Tips.
In summary, in the last QOZ article, I outlined the essence of QOZ, how one qualified for a QOZ, and the steps necessary to gain the benefits under the QOZ.
In essence, the purpose of the QOZ creation was to encourage capital held by taxpayers, via tax incentives, to invest in a new entity created by Congress, the QOZF. As I said in the first TIP where I mentioned QOZ, Congress enacted Internal Revenue Code Section 1400Z, allowing for investors to postpone (and/or eliminate some capital gain). Rather than spend time in this TIP on the issues I have discussed on QOZF, it makes more sense to focus on the most recent proposed legislation on modifying the law in the QOZF.
Summary of Tax Benefits from QOZF
It is worthwhile to summarize the essence of QOZF and then follow with the proposed changes that will impact the existing QOZ law.
In summary, the essence of the current QOZ law is:
1. Congress enacted, in 2017, Internal Revenue Code Section 1400Z, allowing for investors to postpone (and/or eliminate some capital gain) if the investor met the requirements of this Code Section.
2. One of the requirements of Code Section 1400Z is for the investor to place the capital gain from a disposition in a timely reinvestment, within what is known as a QOZF.
3. The requirement to reinvest timely is within this Code Section. That timeframe has generally required the reinvestment period to be 180 days after the disposition of property that generated the capital gain.
If the taxpayer meets the requirements within the QOZ rules, the taxpayer has the potential for major tax benefits:
The capital gain generated by a taxpayer from other investments, not looking to the QOZF, can defer the gain generated from another investment by properly placing funds into a QOZF. This gain is deferred, if properly undertaken, at the end of 2026. (See below for a proposed change on this issue of timing.)
If the investor remains in the QOZF for at least 5 years, the investor can exclude 10% of the gain that is being deferred. (See below for changes proposed in this area.)
If the investor remains in the QOZF for at least 7 years, the investor can exclude the prior gain as to another 5%, making the total exclusion 15%, i.e., the 10% noted above and an additional 5%. (See below for a proposal on this issue.)
The other major change for the taxpayer in the QOZF is to exclude all gain from investing in the QOZF that is generated on the sale of the interest in the QOZF if the taxpayer has held the fund for at least 10 years and has otherwise qualified under this rule.
Proposed Changes to QOZF
Under a bipartisan proposal of senators and representatives in Congress, new legislation is being proposed to modify some of the above positions. Most of these proposals are supportive of the continuation of the QOZF laws; the proposals also add even more incentives for those involved in QOZF—at least in most instances.
In summary, here are the major parts of the new proposals:
Congress will aid and help generate more support and technical advice to set up or further QOZF, especially in high-poverty areas.
The opportunity to defer taxes under current law ends at the end of 2026. The proposal is to extend this period of time through 2028, a 2-year extension.
If there are new or existing qualified investments in a QOZF, the 10% rule, mentioned above, to exclude gain, applies for such investments made by 12/31/2023 and held through at least 12/31/2028.
Similar to the 10% rule mentioned above, the additional 5% exclusion, discussed above, applies to new and existing investments made as of 12/31/2022 and held through at least 12/31/2028. Thus, not only is there the 2-year extension mentioned above, from 2026 to 2028, but this change also allows the total of the 15% exclusion (the 10% and the additional 5%) if the investment is held for at least 6 years; this is a reduction from the prior 7-year rule.)
There will be a bigger burden on QOF to provide additional reporting to the government as to the activities of the QOF.
On the good side of the ledger, under the proposed changes, taxpayers will be able to form partnerships that can, if qualified, invest in Other QO Funds. These are called “QOF Feeder Funds.” (QOFFF) This is a change as the current law does not allow a QOF to invest in another QOF.
There will be an elimination or sunsetting of QOZ that are now considered as not being in what is labeled to be an “impoverished” area. (This change, if passed, will be based on the median family income.)
Will This Proposal Become Law?
It appears there is very strong support for most of the above changes to become law. Keep your eyes open. This one is moving fast.**
(For more on this topic of proposals impacting QOZF, see XII, Number 112 National Law Review (4/21/2022); see also the proposed law: The Opportunity Zones Transparency, Extension, and Improvement Act.)
Dr. Mark Lee Levine, Professor, University of Denver