The Tax Cuts and Jobs Act of 2017 introduced a new community development investment vehicle: opportunity zones. This program incentivizes private capital investments in low-income areas nationwide that have experienced a lack of business growth. This tax incentive is centered on the deferral, reduction, and elimination of capital gains income taxes through the use of qualified opportunity funds. This interactive map identifies all opportunity zones across the country.
A qualified opportunity fund (QOF) is an investment vehicle that is required to be set up as either a partnership or corporation for investing in eligible property that is located within a qualified opportunity zone. Opportunity zones do not negatively impact property tax revenue within communities unless communities choose to offer such incentives.
What types of entities are eligible to be QOFs or qualified opportunity zone businesses?
An entity is eligible to be a QOF or a qualified opportunity zone business if it’s treated as either a partnership or corporation for federal tax purposes, and it’s created or organized in one of the 50 states, the District of Columbia, or a U.S. possession. The regulations also clarify that pre-existing entities are eligible to be QOFs and qualified opportunity zone businesses as long as they meet all of the QOF or qualified opportunity zone business requirements outlined in Section 1400Z-2(d).
It’ll be challenging for pre-existing businesses to meet the QOF and qualified opportunity zone business requirements considering that either 90 percent or substantially all of their tangible property must be qualified opportunity zone business property, which excludes any property acquired on or before Dec. 31, 2017.
Potential opportunity zone investors should consider these items when they look to invest in your community:
- Investors looking to reduce and defer tax on gains might be best served by finding an existing qualifying fund to invest in. Typical fund investment analysis rules still apply. Investors should make sure that the fee structures and investment goals align with their criteria.
- A business that wants to purchase or relocate assets in an opportunity zone might be best served by creating its own opportunity fund. By completing a relatively simple registration process, a business can create and manage a fund that’s focused only on the qualifying property owned.
There are several things that you can do to help your community prepare for potential investors.
This investment provides investors with their first opportunity zone tax break, as they defer the tax on the capital gain that’s invested in a fund within 180 days.
The IRS released a draft version of Form 8996 and its instructions contemporaneous with the release of the regulations. QOFs will be required to attach Form 8996 to a timely filed tax return to self-certify as a QOF, report annual compliance with the 90 percent asset test, and calculate any penalty for failure to satisfy the 90 percent test. A single-member LLC treated as a disregarded entity for federal income tax purposes could not itself be a QOF.
How can you prepare for and encourage potential opportunity zone investments in your community?
There are several things that you can do to help your community prepare for potential investors:
- Determine what types of investments your community would want within your opportunity zones. It’s important to determine if the desired investments are allowed by the opportunity zone rules as there is a limited scope.
- Once you have a desired outcome for your opportunity zone, consider putting together marketing materials to help advertise your community to potential investors. Some communities are using social media, presentations, and information sheets to help market their community and share what types of investments they’re seeking.
- Communities can submit a referral form on MSHDA’s website to connect investors and/or opportunity funds with potential state resources.
- Investors have only six months once a capital gain is realized to invest. In order to expedite the investment process, be sure your zones are opportunity-zone-ready. Review the zoning and make any changes to ensure your opportunity zone’s zoning match your desired investment. Your opportunity zones will be more enticing if you remove the barriers and make the process friendlier for investors.
Generating a social, as well as financial, benefit
Impactful investing strategies rarely come with such a significant tax incentive. The growth of an investment in a QOF can deliver the unusual combination of social, community, and individual financial benefits. As of now, however, the opportunity is only available for eligible investments made on or before Dec. 31, 2026.
We anticipate the IRS will release further regulations soon, which will give even more details about how to best utilize this incentive. The sooner gains are invested in an opportunity fund, the more positive impact they can make in an opportunity zone — so act now.