The upside of reform: Opportunity Zone funds
With more than 8,700 Opportunity Zones designated across the US, this is an attractive investment for investors and fund managers. And we are uniquely positioned to help with all stages of O-Zones investment cycle – from due diligence to exit.
What EY can do for you
Federal Opportunity Zones (O-Zones) were created when the Tax Cuts and Jobs Act (TCJA) added Sections 1400Z-1 and 1400Z-2 to the Internal Revenue Code (IRC). These IRC sections outline substantial tax incentives for investors who choose to reinvest capital gains into Qualified Opportunity Funds (QOF) that make investments into O-Zones. Opportunity Zones are census tracts that have been previously identified and located within economically distressed areas.
To qualify for the O-Zone tax benefits, re-investment of capital gains into a QOF is required within 180 days. The capital gains can be reinvested by a fund or entity, or can be reinvested by an individual who has direct capital gains or who receives a Schedule K-1 with capital gain from a fund investment.
The tax benefits
There are three main tax advantages from investing in O-Zones:
- The capital gains reinvested can be deferred until the earlier of the date the investment is sold or December 31, 2026.
- If the investment is held for more than 5 years, then the amount of tax due on the original capital gain is reduced by 10%. If the investment is held more than 7 years, then the amount of tax due is reduced by an additional 5%, or 15% in total.
- Gains from disposition of an investment in a QOF are tax-free if held more than 10 years.
Are your funds and investors employing the right strategies to capitalize on O-Zones?
Types of capital gains eligible for reinvestment
Capital gains can come from any asset class, including indirect gains flowing through from asset management funds. For example, trading in securities, sale of real estate or personal property capital gains may all be eligible for reinvestment into a QOF. If a fund has made a 475(f) mark-to-market election, the mark-to-market income is not considered a capital gain and thus, 475(f) income is not eligible to be reinvested into a Qualified Opportunity Fund. In addition, capital gains that were part of an offsetting position or straddle are also not eligible.
Timing of reinvestment
Capital gains that are eligible to be reinvested in a QOF must be reinvested within 180 days. The 180 days starts on the date the capital gain was realized. For taxpayers using capital gains reported on a Schedule K-1, the 180-day period starts on December 31.
Operation of Qualified Opportunity Zone funds
Once the capital gains are reinvested into a QOF, the QOF must invest 90% of its assets into Qualified Opportunity Zone property. Failure to comply with QOF requirements will result in the QOF incurring tax penalties. Qualified Zone property can be a Qualified Opportunity Zone entity or Qualified Opportunity Zone property, both of which are described more fully to the right.
Why choose us as your trusted advisor?
Our services include:
- Advise on potential tax benefits and penalties as described in IRC Sections 1400Z-1 and 1400Z-2 and relevant IRS guidance
- Model estimated benefits based on amount of capital raised, timing of capital contributions, property acquisitions, fees or profit sharing arrangements and other factors
Qualified Opportunity Zone creation
- Review organization documents, offering memorandum profit sharing or other fee arrangements
- Prepare Form 8996 to certify the QOF
Opportunity Zone property
Review contemplated acquisitions and provide advice on whether they it will qualify for tax benefits
- Advise on the requirements for substantial improvement
- Assist with compliance with the “working capital safe harbor”
- Evaluate operating model regarding single-asset funds vs. multi-asset funds
- Analyze property tax, transfer tax, and other state and local taxes that may be incurred
- Cost segregation reports for tangible property*
- Valuation reports for tangible property*
- Review any property leases with respect to qualification for US federal income tax purposes
- Review transaction documents, including but not limited to LLC operating agreements, lease agreements, purchase agreements, management contracts, etc., and provide tax-related comments
- Analyze whether any state or local tax incentives may be available
*Please note that our involvement may be limited if the fund is an Ernst & Young LLP audit client.
- Preparation of annual filing of Form 8996
- Advise client regarding appropriate method of calculating qualified asset percentage based on asset values from an applicable financial statement or cost of acquisition
- Preparation of federal and/or state tax returns
- Preparation of other applicable yearly tax compliance (e.g., 1042/1042-S, 8804/8805)
- Computation of quarterly tax estimates, if necessary
- Track cash available for distribution between profits from qualified assets vs. contributed capital
- Preparation of schedules to track permissible distributions to investors, implications of subsequent capital raises, implications of selling O-Zone property and requirements for reinvesting capital
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