Proposed Updates to The Opportunity Zone Investment Program
The Opportunity Zone Investment Program (the “Program”) was authorized by the 2017 Tax Cuts & Jobs Act (“TCJA”) as a mechanism to stimulate economic development in certain low-income community population census tracts designated as Opportunity Zones (“OZs”) by providing tax incentives to investors.[1] Congress intended to create three main incentives to encourage investment in Qualified Opportunity Zones (“QOZs”): (1) the deferral of inclusion in gross income for capital gains that are reinvested in a qualified opportunity fund, (2) a step-up in basis as to the QOF investment, which such benefit has largely expired, and (3) the exclusion of post-acquisition capital gains on investments in opportunity zone funds that are held for at least 10 years from gross income.[2]
The Opportunity Zones Transparency, Extension, and Improvement Act (the “Bill”), introduced on April 7, 2022, seeks to expand and reform the Program by reviving and maintaining the intended incentives otherwise subject to being timed out by statutory deadlines. Further, the Bill seeks to expand information reporting requirements and stipulates tax penalties for noncompliance.
The Bill proposes several revisions which, if passed, would establish six major changes.
Extend Deferral Period
First, the bill would extend the temporary deferral period for investors in the Qualified Opportunity Zone Fund (“QOF”) from 2026 to 2028. Absent this proposed revision, the temporary deferral period would otherwise expire prior to the 10-year holding period required for a tax-free disposition of an investor’s QOF investment.[3] Thus, the Bill reestablishes the tax-incentive and encourages investment into the QOZ. Further, under the TCJA, QOF investors were entitled to a 10% stepped-up basis in their QOF investments if they held on to their investment for at least five years prior to the end of the deferral period (this incentive expired after December 31, 2021).[4] Thus, the Bill revives the 10% stepped up basis by extending the deferral period to 2028.
Reduce Holding Period Requirement
Second, the Bill would reduce the holding period requirement for investors in QOFs to receive an additional 5% step-up in basis from seven years to six years[5]. In addition to the 10% percent stepped up basis explained above, an extra 5% percent stepped-up basis would occur if the investor held the property for seven years prior to the end of the deferral period (this incentive expired December 31, 2019).[6] Thus, the Bill also revives the additional 5% stepped-up basis incentive for investments made on or before December 31, 2022 by decreasing the holding period from 7 years to 6 years.
Early Sunset for Certain Census Tracts
Third, the Bill provides for an early sunset of OZs in census tracts where the median family income exceeds 130% of the national median family income and has a poverty rate of less than 30%, excluding students enrolled in institutions of higher education.[7] However, state governors may request relief from the U.S. Department of Treasury if the designation is otherwise consistent with the purpose of the program.[8]
Reporting Requirements and Penalties
Fourth, the Bill imposes reporting requirements and tax penalties for QOFs, qualified businesses, and investors in funds.[9] The Bill requires QOFs to file annual information returns, to include information detailing the QOFs total assets[10], property[11], dispositions on investment[12], residential units[13] and employees in the OZ investment[14]. Failure to comply with reporting requirements could result in tax penalties ranging from $500 to $250,000.[15]
Qualified Feeder Funds
Fifth, the Bill enables QOFs to invest in other QOFs, defined as Qualified Feeder Funds.[16]
Funding
Lastly, the Bill provides $1 billion for a State and Community Dynamism Fund to assist state and local governments with technical assistance, capacity building, and financing support.[17]
If enacted, the Bill would reinvigorate the Program and encourage additional QOZ investments. The foregoing summaries are general and should not be construed as legal advice applicable to any specific situation. If you have any questions regarding the status or effect of the Bill, please contact a Baird Holm LLP attorney.
Mychal McAdoo, Summer Associate
[1] See BUDGET FISCAL YEAR, 2018, PL 115-97, December 22, 2017, 131 Stat 2054; see also 163 Cong. Rec. H9943-06, H10090.
[2] See BUDGET FISCAL YEAR, 2018, PL 115-97, December 22, 2017, 131 Stat 2054
[3] 26 U.S.C.A. § 1400Z-2(c) (West).
[4] Id. at § 1400Z-2(b)(2)(B)(iii) (West).
[5] Compare 26 U.S.C.A. § 1400Z-2(b)(2)(B)(iv) (West) with Opportunity Zones Transparency, Extension, and Improvement Act, S. 4065, 117th Cong. § 301(b).
[6] Id. at § 1400Z-2(b)(2)(B)(iv) (West).
[7] See Opportunity Zones Transparency, Extension, and Improvement Act, S. 4065, 117th Cong. § 101(g)(3)(B)(i)-(ii).
[8] Opportunity Zones Transparency, Extension, and Improvement Act, S. 4065, 117th Cong. § 101(g)(3)(B)(iii).
[9] Opportunity Zones Transparency, Extension, and Improvement Act, S. 4065, 117th Cong. § 201(a)(1).
[10] Opportunity Zones Transparency, Extension, and Improvement Act, S. 4065, 117th Cong. § 6039K(b)(3).
[11] Opportunity Zones Transparency, Extension, and Improvement Act, S. 4065, 117th Cong. § 6039K(b)(4).
[12] Opportunity Zones Transparency, Extension, and Improvement Act, S. 4065, 117th Cong. § 6039L(b)(6).
[13] Opportunity Zones Transparency, Extension, and Improvement Act, S. 4065, 117th Cong. § 6039L(b)(5)(g).
[14] Opportunity Zones Transparency, Extension, and Improvement Act, S. 4065, 117th Cong. § 6039L(b)(5)(h).
[15] See Generally Opportunity Zones Transparency, Extension, and Improvement Act, S. 4065, 117th Cong. § 6726.
[16] See Opportunity Zones Transparency, Extension, and Improvement Act, S. 4065, 117th Cong. § 302(b).
[17] See Opportunity Zones Transparency, Extension, and Improvement Act, S. 4065, 117th Cong. § 401.