In April 2019, the US Treasury Department released the second round of proposed regulations related to the “Opportunity Zone” project which was enacted as part of the Tax Cuts & Jobs Act of 2017. The initiative provides tax incentives to investors that invest in business or properties within qualified designated “Opportunity Zones.”
These areas, which were submitted by each state and reviewed by the federal government, are known as “Qualified Opportunity Zones.” To qualify for the beneficial tax treatment, an investor must use capital gains to fund the investment and the investor needs to “substantially improve” the purchased property unless the property is of “original use,” meaning it has not been depreciated. To “substantially improve” the property, the investor needs to double their initial tax basis in the acquired property within thirty months after purchase.
So, what are the benefits of the Opportunity Zone program?
First, a taxpayer can defer the tax on the capital gain used to purchase the property for up to seven years (until 12/31/2026). Second, a taxpayer can reduce the capital gains tax (the same gain that is deferred) by up to 15% if the Opportunity Zone investment is held for at least five or seven years. Finally, the biggest advantage is that the appreciation in the investment is tax-free, as long as the interest in the investment is held for at least ten years and the investment meets the improvement qualifications.
Clarifications in Regulations Proposed in April 2019
The April proposed regulations clarified a number of Opportunity Zone questions, including clarity around buying or starting businesses through the Opportunity Zone program, the use of net Section 1231 Capital Gains to fund the investment, guidance related to Opportunity Zone fund organization, and information for the eventual disposition of fund assets and interests. In addition to property purchases and development projects, there is now a taxpayer-friendly three-part “Safe Harbor” that would allow for the acquisition or origination of a qualified business to be eligible for tax-free appreciation through the Opportunity Zone initiative.
Revenue Ruling 2018-29
Another piece of tax guidance recently announced was Revenue Ruling 2018-29 which deemed that a taxpayer must only “substantially improve” their investment in a building rather than substantially improving both the building and the land that makes up their investment. Hence, the taxpayer does not have to substantially improve the land that the building sits on or the land acquired in the acquisition. In the Revenue Ruling, the taxpayer purchased property with 60% of the total purchase price allocated to the land and the remaining 40% of the purchase price allocated to the value of the building. The IRS concluded that the taxpayer had to “substantially improve” only the 40% of their investment that related to the physical building and not the related land. Therefore, on paper, it would appear that the IRS opened the door to purchasing land and not having to improve the land while still qualifying for the beneficial tax treatment offered through the Opportunity Zone initiative. However, Treasury has repeatedly stated in the proposed regulations that “Land Banking” is disallowed.
The rules around investing in Opportunity Zones from a commercial real estate perspective are much clearer than they were before the April 2019 proposed regulations
President Trump has expressed a desire to expand the Opportunity Zone program and allow for more zones to qualify. Whether this comes to fruition or not is another matter. However, the program as it is currently enacted does not expire until 2047. Further guidance is expected to be released in late 2019 to clarify Opportunity Zone’s application to certain industries, such as agriculture. While we await this guidance, “Substantially Improving” an old building, buying land and building a ground-up retail center, or rehabbing a multi-family or student housing complex are a few of the types of projects that are commonly being performed within an Opportunity Zone Fund structure. Given Florida’s rapidly growing population, affordable cost of living, and state tax structure, investing in a Florida Opportunity zone is something that any real estate investor should strongly consider.
For further questions on the Opportunity Zone initiative or for assistance with structuring an Opportunity Zone investment, please contact Tyler Davis of SVN Saunders Ralston Dantzler at firstname.lastname@example.org.
About Tyler Davis
Tyler Davis is an Accountant working with the property management division at SVN | Saunders Ralston Dantzler Real Estate. Tyler recently joined the brokerage after spending five years in the tax practice as a manager at PricewaterhouseCoopers in Birmingham, Alabama. Tyler graduated summa cum laude with his Bachelor’s in Accounting from Samford University in 2013 and received his Masters in Taxation degree from the University of Alabama in 2014. After passing the CPA exam, he began his career with PwC in 2014 where he gained valuable experience working with both life and property and casualty insurance companies across the country.