Policy Page – January 2019: The Tax Benefits of Opportunity Zones

Carrie Rossenfeld Policy Page

From SoCal Real Estate’s January 2019 issue:

By Phil Jelsma, Crosbie Gliner Schiffman Southard & Swanson LLP (CGS3)

Anticipation continues to grow about opportunities zones, a new economic development tool consisting of low-income, typically economically distressed communities nominated by state governors and identified by qualified census tracts in the New Markets Tax Credit Program.

The new law provides that the governor of each state is allowed to designate up to 25 percent of low-income census tracts within his or her state as opportunity zones; these either have a poverty rate of 20 percent or above, or the median family income is below 80 percent of the area’s median family income. The Treasury Department can then designate the opportunity zones within each state. (A complete list of designated qualified opportunity zones listed by census tract can be found at

Phil Jelsma | Courtesy a representative of Crosbie Gliner Schiffman Southard & Swanson LLC

With a goal of fueling long-term private-sector investments in low-income urban and rural communities, the Internal Revenue Service (IRS) recently issued new regulations about opportunity zones, allowing them to offer powerful tax benefits.

Opportunity zones offer a chance to uplift low-income neighborhoods and also provide for two main tax incentives. The first is for the temporary deferral of capital gains reinvested in a qualified opportunity fund. The second incentive is an exclusion from gross income from capital gains earned on investments in qualified opportunity funds which are held for at least 10 years.

A qualified opportunity fund is an investment vehicle organized as a corporation or partnership for the purposes of investing in qualified opportunity zone properties, which include qualified opportunity zone stock, any qualified opportunity zone partnership interest, and any qualified opportunity zone business property. Qualified opportunity funds must hold at least 90 percent of their assets in qualified opportunity fund property.

If a qualified opportunity fund fails to meet the 90 percent requirement — and unless it establishes reasonable cause — the fund is required to pay a monthly penalty of the amount equal to 90 percent of its assets over the aggregate amount of qualified opportunity zone property held by the fund multiplied by the tax underpayment rate. If the fund is a partnership, the penalty is considered proportionately as each partner’s distributable share.

The maximum amount of deferred gain is equal to the amount invested in the qualified opportunity fund by the taxpayer during the 180-day period beginning on the date of sale of an asset to which the deferral pertains.

The basis of an investment in a qualified opportunity zone fund immediately after acquisition is zero. If the investment is held by the taxpayer for at least five years, the basis on the investment is increased by 10 percent of the deferred gain. If the investment is held by the taxpayer for at least seven years, the basis of the investment is increased by another five percent of the deferred gain.

The second main incentive excludes from gross income the post-acquisition capital gain on an investment in the qualified opportunity zone fund that is held for at least 10 years. Specifically in the case of the sale or exchange of the investment in a qualified opportunity zone fund held for more than 10 years, at the election of the taxpayer, the basis of the investment in the hands of the taxpayers is equal to the fair market value of the investment on the date of the sale or exchange. Taxpayers continue to recognize losses associated with investment in qualified opportunity zone funds.

Example: In 2018, an investor sells 1,000 shares of Amazon stock purchased in 2013 for $250,000. The sale at $1,250 per share results in a $1 million capital gain. Instead of paying $238,000 in federal capital gains on the sale, the investor rolls its $1 million gain into a qualified opportunity fund, reinvests the capital in newly issued preferred stock of various operating businesses located in the opportunity zone with a plan to liquidate the fund in 2028. If the value of the investment in 2028 is $2 million, the benefits the investor would receive include investing $1 million instead of the $762,000 of the remaining capital gain that was not reinvested in the opportunity fund, paying $202,300 in taxes in 2026 (85 percent) instead of paying the $238,000 in 2018, and paying no additional tax on the $1 million gain on the opportunity fund realized in 2028.

While opportunity zones offer a chance to uplift low-income neighborhoods, they also provide for generous tax incentives. We will not know the full impact of opportunity zones for some time – since congress asked the IRS to not begin reporting on the operations of the program until 2022.

Phil Jelsma is a partner and chair of the tax practice team at Crosbie Gliner Schiffman Southard & Swanson LLC, a San Diego-based commercial real estate law firm with offices in Los Angeles. He is recognized as a leading joint venture and tax attorney with a 30-year background in real estate exchange transactions, syndications, nonprofit corporations and international tax planning.