Investment Strategies

IRS Guidance Seen Propelling Qualified Opportunity Zone Investments

Tom Burroughes Group Editor October 29, 2018

IRS Guidance Seen Propelling Qualified Opportunity Zone Investments

A relatively obscure part of last year's big tax changes formed a new entity - Qualified Opportunity Zones - which carry significant tax breaks. Wealth managers are taking notice.

US tax authorities recently issued new guidelines on how investment into specially chosen areas of the country – Qualified Opportunity Zones - should be conducted, a development already generating interest from wealth management firms.

Last December’s Tax Cuts and Jobs Act created QOZs. These are designed to put money and resources into poorer parts of the US and areas with particular challenges, whether they be lack of affordable housing, high crime, poverty and lack of opportunity. Qualifying investments in these zones carry exemptions – under certain limits – from capital gains tax, for example.

By putting money into certain projects that have a non-financial as well as a financial return, QOZs also in some ways dovetail with the enthusiasm for impact investing, now a familiar talking point among wealth managers. QOZs exist in all 50 states.

A few days ago, the Internal Revenue Service sought to clear up some ambiguities about how these zones operate. For example, the IRS wants to nail down what is defined as an eligible investment; the timing of investments, and how partnerships conduct themselves in QOZ investments.

Among firms launching funds to tap into the QOZ programs is Cresset Capital Management, which recently rolled out a product. Law firm Chiesa Shahinian & Giantomasi in August said that it had formed and launched its Qualified Opportunity Zone Group, which will advise investors, fund managers, redevelopers and business owners on the legal and regulatory requirements needed to successfully participate in the program.

To seize QOZ opportunities, a taxpayer must realize capital gain income, invest it in a QOF within 180-days of realizing the gain, and elect to defer the gain on his or her tax return (source: Caplin & Drysdale).

The deferred gain is recognized on the earlier of (i) the date the QOF investment is sold or exchanged; or (ii) December 31, 2026. The deferred gain is cut by 10 per cent if the taxpayer has held the QOF investment for five years as of the recognition date and by 15 per cent if the taxpayer has held the QOF investment for seven years.

"Any investor with significant capital gains needs to know about the new Opportunity Zone program because of the incredibly attractive tax incentives it offers,” Derek Uldricks, president of Virtua Capital Management, a US firm, said.

Wealth managers will “look like heroes” if they can tell clients they know how to delay a capital gains tax charge for up to 10 years, reduce CGT by as much as 15 per cent and assume no CGT is paid on what’s reinvested in QOZ-related funds, he said. “The tax benefits of the Opportunity Zone program cannot be understated,” Uldricks said.

“Because the Opportunity Zone program incentivizes private capital to flow into areas that might otherwise not receive it, we will see increased economic activity that will spur new jobs, accelerate redevelopment and improve the impacted communities. Whether the project be new affordable housing, a hotel that provides new jobs in the local area, or refurbishing an old office building, the deployment of new capital will create social benefits that we believe will leave a lasting impact for local communities,” he said.

The QOZ investment process works as follows: A has an unrealized capital gain of $1 million on some stock in A’s investment portfolio. Because A spoke to an advisor, A decided in early 2018 to sell the position and reinvest the gain into a Qualified Opportunity Fund that invests in distressed low-income communities. A expects to hold this investment for at least 10 years. A will be able to defer the capital gains tax on the $1 million stock investment until December 31, 2026. A will be able to increase the basis of the investment by 15 per cent of the $1 million deferred gain, resulting in only $850,000 being subject to taxation when the investment is ultimately disposed of. In addition, A won’t owe tax on the appreciation after the investment is made in the Qualified Opportunity Fund.


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