Investors in Qualified Opportunity Funds participating within designated Qualified Opportunity Zones can take advantage of federal tax benefits in exchange for their contributions to economic growth and investment in distressed communities. Project sponsors can also benefit from lower-cost capital generated by the program.
How it works
The Opportunity Zones program offers federal tax incentives for investing unrecognized capital gains in Qualified Opportunity Funds, which are investment vehicles created specifically for these purposes. The amount of benefit ultimately recognized depends on the holding period of the investment.
- Deferral: Investors receive a temporary deferral of tax on capital gains reinvested into Qualified Opportunity Funds. The reinvestment must be made within 180 days of the sale creating the gain. The period of deferral ends upon the earlier date of the sale of the reinvestment in the Qualified Opportunity Fund or Dec. 31, 2026.
- Reduction: The reduction benefit provides investors a step-up in basis, the amount of which is contingent on the length of time they maintain the investment in the qualifying fund. If the investment is held for five years, 10 percent of the original gain is eliminated. If it is held for seven years, an additional 5 percent is eliminated. In total, the reduction benefit allows investors to potentially exclude up to 15 percent of the original gain from taxation.
- Exclusion: If the investment is held for at least 10 years, the appreciation on the investment is permanently excluded from taxation. Based on a plain reading of the new law, it appears this only applies to additional appreciation after the investment in the Opportunity Fund is made. As additionally noted below, further guidance is needed from the IRS or Treasury Department to clarify uncertainties within the provisions.
*This model assumes a 23.80 percent federal tax rate, 5 percent growth rate and 10 percent annual investment return. This model is for illustration purposes only, and contains certain financial assumptions as to the possible future results that are inherently uncertain and subjective. We make no representation or warranty as to the attainability of those assumptions or whether future results will occur as illustrated.
How to establish a certified Qualified Opportunity Fund
Eligible taxpayers may self-certify to become a Qualified Opportunity Fund by attaching to its tax return Form 8996. No approval or action by the IRS is required.
Where are the Opportunity Zones?
Use our interactive map to search the complete list of Opportunity Zones that have been nominated, certified and designated.
There are a number of open issues surrounding the Opportunity Zones that require guidance from the U.S. Treasury Department or Internal Revenue Service. The first round of guidance arrived in late October and more is anticipated by year-end. We expect the additional guidance to focus on open questions related to operational issues, such as the availability of the 31-month runway for the deployment of funds in a direct investment model and the ability for residential rental property with a triple net lease to qualify as an active trade or business for the purpose of qualification as qualified Opportunity Zone business property. We will provide regular updates as the program continues to take shape and investment criteria and timing is outlined.
How we can help
By leveraging our expertise in real estate development, transactions and specialty tax planning, Baker Tilly is uniquely positioned to help potential investors and project sponsors take advantage of the Opportunity Zones program.
- Tax planning
- Selective investment offerings that have undergone extensive due diligence by Baker Tilly Capital
Project sponsor services
- Financial modeling showing the after-tax impact of OZ benefits and recommending strategies to optimize the capital stack
- Cost segregation studies to accelerate depreciation recovery
- Construction audit services to ensure adherence to construction contract terms
- Fund administration
- Identify and source other credits and incentives
- Potentially raise capital through Baker Tilly Capital (subject to diligence and an approval process)
Baker Tilly has extensive knowledge of comprehensive capital structures, including tax credits and incentives, traditional lending programs and nontraditional capital sources. If you are looking to invest gains in or leverage the Opportunity Zones program for a business or project benefitting low-income communities, connect with us today.