- March 06, 2020
- Annemarie Aguanno
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Qualified Opportunity Zone Investment Regulations Finalize
Proposed qualified opportunity zone regulations issued on October 29, 2018 ( REG-115420-18) and May 1, 2019 ( REG-120186-18) under Code Sec. 1400Z-2 have been finalized with modifications. The regulations. which were issued in a 550 page document, are comprehensive.
The regulations address issued related to all aspects of the gain deferral rules and also various requirements that must be met for an entity to qualify as a qualified opportunity fund (QOF) or as a qualified opportunity zone business. Duplicative rules regarding QOFs and qualified opportunity zone businesses have been combined and definitions of key terms added. The regulations detail which taxpayers are eligible to make the election, the types of capital gains eligible for deferral, and the method of making deferral elections. Revisions are made to the rules applying the statutory 180-period and other requirements with regard to the making of a qualifying investment in a QOF.
The IRS will reflect these regulations in updated forms, instructions, and other guidance in January 2020.
Benefits of QOF Investments
Taxpayers may elect
to temporarily defer capital gain in income if the gain is invested
within 180 days in a QOF. The gain is recognized on Dec. 31, 2026, or if
earlier, upon the occurrence of an inclusion event such as the sale of
the QOF investment. However, 10 percent of the deferred gain is not
recognized if the investment is held five years and 15 percent is not
recognized after seven years. In addition, taxpayers may exclude
recognition of gain on appreciation in the investment if the investment
in the qualified opportunity fund is held for at least 10 years.
Section 1231 gains
The final regulations provide
that eligible gains include the gross amount of eligible section 1231
gains unreduced by section 1231 losses regardless of character. The
proposed regulations took a “netting” approach. The 180-day period for
an eligible taxpayer to invest an amount with respect to an eligible
section 1231 gain begins on the date of the sale of the section 1231
asset rather than at the end of the tax year.
RICS and REITS
The 180-day period for RIC or REIT
capital gain dividends generally begins at the close of the
shareholder’s tax year in which the capital gain dividend would
otherwise be recognized by the shareholder. To ensure that RIC and REIT
shareholders do not have to wait until the close of their tax year to
invest capital gain dividends received during the tax year, the final
regulations also provide that shareholders may elect to begin the
180-day period on the day each capital gain dividend is paid. The
180-day period for undistributed capital gain dividends, however, begins
on either the last day of the shareholder’s tax year in which the
dividend would otherwise be recognized or the last day of the RIC or
REIT’s tax year, at the shareholder’s election.
The aggregate amount of a shareholder’s eligible gain with respect to capital gain dividends received from a RIC or a REIT cannot exceed the aggregate amount of capital gain dividends that the shareholder receives as reported or designated by that RIC or that REIT for the shareholder’s tax year.
Installment Sales
The final regulations allow an
eligible taxpayer to elect to choose the 180- day period to begin on
either (i) the date a payment under an installment sale is received for
that tax year, or (ii) the last day of the tax year the eligible gain
under the installment method would be recognized. Therefore, if the
taxpayer defers gain from multiple payments under an installment sale,
there might be multiple 180-day periods, or a single 180-day period at
the end of the taxpayer’s tax year, depending upon taxpayer’s election.
Partners, S Corporation Shareholders, and Trust Beneficiaries
The
final regulations provide partners, S shareholders, and beneficiaries
of decedents’ estates and non-grantor trusts with the option to treat
the 180-day period as commencing upon the due date of the related
entity’s tax return, not including any extensions. This rule does not
apply to grantor trusts.
Gain from Disposal of Partial Interest in QOF Investment
Gain
arising from an inclusion event is eligible for deferral even though
the taxpayer retains a portion of its qualifying investment after the
inclusion event. If an inclusion event relates only to a portion of a
taxpayer’s qualifying investment in the QOF, (i) the deferred gain that
otherwise would be required to be included in income (inclusion gain
amount) may be invested in a different QOF, and (ii) the taxpayer may
make a deferral election with respect to the inclusion gain amount, so
long as the taxpayer satisfies all requirements for a deferral election
on the inclusion gain amount.
Post-December 31, 2026 Gain Ineligible
Gain arising after December 31, 2026 (including gain mandatorily recognized on that date) is not eligible for deferral.
Death Related Transfers of QOF Investments
A
qualifying investment received by a beneficiary in a transfer by reason
of death remains a qualifying investment in the hands of the
beneficiary.
Acquisition of Eligible Interest from Person Other than a QOF
A
taxpayer may make a deferral election for an eligible interest acquired
from a person other than a QOF. The final regulations do not require
the transferor to have made a prior deferral election for the acquirer
of an eligible interest to make the election.
Further, for interests in entities that existed before the enactment of the deferral provision, if such entities become QOFs, then the interests in those entities, even though not qualifying investments in the hands of a transferor, are eligible interests that may (i) be acquired by an investor and (ii) result in a qualifying investment of the acquirer if the acquirer has eligible gain and the acquisition was during the 180-day period with respect to that gain.
Built in Gains
Built-in gain of a REIT, a RIC, or
an S corporation potentially subject to corporate-level tax is eligible
for deferral. If the deferral election is made, the amount of gain is
not included in the calculation of the entity’s net recognized built-in
gain.
Identification of Disposed Interests in a QOF
The
final regulations permit taxpayers to specifically identify QOF stock
that is sold or otherwise disposed. If a taxpayer fails to adequately
identify which QOF shares are disposed of, then the FIFO identification
method applies. If, after application of the FIFO method, a taxpayer is
treated as having disposed of less than all of its investment interests
that the taxpayer acquired on one day and the investments vary in its
characteristics, then a pro-rata method applies to the remainder.
The specific identification method does not apply to the disposition of interests in a QOF partnership.
Deferred Gain Retains Tax Attributes
The final
regulations make it clear that if a taxpayer is required to include in
income some or all of a previously deferred gain, the gain so included
has the same attributes that the gain would have had if the recognition
of gain had not been deferred. If a deferred gain cannot be clearly
associated with an investment in a particular QOF, an ordering rule
applies to make this determination.
Effective Date
The final regulations are generally applicable to tax years beginning after 60 days after publication in the Federal Register.
With respect to the portion of a taxpayer’s first tax year ending
after December 21, 2017, that began on December 22, 2017, and for tax
years beginning after December 21, 2017, and on or before 60 days after
publication in the Federal Register taxpayers may rely on either the
proposed regulations or the final regulations but not both.