Last November, we published an alert about the qualified opportunity zone (QOZ) regime enacted as part of the December 2017 federal tax reform law. This exciting new tax law allows for (1) deferral until 2026 of capital gain, (2) elimination of up to 15 percent of the deferred capital gain and (3) no tax on appreciation for the investment of the deferred gain if the taxpayer holds the investment for at least 10 years. Our alert discussed the first round of proposed regulations, which provided enough guidance to start use of this new opportunity (pun intended), as demonstrated by the launch of countless qualified opportunity funds (QOFs). Unfortunately, key questions remained unanswered, and these ambiguities prevented many taxpayers from pulling the trigger. On April 17, the IRS issued its second round of proposed regulations that addressed many of these key issues. As with the prior guidance, these new proposed regulations maximize the ability of taxpayers to benefit from this new regime. (Standard attorney caveat: please keep in mind that this publication is only meant to highlight certain items discussed in the new proposed regulations. The opportunity zone regime is complicated with a lot of moving parts and you should consult your tax advisor to ensure compliance with these rules.)
These rules will make it easier for businesses to use the new commercial space developed because of the QOZ regime.
Although the proposed regulations generally provide good news to taxpayers, there are some potential traps for the unwary. For example, it appears that a carried interest will not receive the no tax on appreciation benefit. (The original proposed regulations potentially opened the door for a taxpayer investing a nominal amount of capital gain in a QOF for a carried interest that qualified for the no tax on appreciation benefit. The IRS has shut this door.) Also, although gain invested in a QOF can be deferred until 2026, it is recognized earlier if the taxpayer sells or exchanges the investment in the QOF. The proposed regulations provide detailed rules about such income inclusion events, including that a gift of a QOF interest generally constitutes an income inclusion event, but a transfer upon death does not. Finally, the proposed regulations do not provide any guidance for reconciling the QOZ benefits and the special rules that apply to gains from the sale of a U.S. real property interest by foreigners (FIRPTA). As we noted in another prior alert, although it appears that the no tax on appreciation benefit can apply to a foreigner who invests in a QOF capital gains that the United States would not tax, procedural issues arise with respect to the withholding required for the future sale of the QOF interest or distribution of the flow-through gain. The proposed regulations do not address this.
The QOZ regime provides substantial benefits. If you would like to know more about it, please contact us.
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