New Opportunities for Urban and Distressed Areas
The newly enacted federal Opportunity Zone program could be a game changer for economic development and tax incentive policy here in New Jersey and across the country. The program provides a new avenue for directing investment into certain urban and distressed areas with significant tax benefits.
The Opportunity Zone program was enacted as part of the recently signed Tax Cuts and Jobs Act and provides an opportunity to defer current capital gains and reduce future gains for investing in certain funds organized to direct capital into businesses and property based in the specified zones. The designated zones are selected by the Governor of each state from certain eligible low-income community census tracts, or those eligible for New Market Tax Credit projects.
Today, Governor Murphy announced that the state’s recommendations for Opportunity Zone designations have been submitted to Treasury and include tracts in over 70 municipalities, including Newark, Jersey City, New Brunswick, Camden, Passaic, Trenton and Atlantic City among others. The list of municipalities can be found here. The selection of zones by each state was due to the Department of Treasury yesterday, though there is an opportunity for states to seek an extension until April 20.
The program offers a few federal income tax benefits that are quite compelling for businesses and investors. First, if a business or individual has or will have capital gains from the sale or disposition of any property (including investments, such as stocks and interests in various pass-through entities), the recognition and subsequent taxation of the gains can be deferred if the gain is reinvested in a Qualified Opportunity Fund within 180 days of the sale or disposition giving rise to the original gain. The deferral lasts until the earlier of the following two dates: the date on which the individual or business sells or disposes of the Qualified Opportunity Fund investment; or December 31, 2026.
In addition to the deferral of recognizing the original gain, the Opportunity Zone program also provides a reduction of said gain if the Qualified Opportunity Fund investment is held by the investor for a certain period of time. Specifically, if the individual or business investor holds the Qualified Opportunity Fund investment for at least 5 years, its original deferred gain is reduced by 10 percent. If the Qualified Opportunity Fund investment is held for at least 7 years, the original deferred gain is reduced by 15 percent. Accordingly, taxpayers investing in Qualified Opportunity Funds can defer and potentially reduce capital gains from other property or assets by rolling those original capital gains into the Funds.
Finally, there is also a significant tax benefit for the gains associated from the Qualified Opportunity Fund investment itself. If a taxpayer holds the investment for at least 10 years, the taxpayer’s basis in the Qualified Opportunity Fund investment is increased to fair market value. The result is no recognition of gain from the disposition of a Qualified Opportunity Fund investment held for at least 10 years.
If the investor does not hold the Qualified Opportunity Fund investment for 10 years, gain will be computed using a basis that starts as zero. However, the basis in the Qualified Opportunity Fund investment receives a step-up in basis for the amount of gain recognized that was originally deferred and invested in the Fund. In addition, the Qualified Opportunity Fund investment basis is also increased by 10 percent of the amount of original gain deferred if the Qualified Opportunity Fund investment is held for at least 5 years and an increase of 15 percent of the amount of original gain deferred if the Qualified Opportunity Fund investment is held for at least 7 years.
|Qualified Opportunity Fund Investment Holding Period||
|Less Than 5 Years||
Deferral of Original Gain Until Earlier of: 12/31/26 or Date of Disposition of Qualified Opportunity Fund Investment
Benefit Above + Reduction of Original Deferred Gain by 10 Percent When Recognized
Original Deferral above + Reduction of Original Deferred Gain by 15 Percent When Recognized
Benefits above + No Tax on Disposition of Qualified Opportunity Fund Investment
The designation of Qualified Opportunity Funds will be undertaken in a process similar to the allocation of New Markets Tax Credits by the Community Development Financial Institutions Fund (“CDFI”) to community development entities (“CDE”). A CDE is a domestic corporation or partnership that is an intermediary vehicle for the provision of loans, investments, or financial counseling in low-income communities. CDE certification permits the entity to apply to the CDFI to receive a New Markets Tax Credit allocation to offer its investors and also allows the CDE to receive loans or investments from other CDEs that have received New Market Tax Credit allocations.
A Qualified Opportunity Fund must maintain at least 90 percent of its assets in “qualified opportunity zone property,” which includes stock, partnership interests, business property and buildings. The Qualified Opportunity Funds allow a multitude of taxpayers to participate who ordinarily may not have enough capital on their own to take advantage of the program, in addition to businesses with capital to deploy that are looking for deferred capital gains and low (or no tax) returns if the investment is held on a long-term basis.
Together with additional federal and state tax credit or incentive programs, such as the New Market Tax Credit, EB-5, and Economic Redevelopment and Growth tax credit programs, the new tax law is expected to generate additional opportunities for capital investment in low-income areas. In light of this, businesses and investors must plan accordingly to take advantage of the possible funding and investment opportunities that are expected to result from the Opportunity Zone program.
The Redevelopment Law Practice Group at Sills Cummis & Gross will continue to report on this program at www.redevelopnj.com as it embarks on initial Opportunity Zone projects around New Jersey.