Qualified Opportunity Fund Social Impact / ESG Benefits?

QOF will enable investors to not only take advantage of favorable tax benefits but will help establish new norms for economic activity that are better aligned with economic, environmental and socially sustainable goals that benefit future generations. 

• One out of six Americans lives in low-income census tracts;

• Despite impressive US employment gains, low-income census tracts have seen a net job loss; 

• Need for business growth and affordable housing within low-income census tracts is crucial;

• Leading philanthropic organizations such as Kresge Foundation and Rockefeller Foundation are working with economic policy groups to define and implement programs for measuring the impact of OZ investments. 

Treasury Proposed Regulation Update

On October 19, 2018, the Treasury Department and IRS issued highly-anticipated proposed regulations (“Proposed Regulations”) for Qualified Opportunity Zone investments. (2)  
The Proposed Regulations provide additional guidance on several issues, including both fund related mechanics and investment related questions. Below is a brief overview of the Proposed Regulations most crucial to potential QOF investors:
 

Treatment of Eligible Gains

• Only income treated as short-term or long-term capital gain under the Internal Revenue Code (“IRC”) section 1400Z-2(a)(1) is eligible for deferral.  

  • Only capital gains are eligible for deferral under the OZ program.

  • When the original capital gain is realized by the taxpayer it will retain its original status i.e.., the short-term capital gain will remain short-term when realized.

• Partnerships and other pass-through entities are eligible for special gains deferral.

  • The Proposed Regulations 180-day reinvestment period starts on the last day of the partnership’s or pass-through entity’s taxable year, rather than the sale date.

• It is anticipated that taxpayers will elect to defer eligible gains on Form 8949 which would be attached to their federal income tax return for the taxable year.

Investments Held for at Least 10 Years

• Under IRC section 1400Z-2(c), a taxpayer effectively eliminates any gain that might be realized upon the sale of interest, eliminating any federal tax liability after a 10-year holding period.

• After the opportunity zones expire, the 10-year rule is still applicable if the sale occurs prior to December 31, 2047.  

Taxpayers Eligible to Elect Deferral 

• Taxpayers include individuals, C corporations (including regulated investment companies and real estate investment trusts), S corporations, partnerships, trusts and estates.

Other Clarification - QOF requirements include:

• Process for certifying a QOF and IRS forms;

• Asset valuations for purposed of the 90% Qualifying Asset Test;

• “Substantial Improvement” calculations and test to real property;

• Safe harbor for working capital in QOFs.

The Treasury has scheduled a public hearing for January 10, 2019 and will accept comments on the Proposed Regulations in the interim. The Treasury is expected to subsequently issue final regulations. Note, the Proposed Regulations indicate that this guidance may be applied to transactions that occur before the final regulations are issued.(3)

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Qualified Opportunity Funds (“QOFs”) are a particularly strong match for investors looking to minimize capital gains taxes, while generating further tax-free capital gains, over a ten-year period. The Proposed Regulations clarify opportunity zone investments, likely stimulating demand for QOFs as investors seek to maximize benefits under the relegations by investing prior to December 2019.