The tax reform act commonly known as the Tax Cuts and Jobs Act (TCJA) created the Qualified Opportunity Zone (QOZ) program, a unique tax incentive program for investments in designated low-income communities. In the greater Los Angeles area, there are 274 designated QOZs, including locations in Sylmar, Sun Valley, Northridge, Canoga Park, North Hollywood, Hollywood, Culver City, Downtown LA, and Long Beach. Time is of the essence to take advantage of the program —it expires Dec. 31, 2026. Investors who make an eligible investment could realize significant federal tax savings, particularly if they invest in 2018.
The QOZ program permits taxpayers to permanently exclude up to 15 percent of the capital gains from the sale of almost any asset and defer the recognition of the remaining 85 percent of the gain. Additional gain arising from the QOZ investment can be excluded entirely if held 10 years. The capital gain from the sale of an asset must be invested into a Qualified Opportunity (QO) Fund within 180 days of the sale closing. Note that only an amount equal to the gain needs to be reinvested – not the entire sales price. Also note that prior investments in QOZ property are not eligible for the 15 percent gain exclusion or the 85 percent gain deferral.
A QO Fund is a partnership or corporation that invests at least 90 percent of its funds into QOZ property. Eligible QOZ property includes QOZ stock, a QOZ partnership interest, or a direct investment in property used in trade or business conducted in a QOZ. Among other provisions, a QOZ Business must have a minimum of 50 percent of its gross income derived from the active conduct of a trade or business in the QOZ. Substantially all of the QOZ business’s tangible property must be purchased after Dec. 31, 2017, and the original use of the property or the underlying QOZ business in the QO Zone must begin with the QO Fund. If the original use requirement is not met, taxpayers may still reap the tax benefits if the QO Fund or the underlying business substantially improves an existing property. “Substantial” is defined as capital expenditures within a 30-month period that exceeds the original purchase price of the property, and substantially all of the property is used in a QOZ.
HOLDING PERIODS FOR DEFERRAL AND EXCLUSION
Taxpayers who satisfy the above criteria are eligible to defer capital gains tax on reinvested amounts for as long as the taxpayer holds the qualifying investment, but no longer than Dec. 31, 2026. Note that if the QO Fund asset is not sold as of that date, the taxpayer has “phantom income” from triggering the capital gains on the rollover investment.