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.
The QOZ program does not have a minimum required holding period for the deferral, but taxpayers can receive two increments of additional basis in a QO Fund investment. If the taxpayer holds the QO Fund investment for at least five years, the basis bonus is equal to 10 percent of the original gain deferred, which means only 90 percent of the deferred gain invested in a QO Fund would be subject to tax. If the taxpayer holds the QO Fund investment for at least seven years, the basis bonus is equal to 15 percent, leaving 85 percent of the original deferred gain subject to tax.
Taxpayers can exclude all of the post-acquisition gains in the QO Fund if they hold the property for 10 years. At that point, the taxpayer can elect, upon sale of the investment, to have a basis in the QO Fund investment equal to its fair market value. This results in no tax on the sale of the QO Fund investment, other than any rollover gains deemed recognized on Dec. 31, 2026.
EARLY BIRD GETS THE WORM
The QOZ program rewards those who invest early. Many of the benefits expire on Dec. 31, 2026, and QOZ areas lose their designations after Dec. 31, 2028. Making an investment in 2018 could result in significant tax savings, particularly if taxpayers can utilize the post-acquisition gain exclusion. A tax professional knowledgeable of the program’s LA-area opportunities can help taxpayers make the most of this program.
Paul Rosenkranz is a Lead Managing Director in the Los Angeles office of CBIZ MHM, LLC. He has more than 35 years of diversified tax and business consulting experience.