Opportunity Zone Questions

6 Replies

Hello All!

Posting this to 1031 Exchanges because it seems most related, sorry if I messed that up!

Based on what's been released about the Opportunity Zones program, I'm having trouble figuring out the following:

1. It seems that if you hold a property for 10 years, then when you sell there will be no capital gains.  I believe this is because the cost basis of the property is automatically set at the sale price, but maybe I'm wrong?  Is it possible to depreciate the property?  If you depreciate the property to $0 and then sell, is there still no capital gains?  And do we truly have the option to sell the place anytime after 10 years (meaning you can hold it for a very long time and then sell with no capital gains?)

2. Does the program apply to individuals?  Or does the purchase have to be made by a corporation or partnership?  It seems that the updated guidance is that it is a self-certification process.  I read somewhere that 90% of the assets of the "opportunity fund" need to be in an opportunity zone.  So if it's possible to purchase as an individual, does that mean that 90% of the individual's assets need to be in an opportunity zone?

3. What about state taxes?  Does it depend on the state? (i'm in New York).  Or do the same rules at the federal level apply to state (no capital gains if held for 10 years, deferral of existing capital gains if rolled into property in opportunity zone)

Best,
Joe

1. Capital gains tax will be $0. However, you may still be liable for tax on depreciation recapture.

2. From guidance - you need to be a partnership or a corporation and complete a form with the IRS.

3. You should wait for further guidance. I would have to assume most states will follow the fed since this program seems to be like a 'joint-venture' with the state. However, the states will have ultimate say.

Hi Basit - Thank you for this response.  Can you say more about depreciation recapture?  I'm not an accountant so please excuse my ignorance here...It seems that, upon sale, the basis is set to the sales price of the property.  When you depreciate an asset, aren't you just lowering the basis?  The capital gains is typically the sale price minus the basis, right?  But if the basis is set at the sale price, then the capital gains is $0 and there would be nothing to recapture?  

@Joseph Shaggs

Example

Purchase property for $100,000

You depreciate $20,000 over 10 years.

You decide to sell it for $130,000

Based on my understanding of the opportunity zone
$30,000 of the gain would be excluded($130,000 - $100,000)
$20,000 would be subject to depreciation recapture, max fed rate of 25%($100,000 - $80,000)

Summary of rules for Qualified Opportunity Zones (“QOF”):

  • 1.Gain from an “unrelated” party sale or exchange of property
  • 2.Investment in a QOF within 180 days of the sale or exchange of property
  • 3.Gain is deferred until sale of the QOF interest or December 31, 2026, whichever is sooner
  • 4.10% reduction of gains deferred if QOF interest is held for 5 years prior to sale or December
  • 1.31, 2026
  • 5.15% reduction of gains deferred if QOF interest is held for 7 years prior to sale or December
  • 2.31, 2026
  • 6.If the QOF interest is held for at least 10 years, the basis of the investment will equal the
  • 3.FMV of the investment as of the date of sale or exchange ("FMV basis election")

Example: An investor, Z, sells stock, realizing a $500,000 capital gain in July 2018. On August 1, 2018, Z invests $500,000 in a QOF. Z makes an election to apply IRC Sec. 1400Z-2 to the $500,000 gain. No capital gain is recognized on his 2018 tax return filed in 2019.

  • 1.Z sells his interest in the QOF prior to August 1, 2023 (the five year anniversary of the investment in the QOF)
    • $500,000 of capital gain must be recognized at that time
    • Tax is recognized on any appreciation of the QOF interest
  • 2.Z sells his interest on or after August 1, 2023 (i.e. after 5 years), but before August 1, 2025
    • Basis is increased by $50,000 (or 10%); Z recognizes $450,000 of capital gain
    • Tax is recognized on any appreciation of the QOF interest
  • 3.Z sells his interest on or after August 1, 2025 (i.e. after 7 years), but before December 31, 2026
    • Basis is increased by $75,000 (or 15%); Z recognizes $425,000 of capital gain upon the sale
    • Tax is recognized on any appreciation of the QOF interest
  • 4.Z is still invested in the QOF on December 31, 2026,
    • Z recognizes $425,000 of capital gain
  • 5.Z sells his interest after December 31, 2026, but prior to August 1, 2028
    • Z recognizes gain to the extent it exceeds $500,000
  • 6.Z sells his interest on or after August 1, 2028 (i.e., after 10 years)
    • Z will make the FMV basis election and will not recognize gain

Thanks Basit and Chris. I'm looking at buying a few properties in an Opportunity Zone and forming a QOF, so this is helpful. The actual Opportunity Zone Revenue Code language (§§ 1400Z-1 and 1400Z-2) is not too lengthy, if anyone wants to read through, and the IRS has a Q&A out that I found helpful: 

IRS Q&A: https://www.irs.gov/newsroom/opportunity-zones-fre...

§1400Z-1: http://uscode.house.gov/view.xhtml?hl=false&editio...

§1400Z-2: http://uscode.house.gov/view.xhtml?hl=false&editio...

I would recommend talking with your CPA Joseph before pursuing. He/she should at least be able to tell you what not to do! :)