At a Glance
Recently, representatives introduced a new bill that aims to update current Qualified Opportunity Zone (QOZ) legislation. The bill seeks to extend the original bill’s tax benefits, promote better transparency and operations, and change Opportunity Tract designations.
Learn about the potential changes to QOZ regulations and how they might affect your real estate investment tax liability.
QOZ Regulations Outlined in the TCJA
The Tax Cuts and Jobs Act (TCJA), passed in 2017 by the Trump Administration, outlined a beneficial opportunity for real estate investors called the Opportunity Zones program. This program incentivizes investing in economically distressed, low-income areas by offering tax benefits such as capital gains deferral.
Property owners and securities holders must pay capital gains tax on the proceeds when selling their assets. Capital gains rates vary, usually between 15% and 20% for most people. Some investors defer paying this tax by using a 1031 Exchange, a strategy that defers capital gains by investing the funds into another like-kind property.
The Opportunity Zones program uses a similar strategy to the like-kind exchange. Under the program guidelines, investors can put money into a Qualified Opportunity Fund (QOF) for investment in a Qualified Opportunity Zone (QOZ). The benefits are as follows:
- Defer capital gains tax liability when selling an asset
- Reduce a portion of the recognized gains to lessen tax liability
- Exemptions from tax on future gains on the reinvested gain proceeds
- When compared to a 1031exchange in which the proceeds need to be reinvested, in a QOF, only the gain needs to be reinvested; allowing for free cash flow to consider other investments
The TCJA initially offered these incentives with some limitations. Capital gains recognition could be deferred until December 31, 2026, as long as the QOF reinvests in a QOZ within 180 days. It also allowed a 10% permanent capital gains reduction for a QOF held for a minimum of 5 years and another 5% permanent capital gain reduction if the QOF is held for 7 years. Finally, the TCJA allowed a permanent exception if the QOF is held for at least 10 years.
Despite these benefits, the Opportunity Zones program has suffered several issues related to transparency and improper operations. The U.S. Department of Treasury has failed to provide adequate guidance and statutory guidelines along with budget changes, leading lawmakers to create a new bill to clarify the original program’s benefits.
Newly Proposed Opportunity Zone Regulations
On April 7, 2022, lawmakers brought forward the Opportunity Zones Transparency, Extension, and Improvement Act for consideration by the 117th Congress. If approved, the act will implement the following to further the original program’s efforts and offer investors additional tax benefits.
Extended capital gains deferral period
The current capital gains deferral period for QOZ investments is set to expire on December 31, 2026. The new act would extend this deferral period to December 31, 2028, giving investors an additional 2 years to defer capital gains recognition.
The act also proposes to lower the requirement period for the reduced 5% capital gains by one year, meaning the asset would need to be held for 6 instead of 7 years to obtain the additional 5% reduction.
The U.S. Treasury Department delayed issuing appropriate regulations for the original Opportunity Zone program by 2 years. These new changes seek to rectify this timeline and give investors additional time to meet the 10-year holding requirement.
New opportunity zone regulations
The proposed act would make changes to the existing regulations regarding middle-income communities. It proposes to end tract designations with a median family income of 130% of the national average or higher. However, this is not applicable for tracts with a poverty rate of 30% or more for non-student populations.
It also grants states the right to appeal tract determinations, phase out zones, and replace those phased-out zones with eligible land. Moving forward, replacement criteria for OQZ will be based on data from the 2020 census.
Updated reporting requirements
Proposed changes to the Opportunity Zones program include reinstating the original reporting requirements passed in 2017 and outlining expanded transparency and oversight of the program. Changes include requiring the Treasury to produce and publish an annual report on the program and installing monetary penalties for failure to comply.
Suggested penalties range from a daily $500 penalty capped at $10,000 or $50,000 depending on the fund’s size to a $2,500 daily fine between $50,000 and $250,000 for intentional noncompliance.
The new act would allow a QOF to invest in other QOFs. This would permit larger investors to put money into smaller projects identified as qualified feeder funds to broaden investments. The current TCJA rules do not allow this. By opening up this limitation, investors can increase their investment in low-income communities and gain additional tax benefits.
State and community engagement
Under the new bill, states would be given a $1 billion fund called the Community Dynamism Fund to promote investment in low-income communities. These funds can be used for financing, technical assistance, and capacity building.
New Bill Outlook
The passage of the proposed bill is uncertain; however, both the republicans and democrats have shown support, making it a bipartisan effort. It was introduced in both the Senate (4065) and the House (7467) on April 7, 2022, and has garnered little opposition.
Senators Cory Booker, Mark Warner, Tim Scott, and Representatives Dan Kildee, Mike Kelly, and Jackie Walorski have all pushed the bill forward, making a favorable outcome likely.
Maximize Your Tax Benefits With Windes
As tax credits and incentives change, working with a tax planning and accounting firm is essential to keep your real estate investment strategy up-to-date. The professionals at Windes offer tax planning and accounting services to businesses and individuals in Long Beach, Orange County, Los Angeles, and beyond.
We can help your business with strategic financial planning, accounting operations, and back-end office support.
Contact us at 844.494.6337 or firstname.lastname@example.org to learn more about upcoming tax incentive changes and how we can help you maximize your tax benefits.