Opportunity Zone Investments in Wisconsin: Tax Incentives and Rules for Investors
The Opportunity Zones Program, created by the federal Tax Cuts and Jobs Act of 2017, is intended to promote private long-term investment in distressed communities by offering tax incentives for those who invest in specific property that will (hopefully) accelerate economic growth and job creation.
In Wisconsin, there are 120 Qualified Opportunity Zones (QOZ), 11 of which are in Dane County and include the former Oscar Mayer property, the Capitol East District, the Alliant Energy Center, South Madison, south Park Street, the Allied Neighborhood, and the University Research Park, as well as a section of Sun Prairie.
A taxpayer interested in participating in this new economic development tool must be in a position of incurring capital gains tax. The taxpayer can defer their capital gains tax or have portions forgiven by investing in a QOZ, but must do so by investing through a Qualified Opportunity Fund (QOF). The taxpayer “rolls over” the capital gains from the sale of an asset into the QOF within 180 days of the sale. The QOF must use that cash to purchase QOZ Property.
Setting up a QOF
The QOF receiving the taxpayer’s capital gains funds must be properly structured to qualify for this tax benefit. While more direction from the IRS is needed, it is anticipated that a QOF may be a corporation, limited liability company (LLC), or partnership -- all of which must be organized for the sole purpose of investing in QOZ Property that satisfies certain rules.
The QOF is created by self-certification to the IRS through the completion of the certification Form 8996, which will be filed along with the taxpayer’s return. A taxpayer should work with their tax attorney to create a QOF.
At least 90% of the QOF’s assets must be QOZ Property. In other words, the QOF likely needs to be a single purpose entity. If the QOF fails to meet this requirement, there will likely be penalties and adverse tax consequences for the taxpayer.
Tax Benefits of a QOZ Investment
The basic tax benefits of the QOZ investment for the taxpayer (through the QOF) include:
- A temporary deferral of capital gains invested in a QOZ until the taxpayer sells the investment or December 31, 2026 (whichever is earlier).
- A step-up in basis for the deferred gain, resulting in reduction of deferred taxes by 10% for a five-year holding period, and 15% for a seven-year holding period.
- 5 Years - If the taxpayer holds its investment for at least five (5) years, 10.00% of the invested gain is added to the taxpayer’s basis. In other words, if the taxpayer holds the investment for at least five (5) years, 10.00% of the taxpayer’s deferred gain is permanently excluded.
- 7 Years - If the taxpayer holds its investment for at least seven (7) years, 15.00% of the invested gain is added to the taxpayer’s basis. In other words, if the taxpayer holds the QOF investment for at least seven (7) years, 15.00% of the taxpayer’s deferred gain is permanently excluded.
- A permanent exclusion from taxable income of any capital gains on the appreciated value of the QOZ investment held for at least 10 years.
- For example, if the taxpayer holds its interest in the investment, the taxpayer will recognize gain on the original deferred amount (subject to the reductions above) on December 31, 2026. However, when the taxpayer sells the investment after 10 years, it is anticipated that no further gain is recognized. More guidance is needed from the IRS.
QOZ Property Types
QOZ property (“QOZ Property”) includes newly issued stock/partnership interests, or business property in a QOZ.
- QOZ Stock/Partnership Interest includes: (i) an equity interest in a a corporation, LLC or partnership (in the United States) that is a QOZ business or (ii) if the business is new, one that is organized for the purpose of being a QOZ business. The equity interest in a QOZ business must be purchased as an original issuance of equity purchased for cash after December 31, 2017. Additionally, a QOZ business is any trade or business:
- Where substantially all of the tangible property owned or leased by the business is QOZ business property;
- Where at least 50.00% of the business' total gross income is derived from the active conduct of a trade or business and a substantial portion of the business’ intangible property is used in the active conduct of the trade or business;
- Less than 5.00% percent of the property owned by the business is attributable to non-QOZ business property; and
- The business does not conduct any of the following businesses: commercial golf courses, country clubs, massage parlors, hot tub facilities, suntan facilities, racetracks or other facilities used for gambling, or any stores the principal business of which is the sale of alcoholic beverages for consumption off premises.
- QOZ Business Property includes newly constructed or substantially improved tangible business property, which is acquired by the QOF after December 31, 2017 and used by the QOF in a business operating in the QOZ for substantially all the time the QOF holds the property. Here, property is “substantially improved” only if capital expenditures on the property within 30 months of its acquisition equal or exceed the property’s purchase price. Additionally, property does not qualify as QOZ Property if it is acquired from a related person.
Differences Between a QOZ Investment and 1031 Like-kind Exchange
While a QOZ investment may be viewed as similar to a 1031 like-kind exchange, there are some important differences:
- The QOZ investment allows investors to roll over capital gain from sources that are not just “like kind” to the property that was sold.
- The taxpayer can hold (and invest) its cash while locating its investment (there is no requirement for a qualified exchange intermediary).
- The taxpayer is not allowed to defer the gain indefinitely through the QOZ investment. Rather, the initial gain (or 85% of it if the QOZ investment is held for 7 years) will be recognized by December 31, 2026. Therefore, the taxpayer will need funds sufficient to satisfy that obligation.
- The taxpayer may elect to eliminate tax on the appreciated value of the QOZ investment if the taxpayer holds the QOZ investment for at least 10 years.
Rules and Regulations Regarding QOZs and QOFs
The IRS issued guidance in October 2018, and was scheduled to have a public hearing on January 10, 2019 to provide clarification about the proposed QOZ regulations. However, the hearing has been indefinitely postponed due to the shutdown. Therefore, investor questions about QOZs, such as defining “substantial improvements” and “original use” and impacting whether projects quality for the tax cuts, will remain unanswered by the IRS until the shutdown ends.
If you have questions about a QOZ or setting up a QOF, contact our tax or real estate attorneys at Murphy Desmond in Madison, Janesville, Appleton, and Dodgeville, Wisconsin.
Published on January 11, 2019