As the first of several deadlines under the Qualified Opportunity Zone (“QOZ”) program rapidly approaches, investors still on the sidelines are discovering that time is running out on the ability to take advantage of the full suite of tax benefits under the program. December 31, 2019 marks the last day in which investors may roll over capital gains into Qualified Opportunity Funds (“QOF”) and obtain a 15% reduction in the amount of the deferred gain. The QOZ program allows investors to defer the tax on capital gains invested in a QOF until December 31, 2026, at the latest. Investments held for at least 7 years are entitled to a 15% reduction in the amount of the deferred gain. Accordingly, to obtain the full 15% reduction, an investor must trigger a capital gain and invest the gain (all or any portion thereof) in a QOF on or before December 31, 2019. It is important to note that while the deferred gain must be invested in the QOF on or before December 31, 2019 to qualify for the 15% reduction, the QOF itself is not required to deploy the invested funds before year-end. Once the deferred gain is invested, the QOF will have 180 days to acquire qualified property.
For potential QOZ investors tracking gains from the sale of assets used in a trade or business, known as 1231 property, December 31, 2019 could be a hectic day if they intend to qualify for the 15% reduction. Section 1231 of the Internal Revenue Code applies to real or depreciable business property held for more than one year. Gain or loss on the sale of 1231 property is determined on the last day of a taxpayer’s tax year after netting all sales of 1231 property during the year. If the taxpayer has a net 1231 gain for the year, it will be treated as long-term capital gain, while a net 1231 loss will be treated as an ordinary loss. Accordingly, taxpayers will not be in a position to determine the amount, if any, of capital gains from 1231 property until the last day of the tax year, which for individuals and most businesses is December 31. For purposes of the QOZ program, the second tranche of proposed QOZ regulations issued by the U.S. Department of Treasury in April 2019 confirmed that the start date for the 180-day deferral period for net 1231 capital gains begins on the last day of the taxpayer’s tax year. Therefore, it is imperative that investors intending to invest capital gains from the sale of 1231 property in a QOF track 1231 sales throughout the year to ensure that the net result is a capital gain and not an ordinary loss. Further, investors of 1231 gains must be prepared to fund the investment on December 31, 2019 to be eligible for the 15% reduction.
Potential QOZ investors intending to take advantage of the 15% capital gain reduction are running out of time to hit the December 31, 2019 deadline. This looming deadline is even more problematic for investors anticipating investment of 1231 gains, as they will have a 1-day window in which to roll over the gain. Fortunately for investors, they are not required to acquire or even identify a QOZ project prior to December 31, 2019 to qualify for the 15% reduction; they need only invest the deferred gain in a QOF before the deadline, which can be as simple as forming a corporation (C or S) or a limited liability company taxed as a partnership.
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