The Opportunity Zones Transparency, Extension, and Improvement Act
“The Opportunity Zones Transparency Extension and Improvement Act,” that’s the subject of today’s ACTEC Trust and Estate Talk.
This is Travis Hayes, ACTEC Fellow from Naples, Florida. In late September of 2023, the Opportunity Zones Transparency Extension and Improvement Act was introduced as bipartisan legislation in the U.S. House of Representatives. ACTEC Fellow Kevin Matz from New York City is here today to explain what estate planners need to understand about the proposed act.
Kevin Matz: Thank you, Travis. So as Travis just mentioned on September 27, 2023, HR 5761, the Opportunity Zones Transparency Extension and Improvement Act, was introduced as bipartisan- both Democrats and Republicans- legislation in the House of Representatives.
Now, among other things, what the estate planners need to know is that the proposed legislation, if enacted into law, would do two very significant things. Number one, it would extend the investment and tax deferral period for capital gains or invested in qualified opportunity funds from December 31, 2026 to December 31, 2028. And then second, it would permit qualified opportunity funds for the first time to be structured as a fund of funds.
Background of Opportunity Zones and Qualified Opportunity Funds
So, let’s do some background here just to take a step back. So if we turn back the time machine to 2017, the 2017 Tax Cuts and Jobs Act, it included this new tax incentive provision that was intended, designed to promote investment in economically distressed communities known as, is Opportunity Zones. Through this program, investors can achieve three very significant tax benefits.
- Number one, they can achieve a deferral of gain on the disposition of property to an unrelated person until the earlier of the date on which a subsequent investment is sold or exchanged or December 31, 2026. So long as the gain is reinvested in a qualified opportunity fund, which we’ll define in a second, in 180 days or 180 deemed days of the property’s disposition.
- Second, you can achieve the elimination of up to 15% of the gain that has been reinvested in a Qualified Opportunity Fund, provided that certain holding period requirements are met.
- And third, investors could avail themselves of potential elimination of tax on the gains associated with the appreciation in the value of the Qualified Opportunity Fund, so long as it’s held for at least 10 years.
Now, some of the key definitions here: Opportunity Zone. What’s that? That’s an economically distressed community where new investments under certain conditions can be eligible for preferential tax treatment. Localities qualify as Opportunity Zones if they have been nominated for that designation by the state and that nomination has been certified by the IRS.
Another key definition, Qualified Opportunity Fund, that in turn is the investment vehicle that establishes either a domestic partnership or domestic corporation for the purpose of investing in an eligible property that is located in an Opportunity Zone and uses investor gains from prior investments as a funding mechanism.
To become a Qualified Opportunity Fund, there is no pre-approval requirement. The entity simply self-certifies itself by attaching an IRS Form 8996 to the entity’s timely filed federal income tax return for the taxable year, taking into account extensions. The entity has to meet certain requirements general requirement that at least 90% of the assets be so-called Qualified Opportunity Zone property used within an Opportunity Zone, but no prior approval or action by the IRS is required.
Now, there are some important estate planning considerations to consider any time you have interest in Qualified Opportunity Funds. There are some really unique peculiarities. Time will not allow me to go into all of them, but just to highlight a couple. Very significantly, gifts of Qualified Opportunity Fund interest, sometimes referred to as “QOF interest.” They will generally be inclusion events, which means that they trigger the recognition of previously deferred capital gains and also the termination of the relevant holding periods for the Qualified Opportunity Fund investment purposes unless, key word is unless, the gift or other transfers made to a grantor trust. So, whenever you have gifts, always focus on making sure that the recipient of the gift is grantor trust.
In addition, what happens if someone dies holding these investments? Investments in Qualified Opportunity Funds are considered, “income in respect of decedent” or IRD upon the investor’s death. And therefore, the death of the investor does not produce any step up in basis.
Proposed Opportunity Zones Transparency Extension and Improvement Act Legislation
So let’s now turn down turn over to and drill down a little bit more on the proposed legislation. It would do the following five things.
- Number one- and this is very significant for estate planners and just generally for the investor community- it would extend the investment and gain deferral period for two years from December 31, 2026 to December 31, 2028. Those who’ve heard me speak about Qualified Opportunity Funds know that I quite often refer to the outside date as “judgment day,” I watched too many movies growing up, but that would actually push it back by two years. Judgment day from December 31, 2026 to December 31, 2028. Now, why? According to the explanation that accompanied the introduction of this legislation, it took Treasury about two years to issue final regulations concerning Opportunity Zones. ACTEC weighed in with comments there as well. And during this time, many investors’ stakeholders stayed in the sidelines, awaiting the promulgation of clear rules. Thus, the rationale is that extending the deferral period by an equal amount of time will help investors and communities fully utilize this tool as Congress has intended.
- Second, it would reinstate and expand reporting requirements. What do I mean by reinstate? Well, the original legislation that created Opportunity Zones included reporting requirements that ultimately were omitted from the 2017 Tax Act, which again, as many may recall, was a product of the budget reconciliation process. According to the legislative explanation, these requirements will promote transparency, ensure the program is operated as intended, and allow for the tracking of long-term outcomes in designated communities.
- Third, an early sunset would apply to Opportunity Zones that are not impoverished. Now, what I’m talking about there, now while the vast majority of census tracts designated as Opportunity Zones are in quote unquote impoverished areas based on census data, a small number of non-low income communities were in fact designated as opportunity zones. The proposed legislation would sunset for any tracts with a Median Family Income, referred to as MFI, at or above 130% of national MFI, and provide states with flexibility to further sunset additional tracts. Now, states would be able to replace the sunset tracts, one for one, with eligible high-need communities.
- Fourth- and this is very significant for estate planners as well- it would permit investment through a fund of funds. Now, the proposed legislation would allow qualified opportunity funds to be organized as a – “fund of funds” that may invest in other Qualified Opportunity Funds. This, until now, has not been permitted. It actually would be prospective, not retroactive, but prospective in the proposed legislation. More specifically, the definition of a Qualified Opportunity Fund would be expanded to include any “qualified feeder fund.” What is a qualified feeder fund, you may ask? Well, an investment vehicle that invests in a Qualified Opportunity Fund if three conditions are met.
- Number one, such investment vehicles organized as domestic partnership for purposes of investing in one or more corporations or partnerships as the qualified opportunity fund.
- Number two, all investments in investment vehicles are made in cash, solely in cash.
- And then thirdly, not less than 95% of the assets held as equity investments in corporations or partnerships that are opportunity funds are so costumed as measured both on the last day of the first six-month period of the taxable year of the feeder fund and also on the last day of the taxable year of the feeder fund.
A few other items proposed legislation would do, it would also provide operating support and technical assistance to high-poverty and underserved communities through a “State and Community Dynamism Fund.” It would also permit certain brownfield tracks to qualify as Opportunity Zones if they have zero population and are adjacent to a currently designated Opportunity Zone track.
So, in conclusion, this proposed legislation is very notable and actually mirrors bipartisan and also bicameral qualified opportunity fund legislation that was introduced back in 2022 in both the House of Representatives and the Senate but ultimately was not enacted into law. Given everything that has transpired both in the world stage and on the domestic fronts since the introduction of the proposed legislation at the end of September, it remains to be seen when the House of Representatives will be able to turn its attention back to the proposed legislation. That being said, the prospect of a two-year extension of the investment in tax deferral benefits derived from investing in qualified opportunity funds is highly significant, especially to estate planners; as is likewise a proposed expansion of the Definition of Qualified Opportunity funds to permit the investment in a fund of funds for the first time. Thank you for your kind attention.
Travis Hayes: Thank you, Kevin, for enlightening us about the proposed Opportunity Zones Transparency Extension and Improvement Act.
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