The Tax Cuts and Jobs Act (Tax Act), passed in December 2017, offers new tax incentives for taxpayers investing through special vehicles known as "qualified opportunity funds" (QOFs) in certain economically distressed areas across the United States that have been designated as "qualified opportunity zones" (QOZs).

Investments in QOFs provide the following three tax incentives:

  1. Temporary deferral of taxable gain from the disposition of property, to the extent of the amount invested in a QOF during the 180-day period beginning on the date of such disposition. Although a plain reading of the Tax Act seems to extend such deferral to gain from the disposition of any property, the applicable legislative history indicates that it is limited to capital assets. The deferred gain must be recognized on the earlier of (i) the date of disposition of the QOF investment or (ii) December 31, 2026.
  2. Elimination of 10 percent of the deferred gain if the investment in the QOF is held by the taxpayer for at least five years, and an additional elimination of five percent of the deferred gain if the investment in the QOF is held for at least seven years.
  3. Permanent elimination of gain on any post-acquisition appreciation with respect to the taxpayer's investment in the QOF, if the investment in the QOF is held by the taxpayer for at least 10 years.

A QOF must be set up as an entity treated as a partnership or corporation for US federal income tax purposes. Furthermore, at least 90 percent of a QOF's assets must consist of "QOZ Property," generally determined on an annual basis, by measuring the percentage of the QOF's QOZ Property at the end of each six-month period of the QOF's taxable year and averaging the amounts.

QOZ Property generally includes tangible property used in a trade or business if: (i) the property was acquired by purchase (and not from certain related persons); (ii) the original use of the property in the QOZ commenced with the QOF or the QOF substantially improved the property; and (iii) during substantially all of the QOF's holding period for the property, substantially all of the use of the property was in a QOZ. QOZ Property also can include equity in certain corporations or partnerships, generally where substantially all of the tangible property owned or leased by the corporation or partnership is QOZ Property.

To date, the only guidance issued with respect to the QOZ program consists of several frequently asked questions. However, such guidance is limited in scope and many unanswered questions remain. It is not clear when Treasury Regulations will be issued.

While the guidance on the QOZ program is limited, we can assist you or your clients with exploring these investment vehicles and advise on how the tax incentives would apply.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.