The IRS has released the much anticipated second round of proposed regulations for tax reform’s Opportunity Zone (OZ) program. The bipartisan OZ provision enacted under Republicans’ Tax Cuts and Jobs Act (TCJA) (P.L. 115-97) at the end of 2017 is considered on Capitol Hill as one of the most generous and ambitious tax incentives for investors in distressed communities.
Proposed Opportunity Zone Regulations
The long-awaited second batch of proposed rules, Investing in Qualified Opportunity Funds (QOF), NPRM REG-120186-18, was released by the IRS on April 17. The first round of proposed OZ regulations was issued by the IRS last October. Although a third package of OZ regulations was originally anticipated, it remains unclear if and when such rules may materialize.
“These regulations could really put a charge into the Opportunity Zone program,” Tom West, principal in the passthroughs group of KPMG’s Washington National Tax practice, told Wolters Kluwer on April 25 regarding the second round of proposed OZ regulations. “While there had previously been a lot of interest in the regime, there was also concern over perceived limitations on certain kinds of investments or fund structures. With these new regulations, Treasury and the IRS found the authority to accommodate many of the requests made by local governments, developers, and investors and provided new flexibility across the life cycle of a fund, from initial investments, to interim roll-overs, and finally on exit,” West said. “The added clarity on original use, debt-financed distributions, income sourcing rules, and leased property is also very helpful.”
Additionally, West noted that although the second round of proposed OZ regulations clarify certain issues, questions undoubtedly remain. “Not every question is resolved but these regulations should do a lot to spur uptake of Opportunity Zones,” West told Wolters Kluwer.
Bipartisan Opportunity Zone Program
The bipartisan OZ program, championed by Sens. Tim Scott, R-S.C., and Cory Booker, D-N.J., and Reps. Pat Tiberi, R-Ohio, and Ron Kind, D-Wis., was originally conceptualized in a 2015 paper released by the bipartisan public policy organization Economic Innovation Group (EIG). “This set of proposed regulations removes many of the impediments that have kept capital on the sidelines instead of flowing into communities and supporting local growth,” EIG’s President and CEO, John Lettieri, said of the second round of proposed OZ regulations.
The TCJA added Code Sections 1400Z-1 and 1400Z-2, which include procedural rules for designating opportunity zones and provisions allowing qualifying taxpayers to elect certain federal income tax benefits.
Generally, under Sec. 1400Z-2 the following investment tax incentives are provided:
- a temporary tax deferral for capital gains realized on the sale of appreciated assets and reinvested within 180 days in a qualified opportunity fund (QOF);
- the elimination of up to 10 or 15 percent of the tax on the capital gain that is invested in the QOF and held between five and seven years; and
- the permanent exclusion of post-acquisition gains from the sale of an investment in a QOF held for at least 10 years.
QOF Reporting Requirements
The second round of proposed OZ regulations did not include QOF reporting requirements that would enable the IRS to track OZ program progress and assess certain related penalties. Several Democratic lawmakers have expressed concern that the OZ tax incentives could be used to benefit wealthy businesses with no current system in place to measure economic impact.
However, Scott and Booker’s original OZ bill included in the TCJA implemented certain reporting requirements, but the reporting provisions were removed from the final tax package to comply with certain Senate budget rules.
QOF Reporting Requirements – Looking Ahead
To that end, Scott and Booker are expected on Capitol Hill to soon release a bipartisan bill that would implement similar reporting requirements for recipients of the QOF tax incentives. Such reporting requirements would likely aim to measure how investments are impacting each designated opportunity zone.
Additionally, the IRS could potentially address reporting requirements in a third round of proposed regulations. Indeed, the Treasury has requested public comment on how to efficiently measure OZ-related economic impact.
At this time, it remains to be seen whether Congress or the IRS will implement reporting requirements exclusively or in a combined legislative/regulatory effort. Scott and Booker’s forthcoming bipartisan bill is expected on Capitol Hill to require the IRS to collect certain information from recipients of the tax break, including but not limited to evidence of economic impact and job creation. The lawmakers’ offices are reportedly in communication with the IRS and Treasury on the matter at hand.
By Jessica Jeane, J.D.