Most states recognize the federal deferral of gain on qualified opportunity zone investments. A few states limit tax deferral on the gain to in-state qualified opportunity zone designations or include other restrictions. Others provide additional incentives for investments made in low-income communities in the state. These incentives designed to further encourage taxpayers to invest in opportunity zones in the state include:
- income tax deductions;
- additional capital gain exclusions or basis adjustments; and
- tax credits.
What Is the Federal Treatment of Opportunity Zone Investments?
Taxpayers may elect to defer gain on the sale or exchange of property if the taxpayer reinvests the gain in a qualified opportunity zone under IRC Secs. 1400Z-1 and 1400Z-2. The proceeds must be reinvested within 180 days of the sale or exchange in a qualified opportunity zone fund. The gain may be deferred until the earlier of:
- the tax year in which the investment is sold or exchanged; or
- December 31, 2026.
Taxpayers are entitled to a:
- 10% exclusion of the deferred gain if the investment is held for at least 5 years; or
- 15% exclusion if the investment is held for more than 7 years.
If held for at least 10 years, the taxpayer can treat the basis on the date of sale as the fair market value.
What Is a Qualified Opportunity Zone?
A qualified opportunity zone is a low-income community nominated by a state governor and then designated by the U.S. Treasury.
What Is a Qualified Opportunity Zone Fund?
A business entity organized as a corporation or partnership holding at least 90% of its assets in qualified opportunity zone property can be an opportunity zone fund.
What Is the State Tax Treatment of Opportunity Zone Investments?
How each state treats the federal deferral of gain on opportunity zone investments generally depends on a state’s:
- IRC conformity tie-in date; and
- starting point for computing income tax liability.
Most state conformity tie-in dates adopt the federal treatment of opportunity zones. In some instances, states have specifically adopted the federal opportunity zone provisions even if they do not adopt all federal tax provisions.
The computation of corporate income tax liability in most states begins with federal taxable income. To calculate individual state income tax, most states start with:
- federal adjusted gross income (AGI); or
- federal gross income.
So, state income taxpayers can generally defer gain on opportunity zone investments for the same period as provided under IRC Code Sec. 1400Z-2.
What Are Some State-Specific Limitations?
A few states limit tax deferral on the gain to in-state qualified opportunity zone designations or include other restrictions. Restrictions include:
- limiting tax deferral on the gain to in-state qualified opportunity zone designations;
- limiting tax benefits available under the opportunity zones program to certain tax years;
- enacting minimum wage requirements;
- prohibiting specified types of entities from participation; and
- requiring certain application and reporting requirements.
Arkansas allows tax deferral on the gain for state income tax purposes if the qualified opportunity zone is located in the state. Hawaii limits the scope of the tax benefits to opportunity zones designated by its governor.
Maryland enacted legislation limiting tax benefits to certain tax years and applying minimum wage requirements. Further, Maryland legislation created additional application and reporting requirements for lead-based paint affected properties in qualified opportunity zones.
What Other Incentives Do States Provide?
Additional tax incentives designed to guide investors to in-state low-income areas are used by a handful of states.
Ohio allows an income tax credit for investments in Ohio-designated opportunity zones for individuals, trusts, estates, and pass-through entities.
West Virginia allows taxpayers to take a deduction for certain income from business activity in West Virginia opportunity zones on top of the federal exclusion. This generally eliminates state income taxes for West Virginia qualified opportunity zone businesses for up to ten years.
In addition to the federal deferral of gain, Wisconsin allows a subtraction from income for individual taxpayers for an investment in a Wisconsin qualified opportunity fund that invests in an in-state qualified opportunity zone. An additional capital gain exclusion or basis adjustment is allowed for Wisconsin corporate taxpayers for investments in a Wisconsin qualified opportunity fund. Both of these tax provisions are applicable to taxable years beginning after 2019.
By Tralawney Trueblood, J.D., M.B.A.