Opportunity Zones, commonly referred to as Qualified Opportunity Zones or QOZs, were created by the 2017 Tax Cuts and Jobs Act. Formally known as the Investment in Opportunity Act, the relevant portion of the legislation was included in the TCJA to encourage investment of capital gains into specifically designated, economically challenged areas that could benefit from the infusion of funds. In return for directing their assets into the identified areas, taxpayers could receive tax deferrals and even breaks on their earned gains.
How the Deferral and Potential Break Works
If a taxpayer with a recent capital gain diverts the gain into a Qualified Opportunity Fund within 180 days, the investor can defer the tax that would be due on that gain. That deferral will last until the end of 2026 or until the investor disposes of the qualifying investment, whichever happens sooner. Also, suppose the deferral period is at least five years. In that case, the taxpayer will be eligible for an increase in basis of ten percent of the deferred gain (and an additional five percent for a ten-year investment)
How Does an Investor Proceed?
Since the passage of the Act, more than 8,700 specific zones have been created throughout the United States and U.S. Territories. Within those geographic regions, entities (often in partnership with nonprofits and local governments) have created Qualified Opportunity Funds that invest in businesses, real estate projects, and partnerships within the Zones.
There are other rules that the QOF needs to follow. It must invest at least 90% of its assets in QOZ property or a QOZ business, and each of those terms is subject to specific defining characteristics. QOZ businesses must earn at least 50% of the business's gross income from activity within the zone. The QOF can meet the 50% test in one of the following ways:
- 50% of the hours worked by employees and contractors are within the zone.
- 50% of compensation is paid to individuals working inside the zone.
- 50% of tangible property and business functions are inside the zone.
Remember that QOZ businesses may not be involved in operations that fall in the category of "sin business," such as liquor stores, massage parlors, gambling operations, or even less apparent vices like golf courses or country clubs.
Is a Distillery a Sin Business?
This question is hard to answer with a definite yes or no, and a potential investor should seek expert advice before proceeding. The IRS has not issued a clear statement on the topic, and we haven’t seen any good test cases in the public domain. A brewery or distillery that doesn't sell its product for consumption onsite will likely not run afoul of the "sin business" exclusion. On the other hand, a spirits manufacturer that offers tastings and product sales on the premises probably would. Splitting the difference, if the distillery offered samples at no charge but sold products only for consumption offsite, it is hard to say how the IRS would decide. One could make a case that it is within the "spirit" of the law.
This material is for general information and educational purposes only. Information is based on data gathered from what we believe are reliable sources. It is not guaranteed as to accuracy, does not purport to be complete and is not intended to be used as a primary basis for investment decisions. Realized does not provide tax or legal advice. This material is not a substitute for seeking the advice of a qualified professional for your individual situation.