The 2017 Tax Cuts and Jobs Act is known for creating the Qualified Opportunity Zone (QOZ) program, which encourages real estate investors to invest in low-income communities with the intention to stimulate economic development and job growth. Under certain conditions, these private investments may be eligible for capital gains tax incentives. By investing realized gains in QOZs, investors can reduce capital gains tax liability or eliminate it altogether from future value appreciation on QOZ investments.
What about an existing owner of a business or investment property located in opportunity zones? There’s no rule prohibiting existing owners from taking advantage of QOZ tax benefits, but opportunity zone owners can expect to jump through a few extra hoops.
The QOZ program can be complex — considering the potential tax benefits, it’s no surprise! As defined by the IRS, Qualified Opportunity Zone business property is a tangible property if:
In addition to these basic requirements for existing property owners in a QOZ, there’s also the 20% related party rule.
The QOZ business property must be acquired from an unrelated person. If the QOZ business and selling entity are partnerships for tax reasons, the seller and the buyer will be considered related by the IRS if the same persons directly or indirectly own more than 20% of the capital interests or profit interests.
Therefore, an investor cannot sell property to a related party for gain to invest in a QOF. In addition, a QOF or QOZ business owned wholly or partially by a Fund cannot acquire property from a related party, under the 20% related party rule.
Ownership is determined under Code Section 267(b) by:
This has caused investors quite a bit of confusion, especially in how a partner’s ownership interest is measured. If the IRS determines that a transaction is in violation of the 20% related party rule, the current owner or owners would not be able to invest any gain on the sale into a QOF. This gain would be immediately recognized.
Many investors take a conservative approach in fear of violating the 20% related party rule. Although it is possible for existing property owners to take advantage of the tax benefits offered by the Qualified Opportunity Zone program, expect to jump through some hoops.