The 2017 Tax Cuts and Jobs Act added a new tax provision to the Internal Revenue Code, Section 1400Z-2, which aims to provide big capital gains tax breaks to real estate and business investors who make investments in certain economically underdeveloped areas. To be entitled to the capital gains tax break, investors are required to invest proceeds that would be subject to capital gains tax, such as those from the sale of a business or stock, and timely invest them in a Qualified Opportunity Fund (QO Fund).

What Are the Potential Tax Breaks?

Section 1400Z-2 offers three major tax breaks to investors:

  • A temporary deferral (up to eight years) of the capital gains tax that would have been due on the sale proceeds which are invested in the QO Fund;
  • A 10 percent basis step-up of the investment in a QO Fund after five years and an additional step-up of 5 percent after seven years for a total basis step-up of 15 percent of the original investment amount; and
  • A permanent exclusion of the accrued gain from the sale of the QO Fund investment if such investment is held for ten years. This permanent exclusion only applies to the gains accrued after the investment in the QO Fund.

What Is a Qualified Opportunity Fund?

A QO Fund is generally an investment vehicle which is organized as either a corporation or a partnership for the purpose of investing in Qualified Opportunity Zone Property (QOZ Property), and which holds at least 90 percent of its assets in QOZ Property. QOZ Property includes certain qualified corporate stock, partnership or LLC interests and business property.

A QO Fund may invest directly in qualified property (i.e., Qualified Opportunity Zone Business Property) or invest indirectly through a qualified corporation or partnership. If the QO Fund invests indirectly through a qualified corporation, partnership, or LLC, the underlying trade or business must own property substantially all of which is Qualified Opportunity Zone Business Property (QOZ Business Property).

QOZ Business Property is tangible property used in a trade or business, acquired from an unrelated party after Dec. 31, 2017, and used in the Qualified Opportunity Zone (QOZ). In addition, the entity must either be the original user of that property or substantially improve that property.