WELCOME! City of Sarasota Qualified Opportunity Zones Discussion - PowerPoint PPT Presentation

WELCOME! City of Sarasota Qualified Opportunity Zones Discussion April 24, 2019 Brought to you by:

Opportunity Zones (“QOZ”) Background • Created as part of Tax Cut and Jobs Act – 2017 tax reform package. • New Sections 1400Z-1 and 1400Z-2 of the Internal Revenue Code. • Republicans – a promised tax cut, a market-based solution and way to put the power in the hands of the local governments. • Democrats – an approach that steers money into areas in dire need of funding. • Free up latent capital gains to drive economic development in “low - income communities”

What are QOZs? • Population census tracts identified as low-income communities • Each state limited to designating 25% of its low-income census tracts as QOZs • States worked with local communities to identify specific tracts

QOZ Tax Advantage • Deferral Benefits - defer tax on any prior gains invested in a Qualified Opportunity Fund (“QOF”) until the earlier of the date on which the investment is sold or exchanged, or December 31, 2026. • Exclusion Benefits – an investor’s basis in a QOF is $0 (because gains deferred), but the basis of the investment steps up after time: ▫ If held for 5 years - basis increased to 10% of gain deferred ▫ If held for 7 years – basis increased 5% more (cumulative 15%) ▫ If held 10 years or more, basis stepped up to FMV on date investment sold or exchanged. • Invest by 12/31/2019 for full benefits – basis in QOF is $0, unless held for 5 or 7 years (cannot hold for 7 years if not purchased by 12/31/2019) • Even if held for 10 years, the investor will still have paid the toll tax on 12/31/2026.

Deferral Benefits • “ Eligible gain” means: ▫ Treated as capital gain under the Code (excludes gain under Sections 1231, 1245 and 1250) ▫ Would be recognized before 1/1/2027 if not for allowable deferral ▫ Does not arise from a sale with a related person • “Eligible Taxpayers” – individuals, corps (includes REITs), partnerships, trusts and estates • Capital gains must be invested into a QOF within 180 days of date of realization • Special rules apply for partnerships and s-corps ▫ Partnership can rollover the gain itself within 180 days. If elects not to, then the partners can rollover the gain. 180 day period for partners begins at close of the partnership’s tax year.

Organizing and Qualify fying as QOF A QOF self-certifies by attaching IRS Form 8996 to its tax return for the first year in which the QOF elects to be treated as a QOF and for each year thereafter. • 3 primary tests need to be satisfied: ▫ Organizational Test ▫ Purpose Test ▫ Asset Test

Organizing and Qualify fying as QOF Organizational Test • Must be organized as a corporation or partnership for tax purposes (includes LLCs taxed as partnership) ▫ Can be a pre-existing entity if otherwise qualifies (likely difficult) ▫ Nothing special about the entity being used (typical choice of entity analysis would apply as between corporation/partnership) Can be a public fund (similar to other investment funds)  Can also be as simple as a two person partnership 

Organizing and Qualify fying as QOF Purpose Test • Must be formed for investing in qualified opportunity zone property (QOZ Property) • Met by filing Form 8996 self-certification ▫ Certify that governing documents include provisions that purpose of the QOF is to invest in QOZ Property and description of QOZ business(es) • Cannot invest in another QOF

Organizing and Qualify fying as QOF Asset Test • At least 90% of the QOF’s assets must be invested in QOZ Property • QOZ Property includes ▫ Qualified opportunity zone stock (QOZ Stock) ▫ Qualified opportunity zone partnership interests (QOZ Partnership Interests ▫ Qualified opportunity zone business property (QOZBP) • Investments by QOF can be directly in QOZBP or indirectly through an equity interest in another corporation or partnership!

Organizing and Qualify fying as QOF QOZ Stock and QOZ Partnership Interests • Acquired at original issuance for cash after 12/31/17 • Entity was a QOZ Business when the equity was issued ▫ Can be capital or profits interest • During time QOF owns the equity interests, the entity qualifies as a QOZ Business

Organizing and Qualify fying as QOF Qualified Opportunity Zone Business Property • Tangible property used in the trade or business of the QOF ▫ Acquired by purchase after 12/31/17 ▫ Original use in QOZ commences with the QOF, or the QOF “substantially improves” the property ▫ Substantially all of the use was in a QOZ for substantially all of the QOF’s holding period • Substantial improvement means QOF makes capital improvements within 30 months of acquisition of the property in an amount at least equal to the basis of the property when acquired. • Working capital is not QOZBP, but proposed regulations provide safe harbor for reasonable working capital if requirements are met.

Organizing and Qualify fying as QOF • Raw land can be QOZBP ▫ Does not need to be substantially improved to qualify ▫ However, still need to meet active trade or business requirements • Can lease QOZBP Not required to substantially improve or satisfy the “original use” requirement  But need to be arms length  Can be from related parties if certain requirements met  Can’t be an expectation that the leased property will be purchased by the QOF or QOZB for an amount other than FMV at time of  purchase.

Organizing and Qualify fying as QOF Qualified Opportunity Zone Business • Substantially all of the tangible property owned/leased by the entity is QOZBP ▫ Substantially all equals 70% in this context • At least 50% of the entity’s total gross income is derived from an active trade or business • A substantial portion of intangible property is used in the active conduct of a trade or business • Less than 5% is attributable to nonqualified financial property • No sin businesses Golf course, country club, massage parlor, hot tub facility, suntan facility, racetrack, gambling establishment or liquor stores 

Organizing and Qualify fying as QOF • “Trade or business” ▫ Regulations take probably highest standard possible – Section 162 ▫ Rentals on a triple- net basis don’t qualify • 50% of income must be earned within the QOZ 3 safe harbors   50% of hours of employees/ICs in QOZ  50% of amounts paid to employees/ICs are for services performed in QOZ  Tangible property located in a QOZ and management and operational functions performed in the QOZ necessary for at least 50% of gross income of business

Organizing and Qualify fying as QOF • Regulations appear to favor investments by QOF into a QOZ Stock or QOZ Partnership Interests rather than QOZBP directly ▫ Note that a QOZ Business only needs to hold at least 70% of its assets as QOZBP ▫ However, some provisions only applicable to QOZ Business  No prohibition on QOF operating a “sin business”  50% income limitation from active trade or business only applicable to QOZ Business  Working capital safe harbor only applies to QOZ Business ▫ Examples of types of business that could qualify as QOZ Business Rental condo/apartment complex, mixed-use developments, shopping centers, grocery stores, parking facilities, sports and  recreation facilities, hotels, restaurants, offices, manufacturing facilities, clinics  Examples of types of business that would not qualify Sin businesses, banks/financial institutions, branch of existing business that is not a separate legal entity (if fails 50% test), certain  rental businesses (if not active trade or business)

Tri rigg ggering Gain in/Exiting QOF • Deferred gain is recognized on earlier of 12/31/2026 or when investment is “sold or exchanged” Regulations clarify that gain recognition triggered when direct equity in QOF is reduced or the taxpayer “cashes out” a porti on of  its investment  Sales of partnership interests that own an interest in a QOF (special rule for s corps), termination of QOF, Gifts of QOF, S corp conversion, C corp redemptions Non-inclusion events   Tax free corporate liquidations of subsidiaries, transfer at death, contribution to grantor trust, 721 transactions, making or revoking an s election Amount of inclusion = Excess of (i) FMV X remaining deferred gain or (ii) FMV less taxpayer’s basis (which is generally $0 un less  held for at least 5 years) Different rules for partnerships/s-corps 

Tri rigg ggering Gain in/Exiting QOF • New rules for sale of assets of a QOF (if held more than 10 years) ▫ If partnership or s corp sells its assets, then the capital gain allocable to the partner can exclude the gain. ▫ Only applies to capital gains, so sales of “hot assets” don’t qualify ▫ No similar protection for c corps • What about sales of assets prior to 10 years QOF has 12 months to reinvest proceeds into QOZBP  Note that gain triggered as a result of the sale of will be taxable 

Trade or Business Income • “Substantially all” of the tangible property owned and leased by the taxpayer is QOZBP used in a trade or business of the QOZB and meets the other holding period requirements. • At least 50% of the total QOZB’s gross income must be derived from the active conduct of such business and the average of the aggregate unadjusted basis of the QOZBP attributable to “nonqualified financial property” must be less than 5%.