Some clarity allows investors to start contributing to Tucson O-Zone funds to reduce taxes while helping communities grow.
The U.S. Department of the Treasury has released proposed regulations for financing and building in Opportunity Zones and is accepting comments ahead of holding a hearing in January 2019.
Investors interested in the capital gains tax-deferred and tax-reduction program can work under the proposal rules to form funds that finance economic development projects within the O-Zones, which aim to boost private investment in low-income areas.
Pima County has O-Zone designations in 27 census tracts.
The Arizona Commerce Authority hosted a webinar in October to explain what some of the proposed regulations say about forming, investing in and running businesses financed with Tucson O-Zone funds. Here are some of the issues it addressed. I’ve also added what I’ve learned about how the program works.
What is an Opportunity Fund or Opportunity Zone Fund?
O-Zone funds are set up as a corporation or partnership to gather investments and use that money to provide equity in Opportunity Zones.
The funds are certified by the U.S. Treasury Department and face penalties for noncompliance.
O-Zone funds make investments directly to O-Zone business property or indirectly by buying a partnership interest or stock in an O-Zone business.
CoStar is tracking 115 funds that have been formed based on the proposed fed rules. Four of them invest in specifically Arizona or generally in the Southwest. There also are several national funds.
What do O-Zone funds invest in?
Investments are limited to businesses, real estate and business assets in an O-Zone.
Among other things, the funds provide equity capital to develop or redevelop buildings for industrial, warehouse, office and retail uses.
Funds also develop affordable housing, hospitals, hotels and nonprofit sites.
The fund must hold at least 90% of assets in Opportunity Zone property. Assets cannot include cash or intangibles.
Who can participate in O-zone funds?
Real estate investment trusts (REITs), individuals, partnerships, trusts and estates, C and S corporations and regulated investment companies (RICs).
What gains are allowed to be invested in O-Zone funds?
Long- and short-term capital gains, Section 1231 gains and Section 1250 unrecaptured gains.
What tax savings are available?
Here’s an example. If you have $1 million of capital gain and invest that money into an O-Zone fund, you pay
- no capital gains tax on that $1 million until 2026
- taxes only on $900,000 (10% reduction) if you invest in an O-Zone fund for five years up to 2026
- taxes only on $850,000 (15% reduction) if you invest in an O-Zone fund for seven years up to 2026
- no tax on the capital gain earned on the $1 million that you invested in the O-Zone fund if that investment is held for at least 10 years.
How do I claim the O-Zone funds tax benefit?
The capital gain must be invested in one or more qualified O-Zone funds within 180 days of the sale of the asset that created the capital gain.
In order for the tax considerations to apply, the fund must deploy 90% of its capital within six months.
Fill out Internal Revenue Service Form 8949, “Sales and Other Dispositions of Capital Assets.” Indicate that you plan to defer capital gains by investing in an O-Zone fund or funds.
Can I create an O-Zone fund for my business?
Yes. You can establish your own equity fund for growth capital in qualified O-Zone building property.
The trade or business within the O-Zone is eligible for O-Zone fund investment if it
- has at least 70% of tangle property owned or leased by the taxpayer
- derives at least 50% of income from active conduct of the trade or business
- has no more than 5% of average of assets in cash or long-term loans. There is an exemption called a safe harbor that is related to reasonable amounts of working capital.
- is not a golf course, country club, massage parlor, hot tub or tanning facility, gambling facility or store whose principal business is selling alcoholic beverages for consumption off-premises.
Proposed IRS Form 8996 must be submitted.
How do I find an O-Zone fund to invest in or find investors for an O-Zone fund?
The Arizona Commerce Authority is creating a process in which investors, fund administrators and land developers can connect to do business regarding Opportunity Zones. It will take several months for the process to be implemented.
Commercial Real Estate of Tucson can help you find land, building sites, contractors or spaces for your business in O-Zones; introduce you to other professionals and fund managers, and advise you on creating your own Tucson O-Zone fund. Contact Michael Coretz, 520-299-3400 or email@example.com.
Learn more from the Arizona Commerce Authority.