Tax Reform's New Incentives for Investments in Low-Income Communities: Part 1

Please note: This alert was updated as of Oct. 24, 2018.

HIGHLIGHTS:

• A new tax incentive in the Tax Cuts and Jobs Act allows investors selling appreciated securities or other investment property to defer tax on those gains to the extent that the proceeds are reinvested in a Qualified Opportunity Fund. Further tax incentives would allow for exclusion of both some of the deferred gain and any post acquisition gain if the Qualified Opportunity Fund is held long enough.
• Each of the 50 states and the District of Columbia (as well as U.S. possessions) had an opportunity to nominate a minimum of 25 Opportunity Zones located within the state, district or territory.
• Eligible zones must have been nominated by the governor of a state within a 90-day period starting on the Act's date of enactment (by March 21, 2018, unless a 30-day extension was applied for and granted).
• All states nominated Opportunity Zones and the U.S. Department of Treasury accepted those nominations. The designations accepted by the U.S. Department of Treasury are valid until 2028. Absent Congressional action, no new designations can be made.

The Tax Cuts and Jobs Act (the Act), signed into law on Dec. 22, 2017, contained new tax incentives for making investments in low-income communities. The first tax incentive would allow investors selling appreciated securities or other investment property to defer tax on those gains to the extent that all of the proceeds are reinvested in a Qualified Opportunity Fund. In addition to deferring gains that are reinvested in Qualified Opportunity Funds, the provision would reduce such gain subject to tax for those who hold their investments at least five years and would reduce it even further if held at least seven years. The second tax incentive would exempt from tax any post-acquisition gains on investments in the Qualified Opportunity Funds themselves – if they are held at least 10 years.

Under the Act, each of the 50 states and the District of Columbia (as well as U.S. possessions) had an opportunity to nominate a minimum of 25 Opportunity Zones located within the state, district and territory. Eligible zones must have generally been nominated by the chief executive of a state within a 90-day period starting on the Act's date of enactment and under rules described below. The nominated zones must have been either in "low-income communities" as defined below or "contiguous" to designated low-income communities subject to certain statutory limitations.

This Holland & Knight client alert focuses primarily on the rules applicable to the Opportunity Zone nomination and designation process. Part II and Part III focus on the rules for Qualified Opportunity Fund formation and how the tax incentives for Opportunity Fund investors will work.

Background

The Opportunity Zone concept first surfaced in 2016 in legislation introduced on a bipartisan basis by Reps. Pat Tiberi (R-Ohio) and Ron Kind (D-Wis.), as well as Sens. Tim Scott (R-S.C.) and Cory Booker (D-N.J.), to help revitalize economically distressed communities that suffer from a lack of investment and business growth. As re-introduced in 2017, the Investing in Opportunity Act (H.R. 828 and S. 293) attracted a total of 95 co-sponsors (14 in the Senate and 81 in the House). Thus, it was no surprise that the earlier legislation found its way into the Act, initially through its inclusion in the Senate bill and eventually in the final conference agreement.

A central tenet of the legislation is to give state governors the responsibility for nominating Opportunity Zones so long as they comply with certain definitions and rules as set forth below.

Nomination and Designation of Qualified Opportunity Zones

The Act's designation process contained two main components and time frames:

• nomination of the zones by the governor, which had to be submitted in writing within 90 days of the enactment date, unless an extension was applied for (in which case, an additional 30 days may have been granted)
• certification and final designation by the Secretary of the Treasury, which had to be completed within a 30-day consideration period after written nominations were made, unless a 30-day extension was requested by the applicable governor

Nomination of Qualified Opportunity Zones

Section 13823 of the Act adds a new section of the Internal Revenue Code (Section 1400Z-1) setting forth the rules for the nomination by each state's governor of certain "low-income community" population census tracts as "qualified opportunity zones." The Act specifies that the same definition of "low-income community" that is contained in Code Section 45D(e) (governing the New Markets Tax Credit) will generally apply for Opportunity Zone purposes.

Code Section 45D(e) defines a "low-income community" as any census tract if:

• a) the poverty rate is at least 20 percent, or
• b) the median family income does not exceed 80 percent of statewide median family income or, if in a metropolitan area, the greater of 80 percent statewide median family income or 80 percent of metropolitan area median family income

Section 1400Z-1(e) also provides that a population census tract that does not qualify as a "low-income community" under the definition may also be designated as a qualified opportunity zone if 1) it is contiguous to a low-income community population census tract that has been designated as a qualified opportunity zone and 2) the median family income of the tract does not exceed 125 percent of the median family income of the low-income community with which the tract is contiguous. Section 1400A-1(e)(2) limits the number of population census tracts designated as Opportunity Zones on the basis of their contiguity to a designated "low-income community" to no more than 5 percent of the total zones designated within a state.

The legislative history of the provision suggests that governors nominating census tracts for designation should pay particular consideration to areas that:

• are currently the focus of mutually reinforcing state, local or private development initiatives to attract investment and foster startup activity
• have demonstrated success in geographically targeted development programs such as promise zones, the New Markets Tax Credit (NMTC), empowerment zones and renewal communities, and
• have recently experienced significant layoffs dues to business closures or relocations

However, these provisions were not included in the statute as enacted. Thus, governors are free to develop their own criteria beyond the basic thresholds based on poverty rate, median income and contiguity.

Number of Zones That May Be Designated as Qualified Opportunity Zones

As a general rule, the number of zones that could be designated as Opportunity Zones within each state, the District of Columbia or territory is limited to 25 percent of the total number of low-income communities within each state. Many states have well over 1,000 "low-income community" census tracts.

• As an example, there are 3,512 population census tracts meeting the definition of "low-income community" in California, 2,051 in New York, 1,699 in Florida, 1,293 in Illinois and 1,037 in Georgia.

However, if the number of low-income communities in a state is less than 100, then a total of only 25 of such tracts could have been designated as Opportunity Zones.

• For example, there are a total of only 45 low-income community census tracts in the state of North Dakota, 55 in Alaska and 78 in Rhode Island.

There is no limit on the number of zones that may be nominated, but it is likely that most governors did not nominate more than the maximum number of zones that may be designated in their states.

Designated Opportunity Zones

All states and U.S. possessions nominated Opportunity Zones, and the U.S. Department of Treasury accepted those nominations. The official list of all designated Opportunity Zones can be found at the U.S. Department of Treasury website. There are over 8,700 designated Opportunity Zones. By legislation passed after the Act, all of Puerto Rico's low-income community census tracts were designated as Opportunity Zones. The designations accepted by the U.S. Department of Treasury are valid until 2028. Absent congressional action, no new Opportunity Zone designations can be made.

Conclusion and Considerations

Congress has enacted a potent tax incentive for investors to reinvest investment gains in funds designed to provide capital to businesses in distressed communities. States had a very limited time period (until March 21, 2018, unless a 30-day extension was applied for and granted) to nominate qualifying Opportunity Zones within their jurisdictions. All Opportunity Zones have been designated and absent congressional action, these designations cannot be changed and are valid until 2028. 
  

Information contained in this alert is for the general education and knowledge of our readers. It is not designed to be, and should not be used as, the sole source of information when analyzing and resolving a legal problem. Moreover, the laws of each jurisdiction are different and are constantly changing. If you have specific questions regarding a particular fact situation, we urge you to consult competent legal counsel.