The United States Department of the Treasury recently approved 72 qualified Opportunity Zones in 27 municipalities in the State of Connecticut. These zones are designated as part of the federal government’s new Opportunity Zone Program, established in the 2017 Tax Cuts and Jobs Act to incentivize lasting investment in low-income communities. Through the Program, investors can pool their resources into qualified Opportunity Zone property and business, and receive in return a decreased federal tax obligation through the preferential treatment of capital gains. Tax benefits range from (1) temporary deferral of realization of capital gains, to (2) step-up in basis, to (3) permanent exclusion of capital gain from taxable income.
The Opportunity Zone program is available to all investors who desire to delay or reduce their tax obligation on a capital gain. Specifically, investors can avoid/delay paying federal income tax on capital gains by promptly reinvesting those gains in a qualified Opportunity Fund (“Fund”). The Fund is a legal entity, organized as a corporation or a partnership, which holds at least 90% of its assets in qualified Opportunity Zone property (“Qualified Property”). There is no minimum investment amount. Qualified Property includes a broad range of commercial assets, such as mixed-use development and affordable housing, as well as stock in a new or expanding company, a partnership interest, or a mix thereto, and there is no minimum investment requirement. Qualified Property is specifically defined in 26 U.S.C. § 1400z-2, and caveats include that (1) it must be acquired after December 31, 2017, (2) the original use of the property must commence with the Fund, or the Fund must “substantially improve” the Qualified Property, and (3) substantially all of the Qualified Property must be used in the Opportunity Zone while held by the Fund. This Program is to incentivize equity-based investment in Opportunity Zones, because tax savings only result from selling one asset and investing the gains from that sale in a Fund.
The tax benefits afforded to qualified investments in the Fund increase the longer the asset is held by the Fund. As provided above, tax benefits range from (1) temporary deferral of realization of capital gains, to (2) step-up in basis, to (3) permanent exclusion of capital gain from taxable income. Generally, for capital gains reinvested in a Fund within 180 days, realization of that capital gain is deferred until the earlier of the date for which the investment is disposed, or December 31, 2026. A step-up in basis is realized for capital gains reinvested in a Fund for at least 5 years: its basis increases by 10% if a taxpayer holds onto Fund investment for 5 years, and an additional 5% if held for at least 7 years. Thus, an investor can exclude up to 15% of the original gain from taxable income. In addition, for investments held by a Fund longer than 10 years, the basis of that investment is its fair market value on the date that the investment is sold or exchanged. This effectively permits investors to exclude any appreciation on their Fund investment in excess of their original deferred capital gain.
A map of Connecticut’s designated Opportunity Zones is available here. This new Program is a great tool for investors, and provides a unique opportunity to invest in Connecticut’s designated areas, many of which are already experiencing development and business growth.