This is the next post in a series of articles diving into the new “Opportunity Fund” program. In previous posts, we described the general framework for the new Opportunity Fund program, the tax benefits to taxpayers who invest in Opportunity Funds, and how the funds work. Now, we will answer some of the more common questions we have been receiving regarding the program.
Q: How does an Opportunity Fund become eligible to be an Opportunity Fund?
A: It is pretty simple. There are two general requirements. First, an Opportunity Fund must be organized for the purpose of investing in Qualified Opportunity Zone Property.
To accomplish this, we suggest that the Opportunity Fund’s governing documents, particularly the articles filed with the state, reflect this limited operating purpose. The second requirement is that the Opportunity Fund self-certify that it is an Opportunity Fund. To accomplish self-certification, the Opportunity Fund will need to file a form with its federal tax return. This new form was anticipated to be released this summer, but is not yet available, as of today.
Q: What gains are allowed to be invested into an Opportunity Fund?
A: The answer to this question warrants more guidance from the Treasury Department and the IRS. The title of the statute and the conference report indicate capital gains are only eligible, but the text of the statute only refers to “gains.” Gains could include short-term and long-term capital gains, Section 1231, ordinary, and pass-through gains. There is relevant authority to strongly support an argument that all gains are eligible. However, the Treasury Department may take the approach that only capital gains are eligible. Accordingly, the least aggressive course of action before guidance is released, is to only invest capital gains into an Opportunity Fund.
Q: Can LLCs be an Opportunity Fund?
A: We think LLCs taxed as a C-corporation or a partnership ought to be eligible to be a Qualified Opportunity Fund. However, this point is not certain until we receive guidance from the Treasury Department. The safest approach until then, is to organize the Opportunity Fund as a corporation or a partnership.
Q: How long does my investment need to stay in an Opportunity Fund?
A: There are two factors that will influence this answer. First, each Opportunity Fund may have differing requirements on how long the investment must remain in the Opportunity Fund. Second, each investor/taxpayer who rolls over gain from the disposition of an asset will have a choice to make. They can choose an election that will lock up their investment in an Opportunity Fund for 10 years to obtain the tax benefit of tax forgiveness on the appreciation on the investment in the Opportunity Fund. If the 10-year lock up election is not made, then the investor/taxpayer ought to be free to sell their investment in the Opportunity Fund at any time, subject to the Opportunity Fund specific requirements. I presume most Opportunity Funds will require at least a 5-year lock-up of capital and most taxpayers who invest in Opportunity Funds should aim to keep their investment in an Opportunity Fund for at least 5 years to obtain the 10% basis step up.
The Treasury Department nor the IRS have released the election forms as of yet. We will discuss the forms on a subsequent post as soon as they are available.
Q: What is the difference between a Section 1031 (like-kind) exchange and the Opportunity Fund incentive?
A: There are a number of important differences to be aware of:
- Section 1031 exchanges only apply to real estate now (see my post on the Tax Cuts and Jobs Act), but at a minimum, any capital gains are eligible to roll over into an Opportunity Fund.
- Only gains must be rolled over into an Opportunity Fund, not the entire proceeds as is generally the case in a Section 1031 transaction.
- There is a 10% basis step-up after five years, 15% after 7 years, and investment appreciation forgiveness if the 10-year lock up election is made under the Opportunity Fund program. In a Section 1031 transaction, only deferral is achieved (not taking into account estate planning techniques to achieve basis step up).
- All gain deferred under the Opportunity Fund program will have to be recognized the earlier of December 31, 2026 or at sale of the interest in the Opportunity Fund by the investor/taxpayer. There is no recognition of gain under a Section 1031 until the property is sold in a non-recognition transaction.
Q: What types of asset classes are well suited for Opportunity Funds to invest in?
A: Interests in a start-up or real estate are extremely well suited for the program. We understand there are a number of nuances in the various types of arrangements the interests can take, particularly in the real estate context. There may be ways to structure the investment to ensure compliance, so seeking expert advice at the onset is strongly recommended!
Look for subsequent posts with updates on the program announcements and insights into additional questions that arise.
Vikram Agarwal is a shareholder with Bean Kinney & Korman with an expertise in tax law. Please contact Vikram if you would like to learn more about the Opportunity Fund program at firstname.lastname@example.org.
Any tax advice expressed above by Bean Kinney & Korman, PC was not intended or written to be used, and cannot be used, by any taxpayer to avoid U.S. federal tax penalties. If such advice was written or used to support the promotion or marketing of the matter addressed above, then each offeree should seek advice from an independent tax advisor.
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