December 14, 2018
By Marc Wieder, Robert Gilman and Jeffrey Bowden, Anchin, Block & Anchin LLP
The new Economic Opportunity Zones (EOZ) approved as part of the larger Tax Cuts and Jobs Act (TCJA) has been established to spur economic activity — and incentivize investors — in areas most in need. The program expands businesses’ ability to utilize a portion of the estimated $2.3 trillion of unrealized capital gains. If utilized effectively, this EOZ program could return far-reaching benefits to capital flows and incentivize increased activity for the real estate industry.
EOZs are thus being positioned as a boon for developers, investors and the communities in which the real estate activated under this program will bring.
As part of the EOZ program, the IRS designated more than 8,000 low-income communities (including more than 300 in New York City) as Qualified Opportunity Zones (QOZ). Funds are investment vehicles that can be set up as a partnership for investing in eligible property that is located in the QOZ.
Investors can defer taxes on capital gains — which would otherwise face a maximum federal tax rate of anywhere between 20% and 37% plus 3.8% surtax — by investing long-term in these funds, which invest back into low-income communities by developing or re-developing properties within the community. If the investor holds the investment for five years they will pay tax on 90% of the gain they deferred, if held for another two years, they will pay tax on only 85% of the deferred gain. This tax would be payable in 2026.
If the investment is held for at least 10 years, they will pay no tax on the gain from the investment.
There are those in the market, however, who contend that the new EOZ program is nothing more than a dressed-up version of the classic 1031 Exchange. While there are some basic similarities between the two programs, there are critical distinctions. We strongly advise you take a moment to consider the following:
Proceeds and Timing
• EOZ program: Requires only the amount of the gain to roll into a fund, within 180 days of a sale. Since only putting in the gain proceeds is necessary, an investor can take out their original investment.
• 1031 Exchanges: Require the entire proceeds from the sale of the original property to be reinvested into a new property within 180 days to defer the tax on a gain, while also requiring that exchange properties must be identified within 45 days.
Types of Gain
• EOZ Program: The new law places far less restrictions on the type of gain eligible for deferment. It only requires that the capital gain stem from a sale or exchange to an unrelated person. Real estate, personal property, intangibles assets, stocks, and virtually any other capital asset should qualify. This is an exciting distinction that provides a mechanism to unlock capital in the marketplace provided there are capital gains.
• 1031 Exchanges: Under the new tax law, eligibility for 1031 exchange treatment is now restricted to gains from the sale of real property only.
Ancillary Benefits for Brokerage and Construction Professionals
• While not participating in the program as investors or establishing funds, professionals that operate in EOZs will likely see increased activity. With investors incentivized to invest in funds to defer gains, developers will likely seek to acquire land and assets, set up funds, and build and renovate in these areas in greater frequency than before the law was passed.
The new EOZ program established under TCJA is far more expansive and flexible than 1031 exchanges. For the right investor, EOZs may not only bring back greater returns, but also serve as an economic catalyst for the neighborhoods that most need them.
Marc Wieder and Robert Gilman are accounting and audit partners, and Real Estate Industry Group co-leaders at Anchin, Block & Anchin LLP. Jeffrey Bowden is a tax principal and member of the Real Estate Industry Group and Financial Services Practice at Anchin, Block & Anchin LLP.
For comments, questions or concerns, please contact Paul Bubny