The Tax Cuts and Jobs Act of 2017 (the "Act") made significant changes to U.S. federal tax law. One of these changes was the establishment of a new tax regime relating to qualified opportunity zones ("Opportunity Zones") under Sections 1400Z-1 and 1400Z-2 of the Internal Revenue Code of 1986, as amended (the "Code"), to encourage private investment in distressed communities throughout the United States. Investors that wish to defer capital gains recognized upon a sale or exchange of an asset to an unrelated1 party on or prior to December 31, 2026 can invest that gain in a Qualified Opportunity Fund (QOF), which in turn invests in so- called "qualified opportunity zone property." This newsletter will discuss the current status of the Opportunity Zone program, the tax benefits associated with investing in QOFs, what qualifies as qualified opportunity zone property and issues relevant to sponsors in connection with the formation of QOFs.

Part I – The Designation of Opportunity Zones

Individual States (which for this purpose includes possessions of the United States and the District of Columbia) have been tasked with the nomination of census tracts to be designated as Opportunity Zones. Initial nominations were due on March 21, 2018, but the Act permitted each State a 30-day extension. Information with respect to the nominated Opportunity Zones is available on the Department of the Treasury's Community Development Financial Institutions Fund website ( According to the website, the official list of Opportunity Zones (i.e., those that have been certified and designated by the Secretary of the Treasury) will be published in an Internal Revenue Bulletin at a later date. This timing is consistent with the Act, which provides that the Secretary of the Treasury has a 30-day consideration period after the States have submitted their lists of nominated Opportunity Zones. Given this guidance, we expect the official list of Opportunity Zones will be available by the end of May or early June 2018, which takes into account the 30-day extension and the 30-day consideration period.

An Opportunity Zone generally must be a population census tract within a State that qualifies as a "low income community" (LIC) as such term is defined under Code Section 45D(e) (the provision of the Code that applies to the New Market Tax Credit program). In order to qualify as an LIC, a population census tract must have a poverty rate of no less than 20 percent, or a median family income not to exceed 80 percent of either the statewide or metropolitan area income, depending on the tract's location. A tract that is not an LIC but is contiguous to an LIC that is designated as an Opportunity Zone (even if not in the same State) and has a median family income not exceeding 125 percent of the median family income of such LIC may also be designated as an Opportunity Zone. The total number of non-LIC tracts that are designated as Opportunity Zones in a state cannot exceed five percent of the total number of designated Opportunity Zones in such state. Generally, the number of Opportunity Zones designated in each state cannot exceed 25 percent of the number of population census tracts in such State that qualify as LICs, except that if a State has fewer than 100 LICs, it may designate up to 25, and all LICs in Puerto Rico were designated as Opportunity Zones by the Act. Based on information from Treasury, over 41,000 population census tracts are eligible for designation as an Opportunity Zone (31,680 of which are LICs and 9,453 of which are non-LICs that are contiguous to LICs).

Part II – Tax Benefits From Investing in Opportunity Zon

An investor may obtain three types of U.S. federal income tax benefits as a result of its investment of cash in a QOF. Such benefits are available, however, only to the extent the cash the investor invests in QOF interests does not exceed the gains (whether short-term or long-term)2 it has realized from a sale to, or exchange with, an unrelated party of any property held by the investor. Further, in order to be eligible for such benefits, the investor's sale or exchange must occur (x) not later than December 31, 2026 and (y) not more than 180 days prior to its investment in the QOF (such a sale or exchange satisfying clauses (x) and (y), a "recent sale or exchange"). There are no individual or aggregate limitations on the amount of gains that can be deferred or eliminated under the Opportunity Zone program.

If an investor makes an investment in a QOF in excess of the gains it realized from recent sales or exchanges, its investment in the QOF is treated as two separate investments, one investment relating to its recent sales or exchanges, which may qualify for the Opportunity Zone tax benefits, and a separate investment, consisting of the excess amount, which will not qualify for those tax benefits.

The U.S. federal income tax benefits associated with investing in QOF interests are described directly below

Deferral of Gains From Recent Sales or Exchanges

First, upon investing in a QOF, the investor receives a temporary deferral of any reinvested gains that it realized from recent sales or exchanges. Such deferral will extend until the earlier of (i) the investor's disposition of its interest in the QOF, or (ii) December 31, 2026. It is unclear whether the long-term v. short-term character of gains (or, potentially, the ordinary income character of gains, in the case of gains characterized as ordinary income if such gains are deferrable) that are recognized after their deferral under the Opportunity Zone program will be the same as the character such gains would have had if they had not been deferred. Like Section 1031 exchanges, QOF investments provide a deferral benefit, but one important difference is that only the gains an investor seeks to defer need to be reinvested in the QOF, whereas in Section 1031 exchanges the entire value of the "relinquished property" must be reinvested in like-kind property. On the other hand, the deferral benefit of a Section 1031 exchange is indefinite, whereas any gain deferred under the Opportunity Zone Program must be recognized no later than December 31, 2026.

Elimination of a Portion of Gains From Recent Sales or Exchanges Reinvested in QOF Interests Upon Fifth and Seventh Anniversaries

Second, up to 15 percent of the gains realized from recent sales or exchanges and reinvested in a QOF can be eliminated, depending on the investor's holding period with respect to its interest in the QOF. The initial tax basis of an interest in the QOF acquired with reinvested gains from recent sales or exchanges is $0.3 If an investor holds its QOF interest for at least five years, the tax basis of the QOF interest is increased on the fifth anniversary of the investment by 10 percent of the amount of gain initially reinvested in such QOF interest. If an investor holds its QOF interest for at least seven years, the tax basis of the QOF interest is increased on the seventh anniversary of the investment by an additional five percent of the amount of gain initially reinvested in such QOF interest. For example, if the investor acquires its QOF interest on June 30, 2019, for $10 million of reinvested gains from recent sales or exchanges and holds such interest into 2027, then on December 31, 2026, the investor will recognize gains previously deferred in an amount equal to the amount by which the lesser of $10 million and the fair market value of the QOF interest exceeds $1.5 million.

No Gain Upon Sale or Exchange of QOF Interest After Tenth Anniversary of the Investment

Third, if an investor holds its interest in the QOF for 10 years or more, for purposes of determining the gain or loss the investor recognizes from the sale or exchange of such QOF interest, the investor may elect for the basis of such QOF interest to be equal to its fair market value on the date such QOF interest is sold or exchanged (the "FMV Basis Election"). As a result, the investor will not recognize gain and will not owe tax on the sale or exchange of its QOF interest 10 years or more after it acquired the QOF interest.

Investors who are not seeking to defer gain may still invest in a QOF. However, if an investor is not reinvesting gains from recent sales or exchanges, or an investor that is otherwise seeking deferral of gain invests funds in excess of such gain in a QOF, the tax benefits described above will not apply, even if the investor holds its QOF interest for at least 10 years.


1 Throughout this memorandum, parties are "related" to each other if such parties have at least 20 percent common ownership.

2 It is unclear whether gains that are characterized as ordinary income benefit from the Opportunity Zone program or whether such benefits are available only for capital gains. 

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