Key Takeaways
- On July 4, President Donald Trump signed wide-ranging tax legislation, P.L. 119-21 (the Legislation). The Legislation will affect nearly every sector of the economy and every type of taxpayer.
- On July 8, we published a comprehensive alert providing a summary and analysis of the Legislation.
- In this alert, which is part of an eight-part series taking a deeper dive into various portions of the Legislation (International Tax; Opportunity Zone and Tax Credits; Green Energy Credits; Estate Planning and Individual Tax Provisions; Start-up Investors and Business Owners; Employer-Related and Executive Compensation Provisions; Health Care-Related Provisions; and Exempt Organization-Related Provisions), we explain and analyze the implications of the Opportunity Zone, Low-Income Housing Tax Credit and New Markets Tax Credit provisions of the Legislation.
The Legislation combines spending and policy priorities from 11 congressional committees and will reshape federal policy across nearly every sector of the U.S. economy. With respect to the Opportunity Zone program and Tax Credits (non-energy), notable provisions include the following: (i) the permanent extension of the Opportunity Zone program with some modifications made to Opportunity Zone eligibility criteria and investment benefits, as well as the addition of new reporting requirements; (ii) an increase in the number of "9% credits" available under the Low-Income Housing Tax Credit program along with a major reduction in the level of bond financing required in order to receive "4% credits" under the program; and (iii) the permanent extension of the New Markets Tax Credit program.
There is a possibility of one or more additional reconciliation
bills during late 2025 or in 2026 and, therefore, additional
opportunities for enactment of additional provisions, as well as
changes and improvements to the Legislation. And the importance of
engaging with the IRS and U.S. Department of the Treasury as they
develop guidance to implement some of the more complex provisions
cannot be overstated.
Notable changes made by the Legislation to the Opportunity Zone,
Low-Income Housing Tax Credit and New Markets Tax Credit programs
are summarized below.
Opportunity Zones
The Opportunity Zone (OZ) program was created as part of the Tax Cuts and Jobs Act of 2017 (TCJA) with the goal of increasing long-term investments in low-income communities. Under the TCJA, the OZ program generally permits taxpayers to defer recognizing certain types of realized gains (and in some cases to permanently exclude from gross income a portion thereof) if they invest the amount of their gain in a qualified opportunity fund (QOF) within a 180-day period. The QOF must then invest substantially all its funds, either directly or indirectly, in qualifying property located in certain designated low-income communities known as OZs. In addition to the gain deferral/partial exclusion benefits, a taxpayer who invests in a QOF also has the ability to exclude from gross income any appreciation of its QOF investment if it holds such interest for at least 10 years.
The Legislation provides for the OZ program to become a permanent fixture of the Internal Revenue Code (the Code) with the following changes:
New OZ Designations
Beginning Jan. 1, 2027, there will be rolling 10-year OZ designations (i.e., census tracts will be reviewed every 10 years to determine whether they still qualify for OZ designation and state governors will have the opportunity to redesignate OZs in their state based on the updated census tract information). The Legislation also narrows the eligibility criteria for designation as an OZ. As a result of the stricter criteria, there will be fewer qualifying census tracts beginning with the next round and thus fewer designated OZs (because each state generally may designate no more than 25 percent of its qualifying census tracts as OZs).
Modification of Current OZ Benefits
Under the current OZ program, if a taxpayer holds an investment in a QOF for at least five years, the taxpayer receives a basis step-up equal to 10 percent of his deferred gain (effectively providing the taxpayer with a permanent gain exclusion equal to 10 percent). If the investment is held for at least seven years, an additional 5 percent basis step-up is provided. The Legislation retains the ability of a taxpayer who makes an investment in a QOF after Dec. 31, 2026, to permanently exclude 10 percent of the deferred gain if the QOF investment is held for at least five years. The additional 5 percent basis step-up/permanent exclusion for a seven-year hold included in the TCJA is not available for investments made after 2026.
Also, under the current OZ program, all gain that was deferred by investing in a QOF (subject to any permanent exclusions discussed above) must be recognized on Dec. 31, 2026 (the "income recognition date"), unless the investment is sold earlier. The new "income recognition" date for investments made in QOFs after Dec. 31, 2026, is the earlier of (i) the date the investment is sold or exchanged, or (ii) the date that is five years after the investment in the QOF. Thus, unlike the current statutory scheme where the "income recognition date" is a set Dec. 31, 2026, every taxpayer investing in a QOF after 2026 will be able to defer its gain for a set five years as long as the investment is held for such five-year period. It is important to note, however, that this new "income recognition" date applies only to investments made after 2026. Because new investments made now through the end of 2026 will still have an "income recognition" date of Dec. 31, 2026, it is possible there could be a temporary "chill" of new investments in QOFs for approximately the next year and a half until the new rules start to apply.
Lastly, as noted above, under the current OZ program, if a taxpayer holds an investment in a QOF for at least 10 years, the taxpayer receives a basis step-up to fair market value (FMV) on the date the investment is sold or exchanged (effectively providing the taxpayer with full tax-free appreciation on the investment). The Legislation modifies this benefit for taxpayers who hold their QOF investments for more than 30 years by limiting their basis step-up to the FMV of their investment on that 30-year anniversary date.
New Benefits for Investments in Rural OZs
If an investor holds an interest in a QOF that invests, directly or indirectly, in a sufficient amount of tangible property used in a "rural" OZ, the 10 percent exclusion attributable to a five-year holding period is increased to 30 percent. Additionally, the "substantial improvement" requirement for qualifying OZ property is relaxed for property located in a rural OZ.
New Reporting
The Legislation creates new annual reporting requirements for QOFs and qualifying entities in which QOFs invest, known as qualified opportunity zone businesses (QOZBs), and institutes penalties for late filing. Among other items, information on the number of residential units held by, and the full-time employees of, the QOF and/or QOZB will now be required to be reported annually. The Legislation also requires the Treasury to prepare publicly available reports summarizing information related to, among other things, the number and dollar value of investments in QOFs and the impact of such investments on the designated OZs.
Low-Income Housing Tax Credit
The Low-Income Housing Tax Credit (LIHTC) was introduced as part of the Tax Reform Act of 1986 with the goal of incentivizing the construction and rehabilitation of affordable rental housing developments. The program was later made permanent with the passage of the Omnibus Budget Reconciliation Act of 1993. Under the LIHTC program, designated housing credit agencies are vested with the authority to award tax credits to applicants that intend to either construct new affordable rental housing developments or acquire and rehabilitate existing developments as affordable rental housing.
The LIHTC program provides for two types of tax credit awards: (i) "9% credits" made available through a competitive application process, and (ii) "4% credits" made available through a noncompetitive process to projects funded with private activity bonds.
The Legislation makes the following changes to the LIHTC program under Section 42 of the Code:
State Housing Credit Ceiling Increase
The Legislation permanently increases by 12 percent the number of 9% credits available for housing credit agencies to award on an annual basis. The 12 percent increase will be available beginning in 2026.
Expansion of the Tax-Exempt Bond Financing Provision
Under the current LIHTC rules, if 50 percent or more of the aggregate basis of a building and land is financed with tax-exempt bonds that are subject to a state's volume cap, that entire building would be eligible for 4% credits without an allocation from the state (as opposed to just the portion of the building financed with the bonds). The Legislation generally expands that favorable rule to buildings, for which at least 25 percent of the aggregate basis is financed with tax-exempt bonds. This 25 percent standard will apply to buildings financed by bonds that are (i) issued after Dec. 31, 2025 and (ii) provide the financing for not less than 5 percent of the aggregate basis of such building and the land on which it is located.
New Markets Tax Credit
The New Markets Tax Credit (NMTC) program was created as part of the Community Renewal Tax Relief Act of 2000 with the goal of encouraging investment in low-income communities (LICs). The program operates by having certified community development entities (CDEs) apply to the Community Development Financial Institutions Fund (CDFI Fund) for an NMTC allocation, which CDEs can then "award" to projects operating in LICs, generally based on each CDE's chosen "economic development" criteria. An investor will thereafter make an equity investment in an affiliate of the CDE (a Sub-CDE), which will be combined with other project funds in order to arrive at the amount of the NMTC allocation awarded to the project. These combined proceeds will then be used by the Sub-CDE to make loans, with favorable terms, to the project entity. The result of this structure is an aggregate NMTC equal to 39 percent times the NMTC allocation, which is available to the investor over a seven-year period.
For each of the years 2024 and 2025, the total amount of NMTC allocations available to be awarded to CDEs is $5 billion. Awards for this $10 billion "double round" are expected to be announced in the fall. The program has never been permanent but has always been extended prior to any expiration date; the most recent five-year extension came in 2020. Without a legislative extension, the awards to be announced this fall would have been the final round and the NMTC program would have expired at the end of the year.
The Legislation provides for a permanent extension of the NMTC program, with $5 billion of allocations available to be awarded to CDEs on an annual basis beginning in 2026.
Historic Tax Credit
The Legislation made no changes to the federal Historic Tax Credit (HTC) program under Section 47 of the Code. Under the HTC program, a taxpayer can generate a 20 percent tax credit on qualifying expenditures made to rehabilitate a "certified historic structure." While there were advocacy efforts to have some improvements to the program included in the Legislation, specifically including an increase to the credit for certain "small" projects and elimination of the depreciable basis adjustment associated with HTCs, no changes were ultimately made.
Conclusion
With this first Trump administration budget reconciliation bill enacted, taxpayers should determine the expected impacts, consider adjustments and compliance issues as appropriate, and identify possible opportunities the Legislation may create.
Some of the proposed changes and spending cuts that were dropped solely because the Senate parliamentarian ruled that inclusion would have violated the Byrd Rule, which governs the reconciliation process, may be revisited during the Fiscal Year 2026 appropriations process and through stand-alone legislation during the remainder of the 119th Congress. With respect to provisions included in the Legislation, specifically some of the new OZ program provisions, taxpayers should turn their focus toward offering input as the Treasury and IRS develop and issue implementing regulations and related guidance.
It is likely that there will be one or more additional reconciliation bills during late 2025 or in 2026 and, therefore, additional opportunities for enactment of additional provisions, as well as changes, corrections and improvements to the Legislation. We will continue to assist our clients with advancing their federal policy goals; challenging and, when necessary, litigating IRS enforcement missteps; and keeping our clients and friends updated on federal tax- and budget-related developments.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
