The Tax Cuts and Jobs Act enacted section 1400Z-2 of the Internal Revenue Code, which created the qualified opportunity zone program. The program is designed to encourage investment in distressed communities designated as “qualified opportunity zones” by providing tax incentives to invest in “qualified opportunity funds” (“opportunity funds”) that, in turn, invest directly or indirectly in the opportunity zones.
The qualified opportunity zone program generally offers three potential tax benefits to investors:
First, a taxpayer may elect to defer tax on capital gain from the sale or exchange of property with an unrelated person by investing the gain as equity in an opportunity fund within 180 days after the sale or exchange. The deferral ends on December 31, 2026, or sooner if the taxpayer sells its interest in the opportunity fund, and at that time the taxpayer must recognize the gain (and pay tax) with respect to the original property.
Second, if the taxpayer holds its interest in an opportunity fund for five years, it can step up its basis in the opportunity fund by an amount equal to 10% of the deferred gain with respect to the original property and, if the taxpayer holds its interest in the opportunity fund for seven years, it can step up its basis in the opportunity fund by an amount equal to an additional 5% of the deferred gain with respect to the original property (for a total of 15%). The stepped up basis reduces the amount of gain recognized by the taxpayer at the end of the deferral period.
Finally, if the taxpayer holds its interest in the opportunity fund for at least 10 years, it can step up its basis in its interest in the opportunity fund to the fair market value of the interest on the date the interest is sold (enabling the taxpayer to eliminate income tax on any post-acquisition capital gain in its opportunity fund interest, including any capital gain attributable to leverage incurred by the fund).
An in depth discussion of the opportunity zone program and the proposed regulations can be found here: https://www.proskauer.com/report/irs-and-treasury-issue-proposed-opportunity-zone-regulations.