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Final OZ regulations make time-sensitive changes for investing 1231 gains

On Dec. 19, 2019, the Department of Treasury released highly anticipated final regulations covering the opportunity zones program. The final regulations combine two sets of proposed regulations published in October 2018 and May 2019 into one comprehensive package, and the finalized rules feature many taxpayer- and investor-friendly changes from those initially proposed. For additional background and details regarding opportunity zones and the proposed regulations.

This alert focuses on the changes made to a taxpayer’s ability to invest gains on sales of section 1231 property (property used in a trade or business) in a qualified opportunity fund (QOF), which are of time-sensitive significance. It is critical to note that the following have the potential to dramatically alter the amount and timing in which a taxpayer can invest in a QOF in exchange for the program’s tax benefits in 2019.

  1. A taxpayer’s gain from a singular sale of section 1231 property (“1231 property”) is now eligible to be invested into a QOF. Under the proposed regulations, only the taxpayer’s net gain on all 1231 property sales for the taxable year could be invested;
  2. A taxpayer now has 180 days from the date 1231 property is sold to invest in a QOF, whereas under the proposed regulations the 180-day period for investing net section 1231 gains began on the last day of the taxpayer’s taxable year; and
  3. A taxpayer’s eligible section 1231 gain (“1231 gain”) amount is no longer required to be reduced by any losses from 1231 property sales incurred in the previous five years.

The additional flexibility and opportunity these changes provide to potential investors is best illustrated via an example.

Consider a calendar-year taxpayer who in July 2019 sold 1231 property at a gain of $100 and in December 2019, sold an additional 1231 property at a loss of $25. During 2017, the taxpayer had sold 1231 property at a loss of $50.

Under the May 2019 proposed regulations, to determine the eligible 1231 gain amount, the taxpayer first would have to net the two 2019 1231 property sales, to arrive at a total 1231 gain of $75. Next, the 1231 recapture rules further reduce the amount eligible for investment by $50. The taxpayer’s net gain that could be invested in exchange for the opportunity zone tax benefits was $25. Lastly, the taxpayer’s 180-day window for investing the $25 eligible gain would have begun on Dec. 31, 2019.

Under the final regulations, the taxpayer’s $100 gain from the July sale is eligible for investment in a QOF in full, with the 180-day window beginning on the date of sale. No netting or recapture is required.

Effective date. The final regulations are generally effective for tax years beginning after the date that is 60 days from the date they are published in the federal register. However, taxpayers can generally choose to rely on either the proposed or final regulations, so long as they are adopted in their entirety for tax years beginning after Dec. 21, 2017, and on or before the aforementioned effective date. In short, taxpayers can rely upon the final regulations for the 2019 calendar year. With that said, taxpayers considering investing gain from a singular 1231 property sale must keep in mind that their QOF investment must be acquired within 180 days of such sale.  

The final regulations are 544 pages long and cover a plethora of issues. We will release additional guidance on their contents in the coming weeks.

Lastly, as a reminder, Dec. 31, 2019, marks the last day an investment in a QOF can be made in exchange for the benefit of a possible 15% reduction in tax on the gain the investor defers. Thereafter, the maximum reduction is 10%.

We encourage you to reach out to your Baker Tilly advisor to discuss how any of the above may impact your tax situation.

For more information, visit our opportunity zone page.

For more information on this topic, or to learn how Baker Tilly specialists can help, contact our team.

The information provided here is of a general nature and is not intended to address the specific circumstances of any individual or entity. In specific circumstances, the services of a professional should be sought. Tax information, if any, contained in this communication was not intended or written to be used by any person for the purpose of avoiding penalties, nor should such information be construed as an opinion upon which any person may rely. The intended recipients of this communication and any attachments are not subject to any limitation on the disclosure of the tax treatment or tax structure of any transaction or matter that is the subject of this communication and any attachments.

Colin J. Walsh
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