Click here to download Novogradac’s summary, “Opportunity Zones 101: A New Tool for Community Development.”

H.R. 1, signed into law on December 22, 2017, created a new tool for community development, designed to provide tax incentives to help unlock investor capital to fund businesses in underserved communities.

The law allows investors to defer (up to 9 years) paying tax on gains if those gains are invested in Qualified Opportunity Funds that in turn invest in economically distressed communities designated by the governor.  To qualify, the gain must be invested in the Qualified Opportunity Fund during a 180-day period that begins on the date of the sale or exchange that generated the gain.  The deferral is temporary, the gain must be recognized on the earlier of Dec. 31, 2026, or the date the investment in the Opportunity Fund is sold or exchanged. The amount of gain includible is the lesser of the amount of gain originally deferred, or the excess of the fair market value of the investment over the taxpayer’s basis in the investment.

In addition to the up to 9-year deferral of gain, long-term investment is incentivized by allowing for a modest step-up in basis for investments that are held beyond five and seven years. For investment held at least five years, the taxpayer’s basis is increased by 10 percent of the original gain. For investments held for at least seven years, the taxpayer’s basis is increased by 5 percent of the original gain.

Furthermore, as an additional incentive to make long-term, patient capital investments, taxpayer’s holding Opportunity Fund investments for a period of at least 10 years are exempt from any additional gains beyond that which was previously deferred.

Opportunity Funds can be organized in various ways to raise capital from a wide array of investors.  Opportunity Funds must be certified by U.S. Department of the Treasury and are required to hold at least 90 percent of their assets in qualified opportunity zone businesses and/or business property.  If an Opportunity Fund fails to meet the 90 percent requirement, then the fund must pay a penalty for each month it fails to meet the investment requirement. The penalty equals the amount of the short fall, times the underpayment rate under Section 6621(a)(2), which is currently 6 percent.

The same definition of a “low-income community” that is used by the new markets tax credit (NMTC) is the basis for defining an opportunity zone.  The law generally allows for 25 percent of a state’s low-income community population census tracts to be designated as qualified opportunity zones.  Governors are responsible for identifying the areas in their states to be designated as opportunity zones.