ISSUE

There is an interesting provision in the 2017 “Tax Cuts and Jobs Act” that could provide a funding source for those institutions who are looking at Revenue Enhancement Opportunities (alternative business income activities).  New Internal Revenue Code Sections 1400Z-1 and 1400Z-2 provide this opportunity (pun intended).

 

SITUATION

Troas Bible College (TBC) is a private college exempt under Internal Revenue Code section 501(c)(3) and 170(b)(1)(A)(ii).  They are required to file Form 990 annually.

TBC has been approached by a local businesswoman about an “alternative business income activity” proposal.  The idea would be to set up a “Qualified Opportunity Fund” (QOF) that TBC would participate in by establishing a new course of study for students who would work in the endeavor.  The QOF would then seek investors who are interested in investing capital gain amounts in a tax-advantaged investment.

Basically, “Qualified Opportunity Zones” (QOZ) have been mapped out by census data throughout the U.S.  For investments made in these designated zones, investors may defer recognition on invested capital gains.  Investments would be made into a “Qualified Opportunity Fund” that your school could set up or participate in.  The three types of tax incentives include: deferral of tax on capital gains, partial decreases of tax (5-year rule, 7-year rule), and “no additional tax” on capital gains (10 year rule).

Ultimately, the incentive for investors is that they may defer tax on capital gains by investing in funds that operate QOF’s in QOZ’s.  The amount of the tax deferral will depend on the holding period of the investment in the QOF.  Currently, to maximize the tax benefit, investors must invest in a QOF in 2019 as the program “sunsets” on December 31, 2026.

If an investor owned publicly traded stock in MNO, Inc. with a basis of $100,000 and sold it for $1,100,000, they would normally pay taxes on a $1,000,000 capital gain.  If they invested in a QOF in 2019 and held that investment until December 31, 2026, they would defer the taxes on the 2019 sale of MNO, Inc. stock until 2026 and – because it was held in a QOF for seven years – they would receive an “imputed” basis in the stock of 15% of the original QOF investment ($150,000 basis).  (Note that because they are deferring the tax on the $1 million MNO capital gain, their basis in the QOF investment begins at zero.)  With the 10-year rule, there are some “post-acquisition gain calculations” involved as the program technically expires on 12/31/26.

This is a simplified summary.  The information and guidance on QOZ’s is fairly technical.  There are numerous “hoops” to jump through and rules to navigate.  IRB Notice 2018-48 provides a “grid” listing of the designated qualified opportunity zones by state, county, census tract number, tract type, and ACS data source.  The notice is 518 pages long with 516.5 pages consisting of this line-by-line, detailed list.  Much easier to use the “interactive” map (you’ll need Adobe Flashplayer), which is available at:

https://www.cims.cdfifund.gov/preparation/?config=config_nmtc.xml

 

RULES

From Proposed Regulation 1.1400Z2(a)-1:

(a) In general. Under section 1400Z-2(a) of the Internal Revenue Code (Code) and this section, an eligible taxpayer may elect to defer recognition of some or all of its eligible gains to the extent that the taxpayer timely invests (as provided for by section 1400Z-2(a)(1)(A)) in eligible interests of a qualified opportunity fund (QOF), as defined in section 1400Z-2(d)(1). Paragraph (b) of this section defines eligible taxpayers, eligible gains, and eligible interests and contains related operational rules. Paragraph (c) of this section provides rules for applying section 1400Z-2 to a partnership, S corporation, trust, or estate that recognizes an eligible gain or would recognize such a gain if it did not elect to defer the gain under section 1400Z-2(a).

 

BOTTOM LINE

  • The “Tax Cuts and Jobs Act” introduced I.R.C. Sections 1400Z-1 and 1400Z-2 – “Qualified Opportunity Zones.”
  • QOF investments held for five years – taxpayer’s basis is increased by 10 percent of the amount of deferred gain.
  • QOF investments held for seven years – the taxpayer’s basis is increased an additional five percent (to 15%) of the amount of deferred gain.
  • QOF investments held beyond the maximum deferral date (i.e., December 31, 2026) and for a minimum of 10 years – the taxpayer’s basis in its investment shall be equal to the fair market value of the investment on the date it is sold or exchanged, resulting in no additional recognized gain.

Specific questions? Email Dave Moja

The information provided herein presents general information and should not be relied on as accounting, tax, or legal advice when analyzing and resolving a specific tax issue. If you have specific questions regarding a particular fact situation, please consult with competent accounting, tax, and/or legal counsel about the facts and laws that apply.

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