Wisconsin is officially on track to facilitate investment through the new Investing in Opportunity Act. On March 21, 2018, Governor Scott Walker announced his Economic Opportunity Zone recommendations for Wisconsin, which include 120 zones across over 40 counties. Nearly 40 of the 120 zones are located in Milwaukee County, with most located in the City of Milwaukee. A few zones are located outside of the City of Milwaukee in the City of West Allis, the City of West Milwaukee, and the City of South Milwaukee. The U.S. Department of the Treasury now has 30 days (with the possibility of a 30-day extension) to decide which of the zones submitted by the Governor will be certified as “Qualified Opportunity Zones” (QO Zones) for purposes of the recently enacted Investing in Opportunity Act.
The goal of the Investing in Opportunity Act, much like the goal of other community investment programs, is to encourage investment in low-income communities. Some predict that if successful, this program may supplement other popular programs, such as New Markets Tax Credits (NMTC). The Investing in Opportunity Act creates a tax benefit for investors and a new source of capital for real estate projects and businesses located in QO Zones.
The program requires qualified investments to be facilitated through a Qualified Opportunity Fund (QO Fund). A QO Fund is a privately managed investment vehicle, certified by the U.S. Department of the Treasury, and organized as a corporation or a partnership for the purpose of making investments in QO Zones. A QO Fund must invest at least 90 percent of its assets in businesses where (i) substantially all of the tangible assets of the business are used in a QO Zone, and (ii) at least 50 percent of the gross income earned from the business is from the active conduct of business in a QO Zone. For those familiar with the NMTC program, these requirements will sound familiar.
Once QO Funds are formed, taxpayers can then invest proceeds from the sale of property in the QO Fund, thereby allowing the investor to elect to defer recognition of the capital gain on that sale equal to the amount invested in the QO Fund. Deferral of gain only applies to investments in a QO Fund made on or before December 31, 2026. The QO Fund will then use such investments to acquire “qualified opportunity zone property,” which might include stock, partnership interests, or tangible property used in a trade or business, in each case generally located in a QO Zone. Examples of potential QO Fund investments might include a partnership interest in a commercial real estate venture for a project located in a QO Zone or purchase of stock in business located in a QO Zone. Layering local and university innovation and economic development initiatives with the new QO Zones could prove to be a powerful tool for capitalizing start-up businesses.
The value of the investment to taxpayers will depend on how long the investment remains in the QO Fund. If the investment remains in the QO Fund for at least five years, then 10 percent of the deferred gain is eliminated by a step-up in basis. If the investment remains in the QO Fund for at least seven years, the basis of the investment is increased by an additional five percent. Under the program, a taxpayer’s deferred gain must be recognized on the earlier of the date the QO Fund investment is sold or December 31, 2026. The program effectively allows investors to eliminate up to 15 percent of the initial capital gain and to defer tax on the remainder. Any additional gains from appreciation of the value of the QO Fund investment will also be subject to tax. However, such gains are nontaxable if the taxpayer makes a special election and holds the investment for at least 10 years. If the taxpayer elects to sell or exchange its investment in the QO Fund inside of five years, then the taxpayer will have to recognize the entire amount of the deferred gain, together with any gain realized from the appreciation of the value of the QO Fund investment.
Taxpayer sells property with a basis of $1,000,000 for $2,000,000, resulting in a capital gain of $1,000,000. Within 180 days following the sale, taxpayer invests the $1,000,000 capital gain into a QO Fund and elects to defer recognition of the capital gain until the earlier of the sale of taxpayer’s QO Fund investment, or December 31, 2026. The basis of taxpayer’s initial investment in the QO Fund is zero. The QO Fund then uses the proceeds of taxpayer’s investment to acquire a partnership interest in a special purpose entity (SPE) organized for the purpose of developing a real estate project (e.g., a limited liability company). The SPE completes the real estate project within 30 months following the date that the QO Fund acquires its partnership interest, thereby satisfying the requirement that the SPE substantially improves the acquired property within 30 months. The taxpayer holds its $1,000,000 investment in the QO Fund for five years, and during that time, the value of the investment appreciates. Taxpayer elects to sell its interest in the QO Fund following the five-year hold period for a sales price of $1,500,000. Taxpayer’s gain at the end of those five years would be calculated as follows:
|Initial Investment in QO Fund:
||$1,000,000 (Initial deferred capital gain)
|Sales Price after 5 years:
|Basis in Investment:
||($ 100,000) (10% of Initial Investment)
Program guidelines and QO Fund certification are in process by the U.S. Department of the Treasury. Final regulations are expected late 2018 or early 2019.
Contact Michael Best & Friedrich to learn more about how you or your business can benefit from the Qualified Opportunity Zone Program.