On September 28, 2023, a bipartisan group of legislators introduced H.R. 5761, the Opportunity Zones Transparency, Extension, and Improvement Act. This legislation, which is a revamped version of a bill originally introduced in 2022, will bolster the Opportunity Zones incentive by adding an extended deferral period, increased flexibility, and robust reporting requirements. Five highlights from the legislation are as follows:
1. Extension of Deferral Period. One of the key benefits of investing in Opportunity Zones is the upfront deferral from tax for eligible capital gains invested in a qualified opportunity fund (QOF). Originally, QOF investors would have been required to pay tax on the capital gains they deferred (in some cases, after having received a beneficial 10% or 15% step-up in tax basis, discussed below) on December 31, 2026. If the new legislation passes, QOF investors will be able to defer recognition of the invested capital gain for two extra years, until December 31, 2028.
2. New Investors Can Achieve a 10% Step-Up in Basis. In addition to the deferral benefit, some Opportunity Zone investors were eligible for a “step-up” in the tax basis of their invested capital gains, which reduces the amount of tax the investor owes when the deferral period ends. Originally, QOF investors were eligible for a 10% step-up after five years and an additional 5% step-up after seven years. Since the end of the current deferral period is now less than three years away, new QOF investors are ineligible for any basis step-ups under current law. However, because the new legislation extends the deferral period to December 31, 2028, investments made by December 31, 2023, qualify for the 10% basis step-up. Plus, under the new legislation, QOF investors who made their qualifying investments on or before December 31, 2021, could now qualify for the additional 5% step-up. These investors will qualify if they hold their qualifying investment through the end of the deferral period, allowing them to permanently exclude paying tax on a total of 15% of the capital gains they invested.
3. Additional Flexibility. Currently, QOFs, which are the primary investment vehicles for Opportunity Zone investments, can only invest in specific types of property (which excludes other qualified opportunity funds). The new legislation would change this rule to allow a “fund of funds” structure, increasing flexibility in structuring Opportunity Zone investments and making it easier to raise capital and introduce institutional investment to regional or single-purpose QOFs.
4. Elimination of Certain Qualified Opportunity Zones. Only investments in certain census tracts, called “qualified opportunity zones,” are eligible for the Opportunity Zone tax incentives. Currently, there are 8,764 such census tracts across the United States. The new legislation would sunset the qualified opportunity zone designation for any census tract with a median family income at or above 130% of the national median family income and would require states to replace such eliminated tracts with newly designated tracts in need of development. The process of disqualifying census tracts could take nearly a year and a half before disqualification of a particular tract becomes effective. Investments made in a tract prior to its disqualification will generally continue to qualify for the Opportunity Zone incentives.
5. Changes to Reporting Requirements. Under current law, each year, QOFs must file Form 8996, Qualified Opportunity Fund, and taxpayers investing in QOFs must file Form 8997, Initial and Annual Statement of Qualified Opportunity Fund Investments. The new legislation introduces changes to both Forms 8996 and 8997, specifically requiring QOFs and QOF investors to report additional information about their Opportunity Zone investments to the IRS. The additional information will be aggregated and used by policymakers to evaluate the effectiveness of the Opportunity Zone incentive. Although the penalties imposed for failure to comply with the reporting requirements can be expensive (in some cases, as much as $250,000), no penalties will be imposed where there are de minimis errors in reporting.
The Government Publishing Office has not yet printed the official text of this proposed legislation. It is not expected that the text will substantively change prior to printing; however, as with all legislation, its provisions are subject to change during the course of the legislative process.
If you have any questions regarding this legal update, please reach out to Matt Peurach, Lil Martin-Mashburn, or Ryan Bullard.
