Fans of the Showtime series “Billions” may recall seeing in episode four of season five, aptly entitled “Opportunity Zone”, the show’s protagonist, Bobby “Axe” Axelrod, do battle with season five’s new nemesis, Michael Prince, over the chance to invest in an Opportunity Zone in Axe’s hometown of Yonkers. Why would two fictional billionaires compete for the opportunity to revitalize Yonkers? Well, in December 2017 President Donald J. Trump signed into law the Tax Cuts and Jobs Act (the “TCJA”). In previous articles I have addressed the primary benefit the TCJA had on estate planning for higher net worth individuals, namely the doubling of the federal estate and gift tax exemption amount from $5 million to $10 million, adjusted for inflation. However, the TCJA also introduced another concept that could benefit higher net worth individuals through their estate planning, Qualified Opportunity Zones and Qualified Opportunity Funds.
A Qualified Opportunity Zone is a low income census tract nominated by the Governor of that state and certified as a Qualified Opportunity Zone by the Secretary of the Treasury via his delegation of authority to the IRS. So, essentially the IRS certifies the nominated Qualified Opportunity Zones. Qualified Opportunity Zones can receive investments from Qualified Opportunity Funds, which investments are designed to improve the economically disadvantaged community. The purpose of Qualified Opportunity Zones is to incentivize investment in these economically disadvantaged communities by offering preferential tax treatment to the investors. Governor Andrew Cuomo designated 514 census tracts in New York State as Qualified Opportunity Zones, which were all certified as such by the IRS.
A Qualified Opportunity Fund is defined in the Internal Revenue Code as “any investment vehicle which is organized as a corporation or a partnership for the purpose of investing in qualified opportunity zone property (other than another qualified opportunity fund) that holds at least 90 percent of its assets in qualified opportunity zone property, determined by the average of the percentage of qualified opportunity zone property held in the fund as measured (A) on the last day of the first 6-month period of the taxable year of the fund, and (B) on the last day of the taxable year of the fund.” Basically, a Qualified Opportunity Fund is an investment vehicle for investing in Qualified Opportunity Zones. To qualify as a Qualified Opportunity Fund a taxpayer need only attach a form 8896 to their timely filed federal income tax return.
The benefit to a taxpayer of investing in a Qualified Opportunity Fund is deferral of recognition of capital gain. To qualify a taxpayer must reinvest capital gains into a Qualified Opportunity Fund within 180 days of the recognition of the gain. In exchange for reinvesting the capital gain into a Qualified Opportunity Fund the taxpayer can receive three benefits. First, a taxpayer can defer recognition of the capital gain until the earlier of 1. The sale of the asset in the Qualified Opportunity Fund; or 2. December 31, 2026. The primary benefit here is the concept of time value of money, i.e. a dollar today is worth more than a dollar tomorrow. So by deferring paying the capital gain tax until 2026, you are essentially paying less in tax in today’s dollars. You also have the opportunity to invest the money you would have paid in tax until you actually pay the tax, so the tax dollars can generate interest or appreciate in value. Second, if you hold the investment in the Qualified Opportunity Fund long enough some of the capital gain will go away. The way to think about this is that you have a zero basis in the capital gain, i.e. you will owe tax on the full amount of the gain had you not invested in the Qualified Opportunity Fund. If you hold the investment in the Qualified Opportunity Fund for five years you get a 10% basis step up, meaning you do not have to pay tax on 10% of the capital gain. If you hold the investment for seven years you get an additional 5% basis step up, meaning you do not have to pay tax on 15% of the capital gain. However, remember that the outside date for payment of the tax is December 31, 2026, so in order to get to the seven years, you would have to have invested in the Qualified Opportunity Fund by December 31, 2019. However, there is still ample time to invest before the five year mark and receive the 10% step up. Third, if you hold the investment in the Qualified Opportunity Fund for at least ten years, all subsequent appreciation, after paying the tax on December 31, 2026, is excluded from tax. This means your investment could quadruple in value after December 31, 2026, and as long as you hold the investment for ten years you will pay $0 in capital gain tax. One caveat is that you must dispose of the asset by December 31, 2047 to realize the 100% basis step up.
Estate Planning Considerations
Investing in a Qualified Opportunity Fund can be a useful tool for high net worth individuals to maximize their estate tax plan. The primary downside of the investment in a Qualified Opportunity Fund is that the asset value of the Qualified Opportunity Fund will be included in your estate for estate tax purposes. So, to the extent you estate is over the federal estate tax exemption threshold, the full value of the Qualified Opportunity Fund will be taxed at 40%. To avoid this, you can transfer your interest in the Qualified Opportunity Fund to an irrevocable grantor trust. The IRS regulations allow for this, and because the trust is a grantor trust, it is not considered a taxable event. The benefit of holding the Qualified Opportunity Fund in an irrevocable trust are: 1. The asset value and any appreciation is removed from your estate for estate tax purposes; 2. On December 31, 2026 you can still pay the deferred capital gain tax due, which serves as a means to further reduce your estate for estate tax purposes and allows the asset in the Qualified Opportunity Fund to continue to grow in the trust income tax free; and 3. The primary downside of transferring assets into an irrevocable trust is that your heirs lose the step up in basis they would receive at death, had the asset been in your taxable estate. However, here, if the Qualified Opportunity Fund holds the investment for ten years and disposes of it prior to December 31, 2047, there is a full basis step up, so your heirs would not owe any capital gains tax. So, if properly structured and held long enough, the Qualified Opportunity Fund’s appreciation can grow both estate tax and capital gains tax free.
As I set out in my article entitled, “Estate Planning Opportunities With the Tax Cuts and Jobs Act”, many opportunities exist for high net worth individuals under the TCJA. Investment in Qualified Opportunity Zones is another example of that. The estate planning attorneys at Twomey, Latham, Shea, Kelley, Dubin & Quartararo are available at your convenience to answer your questions about Qualified Opportunity Zones and Qualified Opportunity Funds, or any other estate planning question you may have, and to review your current estate plan to make sure it continues to best represent your wishes and maximize estate tax savings in your estate.
 IRC §1400Z-2(d)(1)