An extra benefit available to some corporations considering tax-advantaged investments in opportunity zones may be of limited use with many businesses struggling to stay afloat during the coronavirus pandemic.
The opportunity zones policy, enacted by the 2017 tax law, was intended to steer wealth to areas that need it by offering capital gains tax breaks to investors. Now, under IRS regulations and the third coronavirus response law, corporations that invest in opportunity zones can essentially split up their gains and losses and get tax breaks for both.
“I think it’s a fantastic idea. I think it’s very creative,” said Rich Lieberman, senior counsel at Dykema Gossett PLLC in Chicago. “But I can’t see from an economic perspective who would be in a position to want to do that.”
As of early January, more than 500 funds have formed to take advantage of the tax breaks, and more than 300 of those had raised a collective $7.57 billion, according to data collected by the firm Novogradac & Co. LLP.
But tax attorneys say this new chance to effectively double-dip into tax breaks will only be a viable option for a narrow set of corporations, especially given how few have cash to spare for a long-term investment amid the pandemic and resulting economic downturn.
How It Works
Investors in opportunity funds can defer tax on profits from sales of stocks, real estate, and other assets until 2026 and reduce the amount of tax on those gains depending on how long they hold their investments. The largest benefits are reserved for investments that are held for 10 years, after which the growth in value of the business or property the fund financed is tax-free.
Under final rules (T.D. 9889) for the incentives released late last year, opportunity zone investors no longer have to wait until the end of the year to tabulate their net gains from sales of business property, such as real estate, under tax code Section 1231. Instead, they can funnel gross gains into opportunity funds.
That wasn’t originally an option under proposed rules (REG-120186-18) released in spring 2019. Lobbying organizations, firms, and bar associations, along with Novogradac and the Economic Innovation Group, which engineered the incentives, asked for the change.
A provision in the recent coronavirus response law (Public Law 116-136) allows corporations to carry losses from 2018, 2019, and 2020 back five years to offset earlier taxable income, one of several measures meant to help businesses weather the downturn.
Using the rule change and this part of the stimulus law, corporations using the tax breaks can bifurcate losses and profits from business property sales and then both carry back a bigger loss under the virus relief law and invest bigger gains into tax-advantaged opportunity funds.
For example, a $10 million gain from business property sales coupled with another $7 million loss would have amounted to a $3 million gain for an opportunity fund to invest at the end of the year under the original IRS proposal, according to Forrest Milder, a partner at Nixon Peabody LLP in Boston.
Thanks to the changes made in the final rules and the recent coronavirus law, Milder said, a company could instead invest that full $10 million gain and use the $7 million loss to get a refund of taxes paid several years earlier.
The loss provision of the virus response law also allows companies to make losses more valuable because they can be carried back to years before the corporate tax rate was cut to 21% from 35%.
“Really, it’s found money,” Milder said.
A $100,000 loss, for instance, equates to a $35,000 reduction under the old rate, as opposed to a $21,000 reduction under the new rate.
“It may be a slightly different form of tax planning that will incent the capital to come in but nonetheless there still is an incentive here,” Orla O’Connor, a former IRS official, now a principal at KPMG in San Francisco, said during a webinar earlier this month.
Companies struggling to meet payroll and pay rent likely won’t want to put their profits into a long-term investment vehicle.
But even for companies that are doing well during this time, it is unclear whether they would then incur losses to carry back for the extra tax benefit, said Lieberman.
“If they don’t need the cash, is it likely that they would have losses?” he said.
And few investors may be willing to dive into deals at the moment to begin with.
“I think there are people that want to make investments,” said Lisa Zarlenga, a former Treasury Department official, now a partner at Steptoe & Johnson LLP. “But right now, things are just frozen.”
But potential investors still do have time to wait and see if market conditions change: the IRS recently pushed the deadline to plug gains into an opportunity fund to July 15 for some investors.