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CLIENT ALERT: New Opportunity Zone Incentives Promise to Spur Economic Development

We’ve received numerous inquiries regarding the qualified opportunity zone (“Opportunity Zones”) program created by the recently passed Tax Cuts and Jobs Act (“TCJA”).[1]  In response, we’ve compiled the following alert discussing:

(i) the current status of the program;

(ii) structuring qualifying investments; and

(iii) tax benefits of Opportunity Zone investments.  

Importantly, while the TCJA established a general framework for Opportunity Zones, this framework more closely resembles an initial outline than a finished product.  Therefore, the Treasury Department must promulgate final rules defining how and when qualified investments may commence. We will provide an update when this occurs.

Background

At least one economic research study estimates that U.S. citizens and companies held over $6 trillion in unrealized capital gains in 2017.[2]  In an effort to recirculate that vast pool of capital back into the economy, particularly in distressed communities, the Opportunity Zone concept was initially proposed by the Investing in Opportunity Act[3] introduced by a bi-partisan coalition of U.S. Representatives and Senators in 2016. The legislation was adopted and passed into law on December 22, 2017 as part of the TCJA. Though somewhat overshadowed by other provisions of the TCJA at the time, Opportunity Zones are beginning to generate enthusiasm as a potentially powerful economic development tool to incentivize investment in low income communities by providing investors with meaningful deferral and partial permanent exclusion of unrealized capital gains.  We await further guidance from the Treasury Department as to the exact mechanics of the program.

Qualified Investments

The Opportunity Zone program aims to facilitate the flow of long-term capital to low-income communities. These low-income communities are designated as Opportunity Zones, which are low-income census tracts, not to exceed 25% of qualifying low-income census tracts, nominated by each state’s governor and confirmed by the Treasury Department.[4] Investments may be made into companies, projects, business equipment and commercial property located within Opportunity Zones (collectively, “Opportunity Zone Property”) by providing tax advantageous treatment to qualifying investments. These tax benefits (discussed in more detail below) include deferral of existing unrealized capital gains, a partial step-up in adjusted basis in the capital asset underlying such gains, and permanent tax exemption on any appreciation of Opportunity Zone investments. 

Importantly, investors will be required to invest in Opportunity Zone Property through a qualified opportunity fund (an “Opportunity Fund”). An Opportunity Fund can be “any investment vehicle organized as a corporation or partnership for the purpose of investing in qualified opportunity zone property,”[5] which must comprise at least 90% of its assets.[6] This 90% threshold is tested at the end of the first 6 month period of the Opportunity Fund’s taxable year and then on the last day of each subsequent taxable year. To become an Opportunity Fund, an eligible taxpayer self certifies by filing a form[7] with its federal tax return. This is in contrast with the New Markets Tax Credit (“NMTC”) program, which channels investment through specialized financial intermediaries known as Community Development Entities (“CDEs”). Further, pending final rules from the Treasury Department, there is no limit on the total amount of eligible Opportunity Zone investment.

Tax Benefits

Opportunity Zones offers three primary tax benefits to potential investors:

  1. Temporary deferral of inclusion in taxable income for capital gains reinvested into an Opportunity Fund.
  2. Step-up in basis for capital gains reinvested in an Opportunity Fund. The adjusted basis is increased by 10% if the Opportunity Fund investment is held for at least 5 years and by an additional 5% if held for at least 7 years, thereby excluding up to 15% of the re-invested capital gain. The deferred gain, subject to any step-up in basis, must be recognized on the earlier of the date on which the Opportunity Zone investment is disposed of or December 31, 2026 (the “Deferred Gain Recognition Date”).
  3. A permanent exclusion from capital gains tax on the sale or exchange of an Opportunity Fund investment if the investment is held for at least 10 years. This exclusion applies only to gains accrued during the Opportunity Fund investment.

To qualify, investors must reinvest the amount of capital gain in an Opportunity Fund within 180 days after the date of sale of the underlying capital asset. The IRS recently clarified that sales of capital assets in the 2017 tax year are eligible for Opportunity Zone treatment if a qualifying investment is made within the 180-day timeframe. That would make June 29, 2018 the deadline to make a qualifying investment, assuming the preceding exchange occurred on the last day of 2017.

In order to receive the total 15% step-up in basis of the re-invested capital gain, which requires a full 7-year holding period before the Deferred Gain Recognition Date, investors must make a qualifying investment by December 31, 2019. To receive the initial 10% step-up in basis of the re-invested capital gain, which requires a 5-year holding period before the Deferred Gain Recognition Date, investors must make a qualifying investment by December 31, 2021.

Next Steps

Opportunity Zones offer a potentially powerful economic development tool for underserved communities by creating an attractive investment opportunity for investors. The partial step-up in basis and exclusion of future appreciation seem to present a compelling alternative to “like-kind” exchanges under Section 1031 of the Internal Revenue Code for investors seeking to defer unrealized capital gains. Opportunity Zones also may supplement NMTCs to incentivize investment in low income communities if Opportunity Funds and CDEs can work together effectively. Further, municipal governments could enhance the attractiveness of investment within their jurisdiction by offering local incentive programs that piggyback on Opportunity Zone investments.

While the Opportunity Zone program appears promising, its full scope and impact will not be known until the Treasury Department issues final rules. We plan to update this information as additional guidance becomes available. Please don’t hesitate to contact us in the interim with any specific questions about Opportunity Zones. We look forward to working with you to develop an individualized solution to achieve your business objectives.

If you have any questions, please contact Jason A. Butterworth (jabutterworth@bmdllc.com) or Kevin Saunders (rksaunders@bmdllc.com).

 

[1] 26 U.S.C. § 1400Z—1.

[2] See Economic Innovation Group, Opportunity Zones Tapping into a $6 Trillion Market, http://eig.org/news/opportunity-zones-tapping-6-trillion-market (last updated March 21, 2018).

[3] S.2868 — 114th Congress (2015-2016).

[4] For all currently designated Opportunity Zones in the U.S.: https://www.cdfifund.gov/Pages/Opportunity-Zones.aspx; for Ohio’s designed Opportunity Zones: https://development.ohio.gov/bs/bs_censustracts.htm; for Florida’s designated Opportunity Zones: https://deolmsgis.maps.arcgis.com/apps/webappviewer/index.html?id=4e768ad410c84a32ac9aa91035cc2375.

[5] 26 U.S.C.A. §1400Z-2(c)(5); I.R.C. §1400Z-2(c)(5).

[6] 26 U.S.C.A. §1400Z-2(d)(5); I.R.C. §1400Z-2(d)(5).

[7] The IRS will publish the required form this summer. https://www.irs.gov/newsroom/opportunity-zones-frequently-asked-questions.

Ohio Supreme Court Clarifies Medical Statute of Limitations

The Ohio Supreme Court issued a decision in late December that clarifies and finalizes the Ohio law regarding the period of time in which patients can assert claims for medical malpractice. The Court was examining the interplay between three different statutes being the statute of limitations, the statute of repose, and the savings statute.

Ohio Hospitals and Healthcare Clinics: It’s Time to Revisit Your Billing and Collection Practices

According to a recent Cuyahoga County case, certain healthcare entities may not be protected from liability when engaging in unfair or deceptive billing acts. This decision is consistent with the growing trend across the country to encourage price transparency and eliminate unfair surprise billing practices by health care organizations. Now is the time for hospitals and other health care organizations to revisit their billing and collection policies and procedures to confirm that they are legally defensible and consistent with best practices.

HIPAA Business Associate Agreements: Why These Contracts Matter

No one loves drafting, reading or negotiating HIPAA Business Associate Agreements (BAAs). Yet many of us need to do so, and some of us do so daily. They are often boring, dense and technical, but BAAs are important from both a legal and a business perspective, and they deserve our attention. Failure to enter a BAA when one is required can constitute a HIPAA violation that results in substantial liability, as demonstrated by certain recent Department of Health & Human Services (HHS) settlements.1 A business associate who makes a disclosure that is not authorized by the applicable BAA or required by law can be subject to civil and, in some cases, criminal penalties. Further, parties are often presented with BAAs that contain onerous one-sided indemnification and other provisions that can be devasting to an organization in the event of a HIPAA breach. The significance of a BAA is often not fully understood by the parties until something goes wrong (e.g., a HIPAA security incident or breach, an Office of Civil Rights (OCR) audit or a fracture in the relationship between the parties) and, at that point, there is limited opportunity to mitigate legal and business risk. Ideally, attention should be given at the commencement of the business associate relationship, when the parties are able, to thoughtfully addressing regulatory requirements, planning and preparing for potential adverse events and appropriately allocating risk among the parties. As with most healthcare regulatory compliance initiatives, a proactive approach with respect to BAAs is preferable. This article provides a broad overview of certain BAA requirements and some practical negotiating tips for the parties involved.

“I’m Out Of Here!” Now What?

We all know that the healthcare industry is experiencing a wave of integration. This trend has been evident for many years. Fewer physicians are willing to assume the legal, financial and other business risks associated with owning their own practices. More and more physicians, including anesthesiologists, are becoming employed by large physician groups, health systems and national providers. This shift necessarily involves not only entry into new employment arrangements but also the termination of existing relationships. And those terminations are often governed by written employment agreements, state and federal healthcare laws and employer benefit plans and other policies and procedures. Before pursuing their next opportunity, physicians should pause for a moment and first attend to the arrangement that they are leaving. Departing physicians need to understand their legal rights and obligations when leaving their current employment relationships in order to avoid unintended consequences and detrimental missteps along the way. Here are a few words of practical advice for physicians contemplating an exit from their current employment arrangements.

Investment Training for the Second and Third Generations

Consider this scenario. Mom and Dad started the business from the ground up. Over the decades it has expanded into a money-making machine. They are able to sell the business and it results in a multimillion-dollar payday for their labors. The excess money has allowed Mom and Dad to invest with various financial advising firms, several fund management groups, and directly with new startups and joint ventures. Their experience has made them savvy investors, with a detailed understanding of how much to invest, when, and where. They cannot justify formation of a full family office with dedicated investors to manage the funds, but Mom and Dad have set up a trust fund for the children to allow these investments to continue to grow over the years. Eventually, Mom and Dad pass. Their children enjoy the fruits of their labors, and, by the time the grandchildren are adults, Mom and Dad's savvy investments are gone.