What We Know About Them So Far, and Defining Their Role Across Central Pennsylvania
By now, many of us have been hearing the latest three-letter buzzword, QOZ, which stands for Qualified Opportunity Zones. But what are QOZs, other than some type of tax deferment program? In this issue of our monthly blog, we sat down with ROCK Brokerage Advisors Heather Kreiger and Greg Finkelstein. They shed some light on what the QOZs really mean for real estate and business in Central Pennsylvania.
Q: Where are the QOZs located?
A: Within the State of Pennsylvania, there are 300 tracts now identified as Qualified Opportunity Zones. In Central Pennsylvania, the counties that were awarded QOZs include Lancaster, York, Lebanon, Dauphin and Cumberland Counties. Below are the exact locations of the Zones across our region, per the PA Dept. of Community and Economic Development:
Q: What is a QOZ?
A: Originally introduced in the Tax Cuts and Jobs Act of 2017, a QOZ is an economically-distressed community where new investments, under certain conditions, may be eligible for preferential tax treatment. Added to the tax code in December of 2017, real estate and/or business investors can defer and reduce their tax on any prior gains that they have invested in a Qualified Opportunity Fund (QOF) until the investment is sold or exchanged, or December 31, 2026, whichever is earlier. This is accomplished by reinvesting capital gains into a QOF, an investment vehicle designed to stimulate economic growth and create jobs and business opportunities in certain distressed and under-served communities.
There are, however, a number of blurry conditions that must be met, and complicated rules to be navigated. The conditions are being clarified by the IRS in the form of regulations, with the most recent revisions appearing as late as April of this year.
Q: What’s eligible and what’s not?
A: Most QOZ investments have involved real estate. Given that real estate is immobile, investments in it have most clearly met the program’s requirements and, therefore, were the simplest and safest investments to pursue. Besides purchasing a property within a delineated QOZ tract, prior provisions of the Tax Cuts and Jobs Act of 2017 stated that at least 70% of a leased physical property must be situated within a QOZ.
Additionally, preexisting firms are not eligible for the newly instated QOZ benefits. The law is designed to draw fresh activity to the areas by requiring that no less than 90% of a business’s lease term be in effect after the commencement of the Act in December 2017.
Furthermore, at least 50% of a QOZ business’s income must be generated within the given Opportunity tract. This latter point has proven rather dubious: certainly, traditional brick-and-mortar businesses, such as a neighborhood diner or grocery store, would qualify for the program. But what about online retailers or startups, which are physically based in a QOZ, yet ship products and generate significant income outside of a QOZ?
The new provisions, released in April, spell out exactly how businesses can meet the 50% income threshold, and the requirements are now more flexible. Under new guidance, any one of the below criteria will clear the test:
- At least 50% of the hours worked by employees and independent contractors occur within the QOZ.
- At least 50% of the total amount the company pays for services performed goes toward services performed in the QOZ.
- The company’s tangible property and management or operational functions performed in the QOZ are necessary to generate 50% of its gross income.
And if a business doesn’t meet any of these “safe harbors,” it can still meet the 50% requirement if it can argue that at least half of its gross income is derived from its “active conduct” within the QOZ. The goal is that these rules will spur investors to invest their capital gains in qualifying startups located with QOZs.
As a word of caution, it’s important for investors to evaluate each project carefully. QOZs are intentionally designed not to function like a get-rich-quick scheme; and while they can help turn a good venture into a great one, they will never turn a bad venture into a good one.
Are you interested in speaking with Heather Kreiger, Greg Finkelstein, or our Brokerage Advisory team? Please email them or contact us at 717-854-5357. We can put you in touch with knowledgeable tax professionals who have an expertise in QOZs.