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Taxing O-Zone Investments Under Subchapter K  

Author:  Karen C. Burke.

Source: Volume 37, Number 01, Fall 2019 , pp.3-29(27)

Journal of Taxation of Investments

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Section 1400Z, enacted in 2017, provides tax incentives for investing in designated opportunity zones (O-Zones). These temporary tax benefits include rollover of realized capital gain, a partial basis step-up, and permanent exclusion of post-acquisition capital gain for qualified opportunity fund (QOF) investments held for at least 10 years. While Congress left to Treasury the task of coordinating O-Zone investments and Subchapter K, the statute gives rise to significant discrepancies between sales of QOF interests and sales of QOF assets. Upon disposition of a QOF interest after 10 years, the investor’s basis in the QOF interest is stepped up to fair market value. Recently proposed regulations would allow constructive Section 743 adjustments to reduce the discrepancy between outside basis and inside basis, eliminating any ordinary income and depreciation recapture on disposition of the investor’s interest. Under the proposed regulations, however, the tax consequences of a sale of QOF assets would be quite different, since a 10-year investor would be allowed to exclude capital gains (but not ordinary income). The Treasury’s ability to prescribe uniform treatment for dispositions of interests and assets may be limited, given Congress’ failure to appreciate the need for parity of inside and outside basis. In accommodating stakeholders’ demands for flexible exit strategies, the proposed regulations risk subverting the principles of Subchapter K while magnifying tax subsidies for investors and investment managers.

Keywords: IRC Sec. 1400Z, opportunity zone partnerships, REG–120186–18, basis adjustments, gain exclusion, sale of interests or assets, debt-financed distributions, IRC Sec. 743 adjustments, IRC Sec. 752 liabilities

Affiliations:  1: University of Florida Levin College of Law.

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