The Tax Cuts and Jobs Act creates a new tax incentive to stimulate economic development in certain low-income communities known as “Opportunity Zones.”  This program will allow businesses and commercial projects located in Opportunity Zones to attract financing that otherwise would not be available to them.  Governor Brown recently announced his proposed selection of California’s Opportunity Zones. Local governments and members of the public only have until March 15, 2018, to submit comments on his recommendations.  Once final, his Opportunity Zone designations will remain in effect for 10 years. Therefore, time is of the essence for those interested parties who want to influence the Governor’s decision in this matter.

Under the new law, a taxpayer may defer paying tax on capital gains realized upon a sale of property if they timely reinvest those gains in a “qualified opportunity fund” that invests 90% of its assets in certain businesses, or business property, that is located, or used, in an Opportunity Zone. In addition to providing for tax deferral, this new incentive allows a taxpayer to exclude all post-acquisition capital gains realized from appreciation of the fund investment from income if the investment is held for at least 10 years.

The initial deferral does not last forever.  A recognition event will occur when the equity interest in the fund is sold, or on December 31, 2026, whichever is earlier.  At that time, the taxpayer will pay tax on the lesser of: (i) the amount of gain deferred, or (ii) the difference between the fair market value of the fund investment, less the taxpayer’s basis in that investment.  Normal basis rules do not appear to apply. The new law states that the taxpayer’s basis in the fund is equal to zero.  However, if the taxpayer holds an interest in the fund for at least 5 years, their basis in the fund is increased by 10% of the capital gain that they deferred.  If they hold the fund investment for 7 years, that basis step-up increases to 15%.  After 10 years, the taxpayer’s basis is equal to the fair market value of the fund investment as of the date it is sold or exchanged. 

The new law provides that the Governor of each state is allowed to designate up to 25% of low-income census tracts within his or her state as Opportunity Zones.  The designation must be made by March 21, 2018.  Low-income census tracts are those that either have a poverty rate of 20% or above, or where the median family income is below 80% of the area median family income.  There are 3,516 eligible census tracts in the State of California, allowing the Governor to designate up to 879 tracts.               

According to Governor Brown’s office,  the recommended census tracts were selected using the following criteria: 

• Focus on Poverty. Within each county, focus was placed on the poorest areas (top 30 percent of eligible tracts).
• Areas with Business Activity. Tracts with at least 30 business establishments were prioritized to focus on those tracts that are zoned to encourage more business investment.
• Geographic Diversity. To increase geographic diversity, the preliminary recommendation maintains a minimum of two tracts per county, if possible.

 A link to an interactive map displaying both eligible census tracts and those recommended by the Governors’ office to be designated as Opportunity Zones can be found, here.