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Qualified Opportunity Zone Planning strategies post OB3 what estate planners need to Know that's the subject of today's ACTEC Trust and Estate Talk.

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Welcome to ACTEC Trust and Estate Talk from the American College of Trust and Estate Council, a professional society of peer elected trust and estate lawyers in the United States and around the globe. This series offers professionals best practice advice, insights and commentary on subjects that affect our profession and clients. And now our ACTEC Fellow host with today's topic.

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I'm actech Fellow Stacy Singer from Chicago. Today we explore how the One Big Beautiful Bill act impacts qualified opportunity zones, QOZs and the planning with sweeping changes to tax laws, estate planners and investors alike must reevaluate their strategies for leveraging qozs as a tool for tax deferral exclusion and community investment. ACTEC Fellow Kevin Matz of New York City breaks down the latest developments, highlighting what's changed, what stayed the same, and how to make the most of QOZ opportunities under the new law. Welcome Kevin.

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Thank you, Stacy, and hello everyone. So on July 4, 2025, President Trump signed into law the One Big Beautiful Bill act, more formally known as HR1 and also known I think I'll refer to it as OB3. Now, OB3 includes provisions that establish a second tranche of the Qualified Opportunity Zone called QOZ and Qualified Opportunity Fund QOF Program that generally applies beginning on January 1, 2027. Now, this second tranche picks up following the conclusion of the initial QOZ qf program on December 31, 2026, which date marks the end of the original program's investment period and also the date when the deferred gain is recognized under current law, that law being under the 2017 Tax Cuts and Jobs Act. So in this talk I'll be addressing the principal features of this second tranche and do so in the context of QOZ planning. That implicates estate planning as I'll further discuss many of the estate planning specific rules in the context of QoZs and QoFs under the 2017 Tax Cuts and Jobs act are effectively unchanged under OB3 accordingly. What does that mean? It means careful identification of interest in QOFs and planning with QOFs continues to be required. In addition, investors in QOFs under the tax Cuts and Jobs act need to be mindful of the upcoming inclusion event date of December 31, 2026. For those who've heard me speak about this before, I love to refer to this as Judgment Day. I know watching too many Terminator movies. Arnold Schwarzenegger grows it growing up and also they have to carefully consider the liquidity needs to fund the deferred gain capital gains tax liability that will very soon just around the corner becoming due as a result of this upcoming gain recognition date. So let's first turn back the clock to 20172017 Tax Cuts and Jobs act included in section 1400 Z2 what was that? A new tax incentive provision intended to promote investment in economically distressed communities referred to as Opportunity Zones. Through this program, investors could achieve the following three significant tax benefits. Number one Deferral of gain on the disposition of property to an unrelated person, generally until the earlier the date on which the subsequent investment is sold or exchanged or December 31, 2026 Judgment Day, so long as the gain is reinvested in a QOF Qualified opportunity fund within 180 days or 180 deemed days of the property's disposition. Notably, there's no interest charge on this deferral. Second, the elimination of up to 15% of the gain that has been reinvested in a QOF provided that certain holding period requirements are met and third, the potential elimination of tax on gains associated with the appreciation in the value of a qof provided that the investment in the QF is held for at least 10 years. Now what's an Opportunity Zone? And Opportunity Zone is in the economically distressed community where new investments under certain conditions may be eligible for preferential tax treatment. Localities qualify as Opportunity Zones if they've been nominated for that designation by the state and the nomination has been certified by the irs. What's the definition of a Qualified Opportunity Fund? A QOF Qualified Opportunity Fund, in turn is an investment vehicle that is established as either domestic partnership or domestic corporation. Note Single Member LLC Disregarded entities are not permissible here for the purpose of investing in eligible property that is located in an Opportunity Zone and uses investor gains from prior investment as a funding mechanism. To become a qof, the entity self certifies itself. The entity must meet certain requirements, in particular a general requirement at least 90% of his assets be quote unquote qualified Opportunity Zone property used within an Opportunity Zone. But importantly, no approval or action by the IRS is required to self certify the entity completes the IRS form 8996 and then attaches that form to the entity's timely filed federal income tax return for the taxable year, taking into account extensions. So let's now focus on on some of the more estate planning specific rules of the Opportunity Zone regime. Now, section 1400 z2e3 provides that in the case of a decedent amounts recognized under this section shall, if not properly includable in the gross income of the decedent, be includable in gross income as provided by section 691. Now, 681, as many of you know, 600 sets forth the rules that apply to a person's receipt of income in respect of decedent or ird. IRD refers to income that's earned by a decedent who was a cash basis taxpayer prior to his or her death, but that is not properly includable in income until after the decedent's death. IRD is not reportable in the student's final income tax return. Rather, it's reportable by the recipient of the IRD item, such as the decedent's estate or some other person who's inherited the asset. Importantly, under section 1014C, there is no step up in basis on death. In the case of ird, that means that if someone inherits an interest in the Qualified Opportunity Fund, they are also inheriting a built in income tax liability that comes due on Judgment Day. And when is that outside date? December 31, 2026. Now, very importantly, what's the amount that comes due? Lots of people haven't focused on this. It is very significant will be of increasing significance as we get closer to December 31, 2026. There's a special rule that caps the fair market value at the date of the triggering event. Section 1400 z2b2 contains a special rule that caps the amount of the gain so as not to exceed the fair market value of the investment as of the date the gain is included in income. What does this mean? It means, let's say the deferred gain amount, putting aside basis adjustments is $20 million. But the QOF interest, Qualified Opportunity Fund interest has gone down to $5 million. Do you include the $20 million or include the 5 million? This rule says you include the lesser of the two amounts and therefore you cap that gain prior to basis adjustments at only $5 million. Very significant. Now people may say, well what about discounts? Does that control lack of marketability? Final regulations that came out in late 2019 published in the Federal Register in early 2020 addressed that specifically anticipated and said essentially no discounts for lack of control and market and lack of marketability for purposes of including determining fair market value. What about gifts and bequests? So under the final regulations, and this stuff is counterintuitive, gifts other than to a grantor trust are treated as a disposition of the QZ investment triggering inclusion of deferred gated income. This is a huge trap for the unwary. I mean, query whether this would survive a challenge to the regulation under Loper Bright doctrine, but that is a trap. The unwary got to watch out for you Make a gift. I make a gift to my son. I don't do it in a grantor trust give a gift of an interest in a QOF that is a deemed sale. Watch out. Okay? In contrast, if the gift's due a grantor trust, it's not treated as a deemed disposition. The Q is the investment and therefore will not trigger inclusion of the deferred gain in income. In addition, final regulations I mentioned issued late 2019 clarified this treatment on also applies to all transactions of grantor trust which would include sales or other transactions of grantor trust such as swaps. Final regulations further clarify that it does not matter whether the investment or capital gain is by the grantor or the grantor trust. Further, bequest upon death permits the transferee to step into the transferor shoes and continue to hold the QOZ investment or QF investment as if the transferee were the original investor. So there is, as mentioned before, no step up in basis respect to QF interest. So what does that mean that the person who's inherited has to do they too have to plan for Judgment Day 12-31-2026 outside date that is sued upon us. In addition, 5 years 70 year 10 year holding period benefits tact to the transferring the case of gifts to grant our trust and also bequest upon death Other estate planning Specific important aspects under the final regulations concerning the pass through entity so the final regulations included special provisions by which gain recognized by a partnership may, except to the extent that the partnership elects to roll over the gain itself, flow through to the partners and be reinvested by such partners into the QoS. In addition, there's a potential for such partners to have an increased period during which to reinvest in gain in the QOF. Now, the partnership's 180 day period begins with the date of sale, but if the gain flows through to the partners, then the partner's 180 day period begins in the last day of the partnership's taxable year. Partners also may elect to use the partnership's 180 day period if they so desire. For example, if the desired investment in the QF is already lined up. Now the final regulations also provide an additional option under which investors may elect to start their 180 day period for their share of gain for the pass through entity on the due date without extensions of the pass through entities tax return for the taxable year in which a sale or exchange took place, generally either March 15th or April 15th the following year. That was an item that ACTEC addressed in his comments back in 2019 on the proposed regulations. Just a few items on for further items of the final regulations that I want to note. Number one, and these are rules that are many cases counterintuitive so you have to know be mindful of in advising clients. Number one, there's no inclusion event in the contributions of Q of interest of partnerships. Okay, that makes sense under section 721. However counterintuitive, if you have a contribution of Q of interest to a corporation, C corporation or S corporation that is an inclusion event under final regulations. A further rule, and this is a huge trap for the unwary what if you transfer an interest in a partnership that holds a QF interest and it's not to a grant or trust? Final regulations came out late 2019 says that is an inclusion event. Again, trapped for the unwary, something that's not consistent with that. If you do the same transfer not to and it's an interest in a corporation that holds Q of interest that is not an inclusion event. And then also there are special rules that apply to Q, QSST and ESBT conversions that you need to be mindful of. So against this backdrop, OB3 includes the following changes pertaining to QOFs and QOZs. Number one, as mentioned before, the QOZ program has been extended indefinitely. There's no longer a termination date with a new second tranche starting on January 1, 2027. The original Qoz program was scheduled to expire for new investments on the judgment date December 31, 2026. OB3 creates a second tranche starting January 1, 2027. In this second tranche, every 10 years, state governors will propose Qozs and the Secretary of the treasury will certify those zones with the effective date for those new QOZ designations to be July 21, 2026 and every 10 years thereafter. Second, the stricter eligibility criteria that apply to QOZ designations based on Basically without going into too much details, OB3 tightens the rules under which census tracts can qualify as Qozs. The OB3 in this regard repeals the much criticized contiguous Tract rule, which allowed a census tract contiguous to a low income community to be designated as a QOC census tract so long as its median family income did not exceed 125% of median family income to low income community to which the tract was adjacent. Third, very significant, there's now a new rolling five year gain deferral and a permanent 10% basis step up. So for investments after December 31, 2026, gains deferred through investment in the QZ program will now be recognized on the fifth anniversary of the investment date, unless there's a earlier sale or exchange, including a deemed sale or exchange as discussed previously rather than on a fixed date. OB3 also makes permanent a 10% basis step up which takes effect immediately before the end of the five year deferral period. This means that after December 31, 2026, all gains that are not prematurely triggered, such as through a sale or exchange or deemed sale or exchange of an investment in QF will have the benefit of a 10% basis increase after 5 years. Notably, OB3 eliminates the additional 5% basis step up which previously applied with a 70 year holding. In the case of 70 year old holding period under tax cuts and Jobs act and caps that benefit at 10%. Fourth, and this too is very significant, there is now a new species of opportunity zone fund called a qualified Rural Opportunity fund and that provides heightened benefits. What is this? It's a qualified Rural Opportunity fund. Let's call it a Q Roth. It's a qualified Opportunity fund in which it's 90% asset test including respect to any QZ business in which a qualified opportunity fund owns an interest is comprised entirely of rural area property. You may ask what's rural area property? Well, it's defined in the statute in OB3 as any area other than number one, a city or town, there's a population greater than 4,50,000 or number two, an urbanized area adjacent to a city or town that has a population nexus of 50,000. Tax benefits to be obtained by QRFs significantly enhanced relative to those available to regular old QOFs. Number one, you get a 30% basis step up after five years compared to the 10% basis step up for regular QOFs. And then secondly, not to get too technical, there's a relaxation of the substantial improvement requirement. Basically, 100% tax to double basis over a period is reduced to 50%. Next, just just to know quickly, there is now gain elimination frozen after 30 years on OB3 eliminates the sunset provisions terminating QZ benefits for QF investments liquidated after 12-31-2047 and establishes in this place a 30 year rolling horizon. Again, elimination respect to post 10 year dispositions of QC investments. For investments sold or exchanged before 30 years, the step up will reflect the fair market value of the investment as of the date such investment is sold or exchanged. In contrast, for investments held 30 years or more, the basis step up will be frozen at the fair market value in the 30th anniversary of the new investment. There's also new reporting requirements and penalties for non compliance under OB3. In sum, so what are we looking at here? We're looking at a January 1, 2027 effective date for tranche two of the opportunity Zone Program. However, very importantly, the rules that implicate estate planning are generally unchanged. So again, nearly all the new QOC provisions take effect after December 31, 2026. There's limited exceptions and that date that's very critical. It marks the end of the original program's investment period and the day when deferred gain is recognized under current law, that is Judgment Day. Now, it's expected that we're going to get regulations issued by treasury prior to January 1, 2027 to fill in the legislative gaps. Now, very importantly, State planning specific provisions that I've discussed effectively unchanged by OB3. So careful identification of interest in QFs, you got to know what you have and planning with them continues to be required. In addition, investors and QFs on the 2017 tax cuts and Jobs act need to be mindful of the upcoming I'm just going to say inclusion event, but let me just substitute for Judgment Day of December 31, 2026. What does this mean? A quarterly Investors in QFS under the Tax Cuts and Jobs act should carefully, carefully consider the liquidity needs to fund the capital gain tax liability that is soon coming due as a result of the upcoming Gain Recognition.