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What happens if I invest in an Opportunity Zone in a state that has not opted to conform to the federal OZ rules?

Since only 31 states have opted to conform to the federal OZ rules, what happens if I invest in an Opportunity Zone in one of the other states? How will that impact my investment and tax savings?

  • Blake Christian
    April 24, 2019

    The answer depends on your state of residency as well as the state you are making an investment into. For example, if you reside in a state that has adopted the OZ program and then invest in another state that has not, you will generate tax in that other state when you have taxable income on the OZ fund investment or when you sell the investment (even after a 10-year hold). If the investment is held through an LLC/ partnership or S corp, and the OZ fund is and LLC or S corp, then you will likely pay tax in that non-resident state. Note you will not get a state tax credit in your home state. Also note that you will have a starting tax basis in the other state of your full purchase price since there is no gain deferral in that state, so your future gain will be less than in your home state. If the OZ investment is an operating business and meets the small business stock rules of IRC Section 1202 (certain industries are ineligible), then investors should consider electing C corp treatment before they reach $50 million in value. This can provide flexibility on exiting the investment between years five and 10 and if you can find a buyer of your stock, the gain will generally not be sourced to the non-resident state since you are selling an intangible.

  • Peter McNeil
    April 10, 2019

    With the exception of Ohio, which we will talk about later, it does not matter what state the Opportunity Zone is in. It only matters what state the investor is a resident of. Being the resident of a non-conforming state, you will need to make the following adjustments at the state level: no deferral of capital gains invested into an Opportunity Zone fund; you will have a different federal and state tax basis that will need to be tracked yearly; because the federal basis will be lower, a federal loss will more likely be limited by the at-risk rules; come 2027 the taxable deferred gain will not be taxable to the state; upon death the state basis will be increased to market value while the federal basis will not; the 10% basis increase after five years and 5% additional basis increase after seven years will not be recognized by the state; the tax-free gain after 10 years will be taxable to the state. The same adjustments will need to be made on the non-resident returns for a non-conforming state. On an additional note, Ohio conforms to the federal, if the Opportunity Zone is inside Ohio. There is no conformity if the Opportunity Zone investment is outside of Ohio.

  • Paul Wassgren
    April 11, 2019

    Any gain recognized in a non-conforming state is taxable at that state's tax rate at the time of the recognition. For example, if QOF X owns property in California, and later sells the property at a profit, there would be California-source income for all investors in QOF X.

  • Phil Jelsma
    April 10, 2019

    The gain on the sale of the asset in 2019 will be taxable by the state and when the OZ property sells in 10 years, that gain will be taxable as well

  • Ed Mofrad
    April 10, 2019

    OZ is a federal program. If you invest in a federally designated OZ, you can use the applicable benefits, regardless of the state's conformity.