As detailed in our previous post, Governor Cuomo signed the 2021-22 New York State (NYS) Budget (The Budget) last month with little fanfare. The Budget contains numerous tax provisions that have broad implications to New York taxpayers.
However, one of The Budget’s potentially unfavorable tax provisions, as set forth in Section DDD of The Budget, is the decoupling from the Federal tax benefits inuring to New York taxpayers that made investments that qualify under the Opportunity Zone program enacted in President Trump’s 2017 Tax Cuts and Jobs Act (TCJA). NYS decoupled from the Federal tax treatment and benefits applicable to investments in Qualified Opportunity Funds (QOFs) for tax years beginning on or after January 1, 2021. Such decoupling will have imminent as well as long term onerous tax ramifications to New York taxpayers that invested in QOFs.
This post will summarize some of the significant tax ramifications arising from The Budget’s decoupling.
History of Federal Opportunity Zones
In 2017, President Trump’s TCJA introduced the Opportunity Zone program to the real estate industry. Federal zones were set to help investors and developers alike save taxes and expand their operations by investing in underserved communities.
The program provided the following favorable tax benefits for investing in QOFs under Internal Revenue Code 1400Z-2(a)(1)(A):
1. Gain Deferral: Taxpayers that timely invested in a QOF could defer the original capital gain on the transaction whose proceeds were invested in the QOF. To receive the gain deferral, they must simply invest their capital gains into an Opportunity Zone (or rather, into a QOF). They can invest any capital gains, even those that occur from sales of stock or business interests, into a QOF and qualify for the gain deferral.
2. Permanent Exclusion of a Portion of the Original Gain: Taxpayers may be able to permanently exclude 10% of their original gain if they meet these requirements:
a. They make their investment before December 31, 2021; and
b. The taxpayer hold that investment for at least five years.
They will then receive a step-up in basis that effectively eliminates 10% of their original gain. They must recognize the remaining gain on December 31, 2026, or the year they dispose of their investment, whichever occurs first.
3. Permanent Exclusion of the Appreciation of Investment in the QOF: Taxpayers who hold their investment for at least 10 years can exclude the gain on their investment in the QOF by receiving a step-up in basis to fair market value when they sell their investment. Although this does not eliminate the original gain (which must be recognized on or before December 31, 2026), it permanently eliminates gains resulting from appreciation within the fund.
Since the adoption of the QOF tax provisions, there has been various perspectives of whether the QOFs enhanced or spurned additional investments in real estate in those economically depressed communities designated as eligible for QOFs. In particular, over the last couple of years, there has been debate over how effective the program has actually been in spurring new development in the New York Tri-State region.
The Budget’s Decoupling From Opportunity Zone Federal Tax Benefits
New York taxpayers, real estate investors and developers are under increased economic pressure arising from the pandemic. NYS decoupling from the Federal tax benefits arising from making investments in QOFs require immediate attention by New York taxpayers that invested in QOFs. As The Budget’s decoupling from the Federal tax benefits is effective for tax years beginning on or after January 1, 2021, it is incumbent that affected New York taxpayers and their tax advisors address the NYS tax costs arising from this decoupling in determining their 2021 Estimated Tax Payments, i.e. the calculation of their June 15, 2021 estimate.
In addition, it is equally important that such affected New York taxpayers identify the long term NYS tax costs of the State’s decoupling, i.e. loss of the aforementioned deferral of capital gains, partial exclusion of capital gains and basis step-up.
How detrimental New York’s decoupling from the Federal tax benefits arising from investments in QOFs will be to New York communities that benefited from Opportunity Zone programs’ investments in terms of enhanced real estate values, more viable businesses and increased employment is unknown. Will New York’s decoupling from the Federal tax benefits of investing in QOFs influence QOF managers to avoid making investments in New York real estate? Only time will tell if New York’s decoupling is a swing and a miss for all affected taxpayers and New York communities.