Not All States Are On Board with the Tax Benefits of Qualified Opportunity Zone Investments

The Tax Cuts and Jobs Act provides very favorable tax benefits to taxpayers that make investments in Qualified Opportunity Zones, but not all states are on board with such tax benefits, and taxpayers should be aware before deciding on a particular investment.

By Jeff Glickman, SALT Partner

One of the highlights of the Federal Tax Cuts and Jobs Act (“TCJA” or “Act”) is the ability for taxpayers to defer and potentially eliminate certain capital gains by making investments in a Qualified Opportunity Zone (“QOZ”).  Beginning Jan. 1, 2018, through Dec. 31, 2026, taxpayers that sell appreciated assets that give rise to capital gains can invest those capital gains in a QOZ.[1]  Depending on the amount of time that the QOZ investment is held, the taxpayer may be able to defer recognition on the original capital gains until as late as Dec. 31, 2026, and potentially eliminate up to 15 percent of those original capital gains. In addition, if the QOZ investment is held for a total of 10 years, the taxpayer can exclude 100 percent of the appreciation on the QOZ investment.[2]

As with any amendment to the Internal Revenue Code (“IRC”), there is always the question of whether states will conform to that change.  Most states conform to the changes made by the TCJA, and since those states generally start their computation of the income tax base with either federal taxable income (for corporations) or federal adjusted gross income (for individuals), the federal QOZ tax benefits will be incorporated for state income tax purposes as well.

However, this is not true for all states, and below are some examples of where states do not fully conform to federal QOZ tax benefits.  Unless otherwise noted, these rules apply to both corporations and individuals.

Massachusetts (individuals only) and California do not follow the federal QOZ tax provisions because their statutes conform to the IRC on Jan. 1, 2005 and Jan. 1, 2015, respectively, which is prior to the enactment the TCJA.  On June 17, 2019, Massachusetts published a Technical Information Release explaining that the state conforms to the federal QOZ tax provisions for corporate income taxes but not for individual income taxes.[3]

In 2018, the North Carolina legislature overrode Governor Cooper’s veto and passed SB99, which specifically decouples to the federal tax QOZ provisions.  Specifically, the legislation requires that taxpayers add back to federal income any capital gains that were deferred as well as any subsequent capital gain that is eliminated under those federal provisions.[4]

Finally, both Hawaii and Arkansas enacted legislation conforming to the federal tax treatment of QOZs, but only with respect to QOZs located in their states.  On Feb. 26, 2019, Arkansas Governor Hutchinson signed SB196, which specifically adopted IRC § 1400Z-2 for tax years beginning on or after Jan. 1, 2018, but defined the term “opportunity zone” to mean “a population census tract located in Arkansas that is designated as a qualified opportunity zone under [section 1400Z] as of Jan. 1, 2019.”[5]

Interestingly, Hawaii enacted legislation in 2018 that decoupled entirely from the federal QOZ tax provisions,[6] but on June 7, 2019, Governor Ige signed into law SB1130, which provides that IRC sections 1400Z-1 and 1400Z-2 shall apply for income tax purposes, except that they “shall only apply to qualified opportunity zones, as defined in section 1400Z-1, that are designated as such by the chief executive officer of this State.”[7]  This legislation is effective for tax years beginning after Dec. 31, 2018, so effectively, Hawaii has different tax treatment for QOZs in 2018 than in years after 2018.

As a result of these rules, taxpayers that reside in a non-conforming state and/or invest in a Qualified Opportunity Zone Fund that holds assets in QOZs located in a non-conforming state need to analyze the impact on their state income taxes since they may not receive any tax benefits at the state level.

In particular, a taxpayer that is a resident of a conforming state that invests in a QOZ located in a non-conforming state may not receive an income tax credit in his or her resident state for taxes paid on income in the QOZ state as a result of such non-conformity.  This is due to the fact that the resident state credit may require that the income for which the resident is seeking a credit be taxable in both states.  However, in the resident conforming state, such income is not included in the tax base.

Aprio’s SALT team has experience in addressing the state tax consequences of transactions resulting from state non-conformity to IRC provisions, and can help taxpayers understand the state tax treatment of a proposed investment in a QOZ and advise on alternative QOZ investments that may provide a more favorable tax result.  We constantly monitor these and other important state tax topics, and we will include any significant developments in future issues of the Aprio SALT Newsletter.

Contact Jeff Glickman, partner-in-charge of Aprio’s SALT practice, at jeff.glickman@aprio.com for more information.

This article was featured in the July 2019 SALT Newsletter.

[1] Each state has designated QOZs – for a map of QOZs, click here.

[2] See Internal Revenue Code §§ 1400Z-1 and 1400Z-2.

[3] Mass. TIR 19-7 (June 17, 2019).  For corporate income tax purposes, Massachusetts conforms to the IRC on a rolling basis (i.e., it adopts changes to the IRC as they are made).

[4] See N.C. Gen. Stat. §§ 105-130.5(a)(26)-(27), (b)(30) and 105-153.5(c2)(5)-(7).

[5] See Ark. Code § 26-51-460 (emphasis added).

[6] See Hawaii SB2821.

[7] See Haw. Rev. Stat. § 235-2.45(k) (emphasis added).

Any tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or under any state or local tax law or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein. Please do not hesitate to contact us if you have any questions regarding the matter.