The year 2018 has been a monumental one for the state and local tax community. If the sweeping changes to the US federal tax code made by the federal Tax Cuts and Jobs Act of 2017 (TCJA) and continued efforts by the states to formulate responses to federal tax reform were not enough, an overwhelming number of pending state and local tax ballot initiatives could lead to additional changes. To say 2018 has been an exciting time for state and local tax practitioners and taxpayers would be an understatement.

In all this excitement, a new section of the Internal Revenue Code deserves some special attention. Taxpayers may take advantage of a new investment program intended to spur long-term economic development in low-income communities designated as “Opportunity Zones.” A recent Eversheds Sutherland legal alert discussed the numerous federal tax considerations related to the Opportunity Zones investment program (OZ program), including the proposed federal regulations and guidance. This legal alert focuses on the state and local tax considerations of investing in Opportunity Zones.

Recap of the Federal Opportunity Zones Investment Program

New Internal Revenue Code sections 1400Z-1 and 1400Z-2 (QOZ Provisions) offer significant opportunities to defer, and potentially permanently reduce, gains from appreciated property invested in Opportunity Zones. In summary, a taxpayer electing to reinvest the gain from a sale or exchange of property in an equity interest in a Qualified Opportunity Fund (QOF) is eligible for the following significant tax benefits:

  • Temporary deferral: Deferral of tax on the reinvested gain until the sale of the interest in the QOF or December 2026, whichever comes first;
  • Step-up basis: If the investment in the QOF is held for at least five years, the taxpayer’s basis in the QOF, which is zero when the investment is made, is increased by an amount equal to 10% of the reinvested gain. If the investment is held for at least seven years, the taxpayer’s basis in the QOF is increased by an additional amount equal to 5% of the reinvested gain (or 15% total); and
  • Permanent exclusion: If the investment is held for 10 years, the taxpayer can—subject to certain limitations—elect to increase its basis in the QOF to the fair market value of the QOF at the time of disposition, effectively excluding post-acquisition gain from its taxable income.

For a more detailed discussion of these benefits, see Eversheds Sutherland’s previous coverage.

State Tax Considerations


Whether the federal tax benefits resulting from the new OZ program will translate into state tax benefits will depend on whether and how a state conforms to the Internal Revenue Code (IRC). The program will have an impact on tax regimes in those states that conform to the IRC, either via floating conformity (e.g., Illinois, Colorado) or fixed-date conformity that has been updated post-TCJA (e.g., Georgia, Maine). Some conforming states have gone a step further and have introduced bills to piggy-back off of the QOZ Provisions and provide state tax incentives for businesses investing in these zones separate and apart from any state benefits that might result from a state’s conformity to the QOZ Provisions.

A bill was introduced in Ohio at the end of August 2018 that would allow for a credit equal to 10% of the amount of any qualifying investment in an Opportunity Zone. Ohio H.B. 727 (2017-2018). This credit would be limited to investments in qualifying funds which invest solely in federal Opportunity Zones located in the state of Ohio. In a similar vein, legislation has been introduced in California that would provide relaxed environmental regulations for certain investments in Opportunity Zones. Cal. A.B. 3030 (2017-2018). Missouri also passed S.B. 773 this summer earmarking $30 million of the state’s annual historic preservation tax credits for projects located in low-income census tracts that may coincide with federal Opportunity Zones.

Taxpayers in states that have not updated their IRC conformity provisions to incorporate the provisions of the TCJA (e.g., California, Minnesota), do not impose a corporate income tax (e.g., Washington), or affirmatively decouple from the QOZ Provisions will lose out on state tax benefits resulting from the federal Opportunity Zone investment program and also may suffer additional administrative burdens. In those non-conforming states, taxpayers will likely be required to recognize the gains invested in a QOF in the year in which the gain is realized, and will not be granted any basis step-up for amounts invested and held in a QOF. When the gain is ultimately recognized at the federal level, taxpayers would want to make sure that gain is not taxed by the state a second time. This mismatch between the federal and state tax treatment of QOF investments will create the need to keep detailed schedules that separately track the federal and state tax treatment of investments in a QOF.

For example, North Carolina has decoupled from the QOZ Provisions and requires an addback of any gain that would be included in the federal taxable income calculation but for the operation of IRC Section 1400Z-2, as well as an addition to taxable income related to any step-up in basis allowed under IRC Section 1400Z-2(c). N.C. Gen. Stat. § 105-130.5(a)(26), (27). However, a taxpayer can take a deduction related to any gain included in federal taxable income where the gain has been previously recognized under North Carolina law, to prevent double taxation of these gains. N.C. Gen. Stat. § 105-130.5(b)(29). Hawaii has similarly decoupled from IRC Sections 1400Z-1 and 1400Z-2, and more states could follow. Haw. Rev. Stat. § 235-2.3(b)(51).

Crossing State Lines

It is fair to say that a single QOF transaction might involve multiple states. As a result of investing in a QOF, a taxpayer will be faced with state tax considerations in the state where the QOF and the Opportunity Zone being invested in are located, in addition to all of the states where the taxpayer is already paying taxes. Depending on whether all of these states conform to the QOZ Provisions, the taxpayer might be required to include the gain in computing its tax liability in one state and yet defer that same gain in another state. Furthermore, state apportionment treatment of capital gains varies from state to state, and also depends on whether the gain relates to the sale of tangible or intangible property.1 For a state that conforms to the federal QOZ Provisions, taxpayers must carefully examine their apportionment factors to ensure that any gain deferral or non-recognition is properly reflected. For example, in a state that includes net gains from the sale of capital assets in the sales factor and also conforms to the deferral of gain under the QOZ Provisions, consideration must be given as to which year the gains should be included in the apportionment factor. Finally, investment in a QOF that owns property located in a state where the taxpayer is not otherwise doing business creates concerns related to an expanded nexus footprint that may lead to increased state tax filings.