An Opportunity Zone is an economically-distressed community where new investments, under certain conditions, may be eligible for preferential tax treatment. Localities qualify as Opportunity Zones if they have been nominated for that designation by the state and that nomination has been certified by the Secretary of the U.S. Treasury via his delegation authority to the Internal Revenue Service.
As a USA Opportunity Zone, the Navajo Nation provides a tax incentive for investors to re-invest their unrealized capital gains into Opportunity Funds that are dedicated to investing into Opportunity Zones designated by the chief executives of every U.S. state, tribal nation, and territory.
Qualified Opportunity Zones and Cannabis
By Julie Hamill on January 30, 2019
POSTED IN CALIFORNIA, FEDERAL LAW AND POLICY, REAL ESTATE
Qualified Opportunity Zones, which provide a tremendous benefit to investors and low income communities, are the hot new topic in the real estate investment world. The cannabis industry is buzzing about investment opportunities in these zones, but we remain skeptical about the ability of cannabis business activity to qualify for the benefits under this new federal program.
Qualified Opportunity Zones were created under the relatively new federal tax law, known as the “Tax Cuts and Jobs Act.” That law authorized each state to nominate certain low-income communities as “qualified opportunity zones.” A list of qualifying census tracts can be found here.
In order to take advantage of the benefits, taxpayers must invest in a Qualified Opportunity Fund, which is an investment vehicle organized as a corporation or partnership for the purpose of investing in qualified opportunity zone property that holds at least 90 percent of its assets in qualified opportunity zone property.
The benefits to investors include (1) a deferral of tax on capital gains from the sale of existing property that are reinvested into a Qualified Opportunity Fund, (2) subsequent basis increases on deferred capital gains reinvested into a Qualified Opportunity Fund, and (3) the elimination of capital gains tax on growth attributable to gain reinvested in a Qualified Opportunity Fund held for at least ten years.
The State of California explains that Opportunity Zones will support new investments in environmental justice, sustainability, climate change, and affordable housing, and has created a website to educate investors about various opportunities.
This brings us to cannabis. Now that the Farm Bill has legalized Hemp, those operating in Opportunity Zones should qualify. However, commercial cannabis activity, outside the industrial hemp context, is federally prohibited. As such, marijuana businesses are treated as criminal enterprises in the eyes of the feds. We’ve written extensively about this. (See here, for example). Unless and until federal laws regarding marijuana are amended, entities conducting marijuana activity are treated as criminal by federal government agencies.
Despite this fact, however, marijuana businesses are still required to pay federal taxes. If they fail to do so, they are subject to liability for tax crimes in addition to other cannabis-related crimes.
We have written extensively about Section 280E and its implications for taxation of cannabis businesses (See here, here, here and here). Section 280E disallows deductions and credits for any amount paid or incurred in carrying on any trade or business if such trade or business (or the activities which comprise such trade or business) consists of trafficking in controlled substances.
Arguably, the benefits provided in connection with Opportunity Zones are not deductions or credits, but deferrals. The new Opportunity Zone clause provides a list of business activity that is disqualified from tax benefits, which includes “any private or commercial golf course, country club, massage parlor, hot tub facility, suntan facility, racetrack or other facility used for gambling, or any store the principal business of which is the sale of alcoholic beverages for consumption off premises.” The disqualified list does not expressly include cannabis businesses.
Some contend that because the statute omits “cannabis activity” or “marijuana activity” from the list of disqualified businesses, marijuana qualifies as an opportunity zone business. However, this does not take into consideration the fact that marijuana activity is considered criminal, and is not recognized as legitimate business activity by the feds. It would seem logical that the statute would not need to expressly name specific types of criminal activity as excluded businesses to ensure that the tax benefits are limited only to desirable business conduct; the assumption (arguably) is that any criminal activity would be prohibited, and not entitled to special tax benefits. Why would the IRS extend tax benefits to a “criminal enterprise”?
As of the date of this writing, the final regulations governing Opportunity Zones have not yet taken effect. The proposed regulations can be found here.
The takeaway is this: cannabis especially in hemp, investors are excited about Qualified Opportunity Zones and are looking for ways to take advantage of the benefits that come along with the new tax law.