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 hesitant to recommend them without reservation. Congress disqualifies certain businesses from participation in Qualified Opportunity Zones, and we have seen some indications Congress is considering disqualifying cannabis businesses as well.
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.
To take advantage of the benefits of these zones, 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. 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 previously written extensively this. (See here, for example). Marijuana’s criminality colors how all federal agencies, including the IRS, treat cannabis businesses.
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.
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 include cannabis businesses.
Because the statute omits “cannabis activity” or “marijuana activity” from the list of disqualified businesses, some contend that marijuana qualifies as an opportunity zone business. However, many tax practitioners worry that cannabis businesses being omitted from the list of disqualified businesses was an oversight that Congress will fix in a technical corrections bill. The list of disqualified businesses isn’t limited to illegal businesses — even if Congress is inclined to relax criminal marijuana laws, it hasn’t shown any indication that it wants to provide tax benefits to marijuana businesses. The final regulations governing Opportunity Zones have not yet taken effect.
Cannabis businesses that invest in Opportunity Zones hoping to benefit from the tax benefit need to weigh the risk that Congress will pull the rug out from under them by adding marijuana businesses to the list of disqualified businesses. If marijuana businesses are able to avoid that fate, however, Qualified Opportunity Zones could provide a great opportunity for investors and low income communities.