Dominic M. Sagora

Duffy Kekel LLP

For those of us fortunate enough to have had an opportunity to have met with Jan Pierce, it should be no surprise that the OSB Tax Section selected him to receive the 2019 Award of Merit.  The Award of Merit recognizes an attorney’s dedication to professionalism in the practice of tax law in Oregon and willingness to serve as a mentor and role model to less experienced tax attorneys.  Considerations for selecting the recipient of the award include reputation, professional conduct, leadership activities, service within the bar and community in general, and pro bono services.

After serving in the military for four years, Jan enrolled at Washburn University in Topeka, Kansas for his undergraduate studies.  After graduation, Jan continued his education at Washburn University School of Law. Jan graduated with honors from law school in 1971, and soon began his clerkship with the U.S. Court for the District of Kansas.  Jan’s position with the U.S. Court for the District of Kansas eventually led him to Portland, Oregon in 1973, where he began his career practicing law as a docket attorney with the IRS.  In 1981, Jan was promoted to Assistant District Counsel in the Portland Office wherein he supervised the civil and criminal work of the Portland IRS attorneys assigned to his group.  In addition, he also supervised the criminal tax work done by IRS attorneys in the four-state area of Oregon, Washington, Alaska and Hawaii for a few years during the time he was the Assistant District Counsel.

In 2000, after 27 years of working with the IRS, Jan was eligible for retirement from government service.  Although Jan retired from the IRS, he was not ready to stop practicing law.  He dedicated the next 19 years of his career to advocating on behalf of clients in the Low-Income Taxpayer Clinic at Lewis and Clark (the “LITC”).  While leading the LITC, Jan helped develop and mentor many of the lawyers who compose our tax law community today.

Under Jan’s tutelage, students in the LITC developed many skills that they would not have otherwise developed in law school.  Students in the LITC tried cases and even appealed two cases to the Ninth Circuit Court of Appeals.  Notably, in 2015, a student in the LITC had the unique opportunity to argue in front of the Ninth Circuit Court of Appeals that the U.S. Tax Court incorrectly interpreted the Qualified Offer Rule when applied to unilateral concession by the IRS after trial.  Agreeing with the student and the LITC, the Ninth Circuit reversed the Tax Court’s decision, and remanded the case for a determination of the amount of attorney fees the LITC was entitled to receive from the IRS.  During Jan’s tenure, the LITC received $150,000 in attorney fees during the period of 2000 to 2015.

Although the Clinic is in great hands under Sarah Lora’s stewardship, Jan will be missed at Lewis and Clark and in the tax law community in general.  Jan dedicated his career to public service and mentoring students and attorneys in our community.  Now, Jan is looking forward to spending more time with his five children and fourteen grandchildren with his well-deserved free time.

 

Jeff Patterson and Dan Eller

Schwabe, Williamson & Wyatt

As part of the 2017 tax reform enacted as the Tax Cuts and Jobs Act (“TCJA”), the Internal Revenue Code (the “Code”) was further amended to add Sections 1400Z-1 (designating qualified opportunity zones (“QOZs”)) and 1400Z-2 (deferral of certain gains related to investments in a qualified opportunity fund (a “QOF”)). This article is the first in a series of at least two articles intended to provide an overview of QOZs and QOFs. In this article, we will provide a brief overview of QOZs and their establishment, before moving to the three primary tax benefits of investing into QOFs. In future writings, we will focus on regulatory and other guidance promulgated by the Department of Treasury (“Treasury”) and the Internal Revenue Service (“IRS”).

Background

The TCJA ushered in sweeping changes to the Code. Some commentators have noted the provisions of TCJA are the most significant since 1986. For some, including ourselves, the QOZ and QOF provisions did not receive much initial attention.[1] As we moved into early- to mid-2018, however, it was clear qualified opportunity zones were going to be a hot topic. By August of 2018, opportunity zone conferences were springing up locally and nationally. Interest was high – and has remained high to the date of the publication of this article. We are receiving regular inquiries from area potential clients and receiving referrals many tax and financial referral partners. This is a hot topic.

Establishing QOZs

The TCJA provided 90 days from in its enactment during which the chief executive officer of each State would nominate for designation as a QOZ certain tracts, and to notify the Secretary of the Treasury of those nominations.[2] The tracts were required to be in “low-income communities,” which were defined to have the same meaning as used in Section 45D(e) (New Markets Tax Credits).[3] Once designated, those tract designations would remain in effect until December 31, 2028.[4]

In Oregon, Treasury confirmed Governor Brown’s designation of 86 tracts around the State, 31 of which are located in the Portland metro area.[5] The Treasury Community Development Financial Institutions Fund (“CDFIF”) maintains a website[6] that includes an Excel spreadsheet detailing the tract designations. CDFIF also maintains a webpage that includes a dynamic mapping system to assist in identifying where the tracts are in a visual presentation.[7] Those resources are the go-to sources for identifying where QOZs are located.

Practice Tip: Whether or not a particular parcel is located in a QOZ is a threshold requirement of the tax benefits described below. You should work with your clients to ensure the parcel is in a low-income community. Check and double check its location against the resources available from Treasury, the IRS, and CDFIF.

Three Primary Tax Benefits of QOFs

Our initial conversations with potential clients and referral partners invariably seemed to start with or include a discussion of a commonly held misunderstanding of QOF investments: people believe investments into QOFs result in no tax being paid. Ever. That is fundamentally incorrect. QOF investments involve at least three primary tax benefits,[8] each of which will be discussed in turn.

Benefit Number One: Deferral

Although we will describe in a future article how QOF investments may be structured, for purposes of this articles it is enough to know that the taxpayer will realize gains from one or more other transactions, and invest some or all of that gain[9] into a QOF (this investment is the “QOF investment”). The taxpayer will have a zero basis in the QOF investment, usually the interest the taxpayer takes in the QOF.[10] We should expect that the taxpayer would have a taxable gain at some point, absent some other provision to the contrary. This is where Section 1400Z-2 comes into play.

Sections 1400Z-2(a) and (b) provide that certain capital gains may be deferred for income tax purposes until the later of a sale or exchange of the QOF investment or December 31, 2026. At its heart, therefore, a QOF investment should be viewed as a deferral mechanism, not a gain elimination device. The reasons why taxpayers believe otherwise flow from the following two potential tax benefits.

Benefit Number Two: Basis Increase

The second primary tax benefit of QOF investments is the ability to increase the taxpayer’s basis in the capital gain portion of the QOF investment from zero to some other amount. In particular, Section 1400Z-2(b)(2)(B)(iii) provides the taxpayer’s basis will increase from zero to 10% of the deferred gain if the taxpayer holds the QOF investment for five years. Additionally, if the taxpayer holds the QOF investment for seven years, the basis boost is up to a total of 15%. Recall the deferral mechanism of Section 1400Z-2(b)(1) is only through as late as December 31, 2026. For tax reasons, in order to obtain a basis boost in the amount of 15%, the taxpayer will need to make the QOF investment by December 31, 2019. Note, time is quickly running out.

Practice Tip: If you have been discussing QOF investments with clients, you should alert them to this important December 31, 2019, “deadline.” Failure to make a QOF investment by that date can lead to the loss of up to 5% of the basis boost described above.

Benefit Number Three: Future Gain Exclusion

The final primary tax benefit is complete gain exclusion for QOF investments held for at least ten years.[11] Section 1400Z-2(c) provides the taxpayer’s basis in the QOF investment will be increased to the fair market value of that QOF investment on the date of the sale or exchange of that QOF investment. This is true as to any QOF investment, so long as the ten years runs and the QOF investment is sold or exchanged before the statutory sunset date for these provisions, which is currently December 31, 2047.[12]

This third benefit appears to be the source of the misconception regarding the taxation of QOF investments. People hear “gain exclusion after ten years” and think they only need to hold the QOF investment for ten years in order to escape taxation on the entire amount of gain invested in the QOF. That cannot be true, however, due to the deadline established in the first tax benefit (above). December 31, 2026 is in all cases less than ten years away from any QOF investment; therefore, some amount of gain must be recognized (as little as 85%) before the gain exclusion and any other upside appreciation in the QOF investment may be excluded.

Practice Tip: In describing the primary tax benefits associated with QOF investments, it is important to work through all three of those benefits. The taxpayer must understand a recognition event is sitting out there in as late as the 2026 tax year. The taxpayer needs to plan for that. If 100% of the proceeds of the transaction giving rise to the capital gain are invested in the QOF, the taxpayer may be forced to liquidate some or all of that investment (thereby eliminating the ability to achieve the third benefit); or use funds from some other source to fund the tax obligation. That could lead to cash-flow issues in late 2026/early 2027.

Conclusion

In summary, in this article we summarized the basics surrounding qualified opportunity zones and their designation. We described the primary tax benefits associated with QOF investments and dispelled some common myths related to the perceived tax benefits of those investment. In future writings, we will delve into Treasury guidance, as well as other topics related to qualified opportunity zones. If you have an interest in any particular topic, please let us know.

[1] Our initial summary of the TCJA included zero references to opportunity zones. See https://www.schwabe.com/newsroom-publications-14837.

[2] 26 U.S.C. §§ 1400Z-1(b), (c)(2)(B).

[3] 26 U.S.C. § 1400Z-1(c)(1).

[4] See 26 U.S.C. § 1400Z-1(f).

[5] See https://www.kgw.com/article/money/business/oregon-picks-prime-portland-real-estate-for-opportunity-zone-program/283-556720559.

[6] Available at https://www.cdfifund.gov/Pages/Opportunity-Zones.aspx. The IRS also published Notices in 2018 (2018-48) and 2019 (2019-42) regarding the designation of the tracts.

[7] Available at https://www.cims.cdfifund.gov/preparation/?config=config_nmtc.xml.

[8] For purposes of this articles, we are focused on federal income tax benefits of investment in QOFs. A future article will address how Oregon treats or plans to treat such investments.

[9] Later IRS guidance cleared up doubts as to which type of gain, concluding that Section 1400Z-1(a) is meant to apply to capital gains. That guidance will be discussed in a future article.

[10] This zero basis relates to the portion of the QOF investment related to the taxpayer’s capital gain. To the extent the taxpayer invests additional property in the QOF (which is permitted but has consequences as to the tax treatment of that additional investment), the taxpayer may have basis related to that additional investment.

[11] 26 U.S.C. § 1400Z-2(c).

[12] This date is set forth in the first round of proposed Treasury Regulations, to be discussed in a future article. Those regulations are available at https://www.irs.gov/pub/irs-drop/reg-115420-18.pdf.

Olivia Schneider Grabacki

Miller Nash Graham & Dunn LLP

The Oregon State Bar (“OSB”) Taxation Section Award of Merit recognizes tax attorneys who exemplify professionalism in the practice of tax law in Oregon, honoring those tax attorneys who serve as role models for other lawyers and whose reputation, conduct, leadership, and public service is truly exceptional.  The Honorable Jill Tanner embodies each of these qualities.

Judge Tanner has paved the way for women in the law, and more specifically, in tax law, for over 35 years.  She worked in private industry, as both an attorney and certified public accountant, implementing domestic and international transactional tax strategies, leading domestic and international due diligence teams, and educating and informing others in legislative working groups at both the federal and state levels.  By serving on the Oregon Tax Court for nearly two decades, including as presiding magistrate judge, she opened doors for other women to pursue a legal career in tax, setting forth an example of integrity and grace on the bench and in the OSB.  This leadership and service are just some of the many reasons the OSB Taxation Section chose Judge Tanner as the recipient of the 2017 OSB Taxation Section Award of Merit.

Judge Tanner has been recognized for her exceptional professional contributions and leadership on many other occasions as well, including the Oregon Women Lawyers Betty Roberts Leadership Award, the Achievement Award from Oregon Commission for Women, the Oregon State Bar President’s Membership Service Award, and the Tax Court Judge of the Year award from the National Conference of State Tax Judges (an organization for which she chaired its annual conference in 2012 as the first woman to do so in thirty years).

After retiring from the bench at the end of 2015, Judge Tanner continues to augment her reputation as a dedicated public and community servant through board positions with local nonprofit organizations, such as the Oregon Women Lawyers Foundation, and through her work with the Legal Aid Services of Oregon.

Judge Tanner is an accomplished and well respected member of the OSB, who embodies professionalism for women in the law, and has worked tirelessly to mentor new lawyers and advance opportunities for other women within the profession.  She has shown exemplary leadership and service to the state of Oregon, to the OSB, and to the community in general, and no doubt will continue to do so for years to come.

Julia C. Rice, LL.M. (Tax)

Attorney, Law office of Julia Rice

Lake Oswego, Oregon

In today’s mobile society, effective estate planning requires an appreciation of the intersection of state laws. This is particularly true when it comes to clients who have moved to Oregon from community property states such as California and Washington.

As this article explains, Oregon estate planners should investigate whether clients have lived in community property states and have community property assets. Clients who come to Oregon with community property assets can achieve significant tax savings through careful planning.

Community Property States. Nine states have community property laws: Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington and Wisconsin.[1] Given that Oregon, a common-law property state, is surrounded by community property states, estate planners in Oregon have a high likelihood of representing clients who have moved here from a community property state.

Specific laws vary in community property jurisdictions. For example, some community property states count the income from separate property as separate property, whereas other states designate the income as community property.

Community Property Defined. In Oregon and other common law property jurisdictions, assets acquired during the marriage are generally considered an individual’s separate property.

In community property states, by contrast, each spouse is deemed to own an undivided one-half interest in all property acquired during the marriage. This presumption typically does not apply to property acquired prior to the marriage or by gift or bequest during the marriage.

In general, a decedent’s interest in community property does not pass automatically to the surviving spouse. Some jurisdictions, however, have modified traditional community property principles to provide for assets to transfer through a right of survivorship.

Uniform Disposition of Community Property Act. To address the differences between property law systems, Oregon has adopted the Uniform Disposition of Community Property Rights at Death Act (the “Act”).[2] The Act preserves each spouse’s rights in property that was community property before the move to a non-community property state, unless the married couple severed or altered their community property rights.[3] ORS 112.715 provides that the Act covers “all or the proportionate part of that [real or personal] property acquired with the rents, issues, or income of, or the proceeds from, or in exchange for, [property acquired as or which became, and remained] community property under the laws of another jurisdiction; or traceable to that community property.”

The Act contains two rebuttable presumptions for determining whether property falls under its ambit. First, the Act is presumed to apply to any property acquired during a marriage while living in a community property jurisdiction. Second, the Act is presumed to not apply to any real property located in Oregon and personal property wherever situated if such property was acquired during the marriage in a non-community property jurisdiction and title was taken in a form that created rights of survivorship.[4] Therefore, if a married couple moves to Oregon and uses the proceeds from the sale of community property to purchase property here as joint owners with survivorship rights, the couple is presumed to have acquired the property as non-community property.[5] For reasons discussed next, couples may instead wish for the property to be treated as community property.

Full Step-Up in Basis. For estate planning clients, one of the most significant benefits of identifying and preserving community property status for real and personal property is the ability to obtain a full step-up in basis when the first spouse passes away. IRC 1014(b)(6) provides a special basis rule for community property states. Upon the death of the first spouse, the surviving spouse receives a basis step-up in both the decedent’s one-half interest in community property as well as the surviving spouse’s one-half interest.[6] A subsequent sale of the property would reflect a basis equal to the fair market value of the entire property at the decedent’s death, which can save the surviving spouse substantial capital gains taxes.

Further, if the asset is depreciable, the step-up in basis allows the surviving spouse to obtain additional depreciation deductions starting from the fair market value of the property as of the decedent’s date of death. These deductions can be used to offset the surviving spouse’s income from other sources.

Additional Tax Benefits. Additional tax benefits exist for property that retains its community property status. IRC §2040 does not apply to community property, which means that a fractional interest discount can be applied if the property qualifies as community property.[7] Married couples can also gift-split their community property without the need to file a gift tax return. Further, under community property laws spouses can form an LLC as a disregarded entity, whereas under Oregon law they would be taxed as a partnership rather than as a disregarded entity.[8]

Planning with Community Property. Attorneys can employ several strategies to ensure clients’ property will maintain community property status. These strategies include properly titling assets, creating community property trusts and drafting property agreements to enable tracing of funds from community property.

Attorneys should ascertain in initial meetings whether clients have lived in a community property state and, if so, whether they were married while they lived there. Without this inquiry it is possible Oregon attorneys may unintentionally transform community property into a different ownership form without recognizing the benefit of preserving that community property status.

In addition to inquiring about whether a client may have community property, estate planners should examine the status of each asset that originated in the community property jurisdiction. Married couples commonly make the mistake of converting their community property into jointly held property with right of survivorship. Unless the couple enters into a spousal or other written agreement confirming their intent to preserve the character of the property, they will lose the tax advantage available to them.

Tracing. Given the broad scope of ORS 112.715, Oregon estate planners have substantial planning opportunities even if the clients say they no longer have any property located in the community property jurisdiction. For example, an Oregon attorney representing clients who have recently moved from California should determine whether they plan to use the proceeds from the sale of their California residence to purchase an Oregon home. If so, the attorney can have the clients execute a community property trust with the husband and wife as trustees.

Community property trusts are revocable living trusts that preserve the community property characteristics of property contributed to the trust. Revenue Ruling 66-283 confirms that such trusts will maintain the community property character of the trust property for income tax purposes.[9] Employing this technique before a couple retitles their community property in Oregon with survivorship rights will avoid the presumption in ORS 112.725(2) against community property status.

If the couple can trace the funds used to purchase the home from their community property and preserve the character of the property as discussed above, the second spouse will receive a full step-up in basis in the home rather than a step-up in basis only for the decedent’s share.

Clients should also avoid commingling community property and common law property so they can trace assets to community property funds. They should keep records to identify and trace property, including the source of funds used to acquire or improve property. Further, keeping separate accounts for community property and separate property is advisable.

Testamentary control. In addition to tax savings, couples may have other planning reasons for maintaining the community property nature of their assets. Since each spouse is deemed to own a one-half interest in community property, the deceased spouse’s share can pass by will or trust to any person, not solely to his or her spouse. A spouse in a second marriage, for example, could direct his or her one-half interest to pass to children from a first marriage rather than to the surviving spouse.

In Oregon, if a couple owns property as joint tenants with right of survivorship or as tenants by the entirety, the spouse who dies first cannot make such a designation.[10] Rather, the decedent’s share would pass directly to the surviving spouse. Preserving community property status for assets may help couples in a second marriage ensure that one-half of the property will remain subject to each spouse’s testamentary control.

Community Property & Probate. The Act can significantly impact the disposition of property at death. As noted above, ORS 112.735 provides that spouses only have testamentary-disposition rights over one-half of any property to which the Act applies. Similarly, for intestate estates, only the decedent’s one-half of the community property will pass pursuant to Oregon’s laws of intestate succession. And, a surviving spouse cannot assert elective share rights against the decedent’s one-half of the property subject to the Act.[11] Thus, attorneys must take care to determine the correct status of all assets that the decedent owned or co-owned. Whether assets count as community property under the Act could determine whether they will pass as part of the decedent’s estate.

Neither the personal representative nor the court has a duty to determine whether the Act applies to the decedent’s property.[12] The duty arises only if the surviving spouse or the spouse’s successor in interest makes a written demand.[13] The personal representative can then institute an action to perfect title to the property.[14] A failure by an heir, devisee or creditor to make this demand can affect the personal representative, heir or devisee’s ability to perfect the surviving spouse’s title to the property.[15]

Property Agreements. Attorneys must also determine whether any spousal agreements or waivers exist that will affect the community property rights of the couple. Agreements that may affect the community property status of property include prenuptial agreements and community property agreements.

Example. Clients meet with an Oregon estate planning attorney. They have lived in Oregon for less than a year, and they lived in California for twenty-eight years before that. They have been married twenty years. They bought a home in California fifteen years ago and have recently sold it. They now own a home in Lake Oswego, which they use as their primary residence. They plan to use the funds from the sale of their California home to purchase a vacation home in Sunriver.

In this case, the attorney should consider a community property trust for the clients. This mechanism will allow the clients to cleanly trace the source of funds for the Sunriver property and allow the property to be characterized as community property. The clients must carefully maintain all records tracing the use of their community property funds to purchase the Sunriver residence.

The wife later came to see the attorney years down the road after her husband had passed away. If the Sunriver residence was recognized as community property under the Act, assuming the property appreciated in value from the date of purchase until the date of death of the husband, the wife’s tax basis would reflect a full step-up rather than a one-half step-up.

For example, if the couple paid $500,000 for the Sunriver home from their community property funds and the property was purchased and held in a trust that preserved the community property status of the new property, when the husband died, if the fair market value of the property was $1,000,000 the wife’s income tax basis of the property would be adjusted to the value of the property at the husband’s death, or  $1,000,000. Thus, if the wife sold the Sunriver residence at its market value of $1,000,000, she would not realize any capital gains tax on the sale.

If the couple had converted the property to joint ownership with a right of survivorship or the property had otherwise not been recognized as community property, the tax outcome would be significantly different. Upon the husband’s death, the wife would receive a step-up in basis only for the husband’s one-half interest in the jointly owned property. Thus, she would have a new tax basis in the property of $750,000 rather than $1,000,000. If the wife sold the property for $1,000,000, she would pay capital gains tax on the $250,000 difference.

In 2015, Oregon ranked third for the highest capital gains tax rates in the nation.[16] The highest combined state and federal capital gains tax rate for Oregonians was 31%.[17] Therefore, the wife could have paid as much as $77,500 in avoidable capital gains tax.

Summary. Attorneys must carefully examine the character of property held by clients and their desires for their property. Estate planners can use a variety of methods to preserve the character of community property. To use the tracing rules under the Act to their clients’ advantage, attorneys can use community property trusts and community property agreements. Further, attorneys must help clients understand the risks under Oregon law of retitling property with survivorship rights and commingling community property with non-community property. By understanding the differences between the state property laws, attorneys can skillfully guide clients through the planning process while using the property laws to their advantage.

[1] Alaska and Tennessee have adopted optional community property systems.

[2] ORS 112.705-112.775.

[3] ORS 112.775.

[4] ORS 112.725.

[5] Id.

[6] IRC 1014(b)(6).

[7] Propstra v. U.S., 680 F.2d 1248 (9th Cir. 1982).

[8] Rev. Proc. 2002-69.

[9] Rev. Rul. 283, 1966-2 C.B. 297.

[10] However, the couple can employ other estate planning strategies to address this potential issue.

[11] ORS 112.735.

[12] ORS 112.745.

[13] Id.

[14] Id.

[15] Id.

[16] https://ballotpedia.org/Tax_policy_in_Oregon.(Ballotpedia, 2015)

[17] Id.