Rollover of Gain From Sale of Empowerment Zone Assets

You may qualify for a tax-free rollover of certain gains from the sale of qualified empowerment zone assets. This means that if you buy certain replacement property and make the choice described in this section, you postpone part or all of the recognition of your gain.

You qualify to make this choice if you meet all the following tests.

1. You hold a qualified empowerment zone asset for more than 1 year and sell it at a gain.
2. Your gain from the sale is a capital gain.
3. During the 60-day period beginning on the date of the sale, you buy a replacement qualified empowerment zone asset in the same zone as the asset sold.

Qualified empowerment zone asset.   This means certain stock or partnership interests in an enterprise zone business (defined earlier). It also includes certain tangible property used in an enterprise zone business. You must have acquired the asset after December 21, 2000.

The DC Zone is not treated as an empowerment zone for this purpose. For the treatment of gain from the sale of a DC Zone asset, see Exclusion of Capital Gains From DC Zone Assets, later.

Amount of gain recognized.   If you make the choice described in this section, you must recognize gain only up to the following amount:

1. The amount realized on the sale, minus
2. The cost of any qualified empowerment zone asset that you bought during the 60-day period beginning on the date of sale (and did not previously take into account in rolling over gain on an earlier sale of qualified empowerment zone assets).

If this amount is equal to or more than the amount of your gain, you must recognize the full amount of your gain. If this amount is less than the amount of your gain, you can postpone the rest of your gain by adjusting the basis of your replacement property as described next.

Basis of replacement property.   You must subtract the amount of postponed gain from the basis of the qualified empowerment zone assets you bought as replacement property.

More information.   For more information about the rollover of gain from the sale of empowerment zone assets, see section 1397B of the Internal Revenue Code.

Increased Exclusion of Gain From Qualified Small Business Stock

Taxpayers other than corporations generally can exclude from income 50% of their gain from the sale or trade of qualified small business stock held more than 5 years. If the stock is in a corporation that qualifies as an enterprise zone business (defined earlier under Increased Section 179 Deduction) during substantially all of the time you hold the stock, you can exclude 60% of your gain.

To claim this increased exclusion, you must have acquired the stock after December 21, 2000. Gain from periods after 2014 will not qualify for the increased exclusion.

The requirement that the corporation must qualify as an enterprise zone business during substantially all of the time you hold the stock will still be met if the corporation ceased to qualify after the 5-year period beginning on the date you acquired the stock. However, the gain that qualifies for the 60% exclusion cannot be more than the gain you would have had if you had sold the stock on the date the corporation ceased to qualify.

If you sell the stock after 2009, disregard the end of the empowerment zone designation on December 31, 2009, in determining whether the corporation qualified as an enterprise zone business during substantially all of the time you held the stock.

For more information about this exclusion, including a definition of qualified small business stock, see chapter 4 of Publication 550, Investment Income and Expenses.

Tax-Exempt Bond Financing

State or local governments can issue enterprise zone facility bonds (a type of exempt facility tax-exempt bond) to raise funds to provide an enterprise zone business with qualified zone property. At least 95% of the net proceeds from the bond issue must be used to finance:

1. Qualified zone property whose principal user is an enterprise zone business, and
2. Certain land used for a related purpose (for example, land where the business is located and a parking lot for customers and employees).

Tax-exempt bonds generally have lower interest rates than conventional financing.

Contact the appropriate state or local government agency to find out if this type of financing is available in your empowerment zone or enterprise community.

Enterprise zone business.   For tax-exempt bond financing, a corporation, partnership, or sole proprietorship is generally an enterprise zone business if all the following statements are true for the tax year.

1. Every trade or business of the corporation or partnership is the active conduct of a qualified business (defined later) within an empowerment zone or an enterprise community. (This rule does not apply to a sole proprietorship.)
2. At least 50% (80% for bonds issued before August 6, 1997) of its total gross income is from the active conduct of a qualified business within a zone or community.
3. A substantial part of the use of its tangible property is within a zone or community. (For bonds issued before August 6, 1997, at least 85% of the use of its tangible property must be within a zone or community.)
4. A substantial part of its intangible property is used in the active conduct of the business. (For bonds issued before August 6, 1997, at least 85% of its intangible property must be used in, and exclusively related to, the active conduct of the business.)
5. A substantial part of the employees' services are performed within a zone or community. (For bonds issued before August 6, 1997, at least 85% of the employees' services must be performed within a zone or community.)
6. At least 35% of the employees are residents of an empowerment zone or enterprise community. (This rule does not apply to businesses in the DC Zone.)
7. Less than 5% of the average of the total unadjusted bases of the property owned by the business is from:
   1. Nonqualified financial property (generally, debt, stock, partnership interests, options, futures contracts, forward contracts, warrants, notional principal contracts, and annuities), or
   2. Collectibles not held primarily for sale to customers.

For a sole proprietorship, the term employee in (5) and (6) includes the proprietor. Also, a business located in a zone or community that would qualify if it were separately incorporated is treated as an enterprise zone business. For example, a business that is part of a national chain could qualify, providing it would meet the definition of an enterprise zone business if it were separately incorporated.

Qualified business.   A qualified business is generally any trade or business except one that consists primarily of the development or holding of intangibles for sale or license.

However, the rental to others of real property located in an empowerment zone or enterprise community is a qualified business only if the property is not residential rental property and at least 50% of the gross rental income from the property is from enterprise zone businesses.

The rental to others of tangible personal property is a qualified business only if at least 50% of the rentals of the property are to enterprise zone businesses or zone or community residents. (For bonds issued before August 6, 1997, at least 85% of the rentals of the property must be to enterprise zone businesses or zone or community residents.)

Also, a qualified business does not include any business listed earlier in item (5) or item (6) under Nonqualified employees in the Empowerment Zone Employment Credit section.

Relaxed requirements during start-up period.   For bonds issued after August 5, 1997, a business will be treated as an enterprise zone business during a start-up period if both of the following apply.

1. It is reasonable, at the beginning of the start-up period, to expect the business to be an enterprise zone business by the end of the start-up period.
2. The business makes bona fide efforts to be an enterprise zone business.

The start-up period is the period that ends with the start of the first tax year beginning more than 2 years after the later of the following two dates.

1. The issue date of the bond issue financing the qualified zone property.
2. The date this property is first placed in service (or, if earlier, the date that is 3 years after the issue date).

Requirements during and after testing period.   For bonds issued after August 5, 1997, a business that qualifies as an enterprise zone business at the end of the start-up period must continue to qualify during a testing period that ends 3 tax years after the start-up period ends.

After the 3-year testing period, a business will continue to be treated as an enterprise zone business as long as it meets an employee residency requirement. To meet this requirement, at least 35% of its employees must be residents of an empowerment zone or enterprise community. However, the following businesses are not treated as enterprise zone businesses even if they meet the employee residency requirement.

1. Any business that consists primarily of the development or holding of intangibles for sale or license.
2. Any business listed earlier in item (5) or item (6) under Nonqualified employees in the Empowerment Zone Employment Credit section.

A business in the DC Zone does not need to meet the employee residency requirement to continue to be treated as an enterprise zone business after the testing period.

Qualified zone property.   For tax-exempt bond financing, qualified zone property is any depreciable real or tangible personal property if all the following are true.

1. You acquired the property after the zone or community designation is in effect.
2. You did not acquire the property from a related person or member of a controlled group of which you are a member.
3. Your basis in the property is not determined either by its adjusted basis in the hands of the person from whom you acquired it or under the stepped-up basis rules for property acquired from a decedent.
4. You were the first person to use the property in an empowerment zone or enterprise community.
5. At least 85% of the property's use is in an empowerment zone or enterprise community and in the active conduct of a qualified trade or business in the zone or community.

Used property may be qualified zone property if it has not previously been used within an empowerment zone or enterprise community.

Special rule for substantially renovated property.   Property will be treated as having met requirements (1) and (4) if you substantially renovate the property. You substantially renovate property if, during any 24-month period beginning after the zone or community designation takes effect, your additions to the property's basis are more than the greater of the following amounts.

1. 15% (100% for bonds issued before August 6, 1997) of the adjusted basis of the property at the beginning of the 24-month period.
2. $5,000.

Special rule for bonds issued after July 30, 1996.   Generally for bonds issued after July 30, 1996, property that you reasonably expect by exercising due diligence to be qualified zone property by an initial testing date will be treated as qualified zone property for the period before that date.

The initial testing date is generally the date that is 18 months after the later of the following dates.

1. The issue date of the bond issue financing the qualified zone property.
2. The date this property is first placed in service (or, if earlier, the date that is 3 years (5 years for certain construction projects) after the issue date).

However, the issuer of the bonds can choose to use any earlier date that comes after the bond issue date as the initial testing date.

Interest not deductible.   No deduction will be allowed for interest on any financing provided from a bond if the interest accrues during the period beginning on the first day of the calendar year in which either of the following occurs.

1. Substantially all of the facility that was financed ceases to be used in an empowerment zone or enterprise community.
2. The principal user of the facility ceases to be an enterprise zone business.

This rule does not apply if the use of the facility ceases to qualify because of bankruptcy or the termination or revocation of the designation as an empowerment zone or enterprise community.

In addition, interest will remain deductible if the issuer and principal user try in good faith to meet the requirements and any failure is corrected within a reasonable period after discovery.

More information.   For more information, see section 1394 of the Internal Revenue Code and the regulations under that section.

Renewal Communities

The Community Renewal Tax Relief Act of 2000 authorizes up to 40 renewal communities in which businesses will be eligible for tax incentives. The tax incentives will be available January 1, 2002, through December 31, 2009.

State and local governments will nominate areas to be designated as renewal communities. Each renewal community must meet eligibility criteria related to population, unemployment, poverty, and general distress.

The Secretary of HUD will designate the renewal communities by December 31, 2001. At least 12 of the designated renewal communities must be in rural areas.

The designation will generally remain in effect until December 31, 2009. The designation may be revoked if the state or local government modifies the boundaries of the area or does not keep certain commitments.

Businesses that qualify and operate in a renewal community will be eligible for the following tax incentives.

• Renewal community employment credit.
• Increased section 179 deduction.
• Commercial revitalization deduction.
• Capital gain exclusion.

Renewal Community Employment Credit

The renewal community employment credit provides businesses with an incentive to hire individuals who both live and work in a renewal community. You can claim the credit if you pay or incur qualified wages to a qualified employee. The credit is for wages paid or incurred after 2001.

The credit is 15% of the qualified wages paid or incurred during a calendar year. The amount of qualified wages you can use to figure the credit cannot be more than $10,000 for each employee for each calendar year. As a result, the credit can be as much as $1,500 (15% of $10,000) per qualified employee each year.

Qualified employee.   A qualified employee is any employee who meets both of the following tests.

• The employee performs substantially all of his or her services for you within a renewal community and in your trade or business.
• While performing those services, the employee has his or her main home within that renewal community.

Both full-time and part-time employees may qualify.

Nonqualified employees.   Certain individuals cannot be qualified employees. For a list of those individuals, see Nonqualified employees under Empowerment Zone Employment Credit, earlier.

Qualified wages.   Qualified wages are any wages you pay or incur for services performed by an employee while the employee is a qualified employee (defined earlier). Wages are generally defined as those wages subject to the Federal Unemployment Tax Act (FUTA) without regard to the FUTA dollar limit.

Also treat as qualified wages certain training and education expenses you pay or incur on behalf of a qualified employee.

Effect of welfare-to-work or work opportunity credit.   Qualified wages do not include any amount you take into account in figuring the welfare-to-work credit or the work opportunity credit. In addition, reduce the $10,000 maximum qualified wages for each qualified employee by the amount of wages you use to figure either of those credits for that employee.

Effect on salary and wage deduction.   In general, you must reduce the deductions on your income tax return for salaries and wages and certain education and training costs by the amount of your renewal community employment credit.

Increased Section 179 Deduction

Section 179 of the Internal Revenue Code allows you to choose to deduct all or part of the cost of certain qualifying property in the year you place it in service. You can do this instead of recovering the cost by taking depreciation deductions over a specified recovery period. There are limits, however, on the amount you can deduct in a tax year.

You may be able to claim an increased section 179 deduction if your business qualifies as a renewal community business. The increase can be as much as $20,000 ($35,000 for 2002 and later years). This increased section 179 deduction applies to qualified renewal property you acquire after December 31, 2001, and before January 1, 2010, and place in service in a renewal community.

Renewal community business.   For the increased section 179 deduction, a corporation, partnership, or sole proprietorship is a renewal community business if all the following statements are true for the tax year.

1. Every trade or business of the corporation or partnership is the active conduct of a qualified business (defined later) within a renewal community. (This rule does not apply to a sole proprietorship.)
2. At least 50% of its total gross income is from the active conduct of a qualified business within a renewal community.
3. A substantial part of the use of its tangible property is within a renewal community.
4. A substantial part of its intangible property is used in the active conduct of the business.
5. A substantial part of the employees' services are performed within a renewal community.
6. At least 35% of the employees are residents of a renewal community.
7. Less than 5% of the average of the total unadjusted bases of the property owned by the business is from:
   1. Nonqualified financial property (generally, debt, stock, partnership interests, options, futures contracts, forward contracts, warrants, notional principal contracts, and annuities), or
   2. Collectibles not held primarily for sale to customers.

For a sole proprietorship the term employee in (5) and (6) includes the proprietor.

Qualified business.   A qualified business is generally any trade or business except one that consists primarily of the development or holding of intangibles for sale or license.

However, the rental to others of real property located in a renewal community is a qualified business only if the property is not residential rental property and at least 50% of the gross rental income from the property is from renewal community businesses.

The rental to others of tangible personal property is a qualified business only if at least 50% of the rentals of the property are to renewal community businesses or community residents.

Also, a qualified business does not include any business listed earlier in item (5) or item (6) under Nonqualified employees in the Empowerment Zone Employment Credit section.

Qualified renewal property.   This is any depreciable tangible property if all the following are true.

1. You acquired the property after the renewal community designation is in effect.
2. You did not acquire the property from a related person or member of a controlled group of which you are a member.
3. Your basis in the property is not determined either by its adjusted basis in the hands of the person from whom you acquired it or under the stepped-up basis rules for property acquired from a decedent.
4. You were the first person to use the property in a renewal community.
5. At least 85% of the property's use is in a renewal community and in the active conduct of a qualified trade or business in the community.

Buildings are qualified renewal property, but they do not qualify for the section 179 deduction. Used property may be qualified renewal property if it has not previously been used within a renewal community.

More information.   See the earlier discussion of the increased 179 deduction under Empowerment Zones and Enterprise Communities for a special rule for renovated property, the section 179 deduction limits, and the recapture rules, all of which also apply in renewal communities. That earlier discussion also tells where to get additional information about the section 179 deduction.

Previous | First | Next

Publication Index | 2002 Tax Help Archives | Tax Help Archives | Home