1031 Exchange in Puerto Rico
The Northern Marianas, Guam, and the U.S. Virgin Islands are all listed as viable locations to carry out a U.S. to U.S. 1031 exchange thanks to a series of government treaty interpretations and regulations last updated in 2005. However, Puerto Rico is not included on this list of coordinated territories.
While this might be disappointing for an investor eying Puerto Rico as a potential place for investment, there may be alternative ways to get the most out of investing in the islands.
But, there is Opportunity Zone....
Another option that is now available is to use the cash to invest in something called a “Qualified Opportunity Zone.” Qualified Opportunity Zones were created recently as part of the Tax Cuts and Jobs Act bill of December 22, 2017.
Established to stimulate community development, the zones are set up to attract long-term investors with alluring tax benefits. Investments in areas of states that have been deemed economically distressed will be granted a new tax break that lets investors reduce, defer, and potentially eliminate capital gains taxes with investments into Opportunity Funds.
While some of the tax benefits are available to investors immediately, Opportunity Zones are designed to encourage investors to stay long term. Investors that remain a full ten years in an Opportunity Zone will receive the most tax incentives.
On May 14, 2019, Puerto Rico approved its own opportunity zones legislation. The local act mirrors the federal opportunity zone legislation to provide local taxpayers with a parallel incentive scenario to the one afforded to federal taxpayers that invest in opportunity zones within Puerto Rico.
Therefore, federal and Puerto Rican capital gains that are timely re-invested in Puerto Rico opportunity zones will receive the immediate tax deferral. If such investment is held for five years, a 10 percent exemption is granted, which increases to 15 percent if held for at least seven years. The main benefit continues to be the permanent exclusion of investment appreciation if it is maintained for 10 years or more.
However, the similarities end there — and not for the worst — as the Puerto Rico incentives go beyond its federal counterpart. If the Qualified Opportunity Fund in Puerto Rico is engaged in a trade or business that will contribute to the diversification, recovery, or social and economic transformation of the community in the eligible zone, additional incentives may be obtained. One of these is the concession of a flat income tax rate of 18.5 percent on the operating income of such activities and a minimum 5 percent investment tax credit that could climb to 25 percent of the cash invested.
Lastly, as an additional tool to encourage business development, the Puerto Rico government has negotiated with the U.S. Department of Housing and Urban Development to apportion approximately $400 million of the billions in Community Development Block Grant (CDBG) funds that will be allocated to the Island to set up a revolving fund with low interest that would assist in financing opportunity zones projects.
In summary, by marrying the federal tax incentives to the local legislation’s attractive income tax rate, investment tax credits, as well as low-cost financing and fund matching from the CDBG, Puerto Rico opportunity zones projects present a unique investment and development opportunity not to be missed.