Gulf Opportunity Zone Act of 2005

fter Hurricane Katrina became the costliest catastrophe in American history, hurricanes Rita and Wilma caused even more damage. In response President Bush signed into law the Gulf Opportunity Zone Act of 2005. The act contains both hurricane- and non-hurricane-related provisions. This article examines only the tax relief provided to those locations.

The first step in understanding the tax benefits for which taxpayers may be eligible is to understand the locations to which the legislation applies. Section 101 of the act adds IRC section 1400M, which defines three areas and three zones.

T HE GO Z ONE
The heart of the Gulf Opportunity Zone Act is the establishment of the GO Zones (see box ) and the tax incentives to help individuals and businesses revitalize and rebuild in those areas. Here is a review of the significant provisions.

Bonus 50% depreciation. The act establishes a bonus 50% first-year depreciation allowance under IRC section 167(a) for qualified Gulf Opportunity Zone property, which includes property described in IRC section 168(k)(2)(A)(i), nonresidential real property and residential rental property located in the zone that the taxpayer acquired and substantially used in the trade or business on or after August 28, 2005. Nonresidential real property and residential rental property must be placed in service by December 31, 2008. All other property must be placed in service by December 31, 2007.

Increase in expensing under IRC section 179. Under general tax law, a business may elect to expense up to $100,000 (adjusted to $108,000 for 2006) for the cost of machinery and equipment bought for the business’s use. The act increases this amount to $200,000 (adjusted to $208,000 for 2006). It also increases the level of investment at which the phaseout applies from $400,000 (adjusted to $430,000 in 2006) to $1 million (adjusted to $1.03 million for 2006). To qualify the property must be placed in service in the GO Zone between August 28, 2005, and December 31, 2007.

Expensing for certain demolition and cleanup costs. Generally there is no allowed deduction for the owner or lessee of a building for loss on demolition or demolition-related expenses, but the act allows taxpayers to expense 50% of qualified GO Zone cleanup costs. A qualified Gulf Opportunity Zone cleanup cost is defined as a cost paid or incurred between August 28, 2005, and December 31, 2007, for the removal of debris from, or the demolition of structures on, real property located in the GO Zone that is (1) held by a taxpayer for use in a trade or business or for the production of income or (2) is IRC section 1221(a)(1) property in the taxpayer’s hands.

Extension of expensing for environmental remediation costs. The act extends IRC section 198 expensing for environmental remediation expenditures through December 31, 2007. (This provision was set to expire for expenditures paid or incurred on or before December 31, 2005.) To qualify the expenditures must be made in connection with a qualified containment site located in the GO Zone and be paid or incurred between August 28, 2005, and January 1, 2008. Note that the act adds petroleum products as a hazardous substance.

Special rules for small timber products. Taxpayers with less than 500 acres of qualified timber property are eligible for an increased expensing limit for this property and a five-year (instead of two-year) net operating loss (NOL) carryback. These special rules for timber products apply to qualified timber property located in the GO Zones.

Treatment of NOL losses attributable to GO Zone losses. The act extends the NOL carryback period from two to five years if a portion of any NOL for any taxable year is a qualified GO Zone loss. A qualified Gulf Opportunity Zone loss includes depreciation deductions for GO Zone property and deductions for certain repair expenses that resulted from Hurricane Katrina, business casualty losses caused by Hurricane Katrina in the GO Zone and moving expenses and temporary housing expenses for employees working in the GO Zone.

Education tax benefits. Generally taxpayers may claim a Hope Credit of $1,500 (adjusted to $1,650 in 2006) and a Lifetime Learning Credit of $2,000. The act doubles these amounts to $3,000 (adjusted to $3,300 in 2006) and $4,000, respectively, for individuals who attend an eligible educational institution in the GO Zone.

Housing tax benefits. The act provides tax benefits to both employers and employees with respect to employer-provided housing for individuals affected by Hurricane Katrina. A qualified employee is one whose principal residence was in the GO Zone on August 28, 2005, and who worked in the GO Zone for a qualified employer that furnished lodging. A qualified employer is any employer with a trade or business within the GO Zone. Qualified employees may exclude up to $600 per month for housing provided by an employer located in the GO Zone. Qualified employers are entitled to a 30% tax credit (maximum $180) for each employee to whom they provide such lodging.

K ATRINA P ROVISIONS E XTENDED FOR H URRICANES R ITA AND W ILMA
While the Katrina Emergency Tax Relief Act (KETRA) of 2005 provided significant tax relief to those affected by Katrina, the majority of these measures did not amend the Internal Revenue Code. But the Gulf Opportunity Zone Act effectively repealed the relevant KETRA provisions and incorporated them into the GO Zone Act and amended the Internal Revenue Code. Here are the most prominent KETRA provisions that have been extended to victims of hurricanes Rita and Wilma.

Use of retirement funds. KETRA had established special rules regarding the retirement funds of individuals who lived in the Hurricane Katrina Disaster Area (see zone 1 ) and sustained economic losses due to the storm. Such individuals can take “qualified Hurricane Katrina distributions” from retirement plans of up to $100,000 without penalty and without the 10% early distribution penalty or 20% mandatory withholding tax; the rollover period to repay distributions is extended to three years and the income tax is spread evenly over three years for the penalty-free withdrawals. Taxpayers who withdrew savings from certain retirement plans to purchase or construct a home but did not do so due to Hurricane Katrina, can recontribute the funds. Katrina survivors also can borrow up to $100,000 from a pension plan and delay repayment for one year for outstanding loans from qualified plans.

The Gulf Opportunity Zone Act extends these special rules to qualified Hurricane Rita individuals and qualified Hurricane Wilma individuals. A qualified Hurricane Rita individual is one whose principal residence on September 23, 2005, was located in the Hurricane Rita Disaster Area (see zone 2 ) and who sustained economic loss due to the storm. Similarly, a qualified Hurricane Wilma individual is one whose principal residence on October 23, 2005, was located in the Hurricane Wilma Disaster Area (see zone 3 ) and who sustained economic loss due to Hurricane Wilma.

Corporate charitable contributions. KETRA removed the 10% charitable contribution deduction limitation for Hurricane Katrina cash donations made by C corporations during the period beginning August 28, 2005, through December 31, 2005. The Gulf Opportunity Zone Act expands this provision to include cash contributions that are related to hurricanes Rita and Wilma.

Casualty losses. KETRA provided that casualty losses attributable to Hurricane Katrina that occurred in the Hurricane Katrina Disaster Area on or after August 25, 2005, are fully deductible. The GO Zone Act extended this provision to casualty losses that occurred in the Hurricane Rita Disaster Area on or after September 23, 2005, and in the Hurricane Wilma Disaster Area on or after October 23, 2005, that were attributable to these horrendous storms.

Earned Income Tax Credit (EITC) and Child Credit. Under KETRA individuals affected by Hurricane Katrina could use their 2004 earned income amount to calculate the earned income tax credit and refundable child credit on their 2005 tax returns if their earned income in 2005 was less than it was in 2004. The GO Zone Act allows those affected by hurricanes Rita and Wilma to do the same.

Employee-retention credit. KETRA created an employee-retention tax credit equal to 40% of the first $6,000 in wages paid to eligible employees by employers of 200 employees or less located in the Katrina Core Disaster Area (see zone 1 ) for the period the business is rendered inoperable by hurricane damage. The GO Zone Act makes this credit retroactive and also includes larger employers and employers that were affected by hurricanes Rita (see zone 2 ) and Wilma (see zone 3 ).

Mortgage revenue bonds. KETRA waived the first-time home buyer requirement for eligibility for low-interest-rate mortgages and allowed up to $150,000 of loan proceeds to be used to repair Hurricane Katrina-damaged homes. The GO Zone Act extends these provisions to individuals affected by Rita and Wilma.

PLANNING OPPORTUNITIES
The act provides many planning opportunities for CPAs in advising their clients. The following are just a few examples.

Retirement plans. There are many planning opportunities with respect to retirement plan funds. Before looking at distributions, CPAs must advise clients about the negatives of taking money out of a retirement plan (that is, less money for retirement). Taking a personal loan may be a better option. It is important to note that all CPAs nationwide must understand these rules since many people affected by the hurricanes are relocating to areas that were not hit by the hurricanes, but nonetheless they have legitimate losses.

Investment incentives. The act provides investment incentives through bonus depreciation and increased expensing. CPAs should advise their clients who are interested in investing in the GO Zone of these incentives.

Federal tax returns. CPAs may want to review 2005 federal tax returns for certain clients to determine whether filing amended returns would result in better tax results.

LOOKING AHEAD
The extensive legislation and guidance that were issued in the wake of the three hurricanes offer CPAs many tax-planning opportunities for clients affected by the storms. While this legislation targeted specific areas in the southern United States, persons affected by the storm who may be entitled to some form of tax relief are moving to other areas of the country. Therefore, all CPAs must understand the tax relief offered under the act. Keep an eye out for additional guidance, which is likely to come.