The Gulf Opportunity Zone Act of 2005 (the “Act”) created the Gulf Opportunity Zone (the “GO Zone”) that includes the portion of the Hurricane Katrina disaster area determined by the President to warrant individual or individual and public assistance from the Federal Government under the Robert T. Stafford Disaster Relief and Emergency Assistance Act by reason of Hurricane Katrina. The Mississippi counties included in the GO Zone are:

Adams, Amite, Attala, Claiborne, Choctaw, Clarke, Copiah, Covington, Forrest, Franklin, George, Greene, Hancock, Harrison, Hinds, Jackson, Jasper, Jefferson, Jefferson Davis, Jones, Kemper, Lamar, Lauderdale, Lawrence, Leake, Lincoln, Lowndes, Madison, Marion, Neshoba, Newton, Noxubee, Oktibbeha, Pearl River, Perry, Pike, Rankin, Scott, Simpson, Smith, Stone, Walthall, Warren, Wayne, Wilkinson, Winston, and Yazoo Counties.

1. What are the highlights of the bill that cover capital cost recovery?

50% Bonus First-Year Depreciation

The Act provides taxpayers with an additional bonus first-year depreciation allowance in an amount equal to 50% of the adjusted basis of qualified GO Zone property. Qualified GO Zone property is property that meets all of the following requirements:

• The property falls within a specified category. Notably, the categories include tangible personal property with a recovery period of 20 years or less, qualified leasehold improvement property, nonresidential real property and residential rental property;
• Substantially all of the use of the property is in the GO Zone and the property is used in an active conduct of a trade or business;
• The original use of the property in the GO Zone commences with the taxpayer on or after August 28, 2005;
• The property is acquired by the taxpayer by purchase on or after August 28, 2005, and no written binding contract for the purchase of the property was in existence prior to August 28, 2005; and
• The property must be placed in service by the taxpayer on or before December 31, 2007 (December 31, 2008, in the case of non-residential real property and residential rental property)

A taxpayer that manufactures, constructs or produces property for its own use meets the acquisition requirement if it begins manufacturing, constructing or producing the property after August 27, 2005 and the property is placed into service no later than December 31, 2007 (December 31, 2008, in the case of non-residential real property and residential rental property).

The following property is ineligible for the 50% bonus first-year depreciation:

• Property that is financed with the proceeds of tax exempt bonds;
• Property that must be depreciated under the alternative depreciation system; and
• Any qualified revitalization building with respect to which the taxpayer has elected to write off certain revitalization expenses under Code section 1400I (related to “renewal communities”).

Increase in Section 179 Expensing

Section 179 of the Internal Revenue Code allows taxpayers to expense the cost of certain assets (i.e. deduct immediately instead of capitalizing and depreciating the asset over time) in the year the assets are placed into service. Under pre-Act law, the maximum amount that a taxpayer may expense in a tax year under section 179 is $100,000 for tax years beginning after 2002 and before 2008. The amount is indexed for inflation for tax years beginning after 2003. For example, the maximum amount that a taxpayer can expense under section 179 in 2006 (but for the increase provided by the Act) is $108,000. Further, the deduction begins to phase out for property placed in service during the tax year in excess of $400,000 indexed for inflation (the investment ceiling that triggers the phase for property placed into service in 2006 is $430,000).

The Act increases the maximum amount that taxpayers can expense under section 179 for qualified section 179 Gulf Opportunity Zone property. Such property includes property that is eligible for expensing under section 179 (tangible personal property), and is qualified GO Zone property as defined for purposes of the 50% bonus first-year depreciation (see above). The Act increases the maximum amount that can be expensed under section 179 by the lesser of (1) $100,000 or (2) the cost of the qualified section 179 GO Zone property placed in service during the tax year. The Act also increases the investment ceiling by the lesser of (1) $600,000 or (2) the cost of the qualified section 179 GO Zone property placed in service during the tax year.

Thus, taxpayers may expense up to $208,000 of qualified section 179 GO Zone property placed into service in 2006, and the deduction will not begin to phase out unless the taxpayer places into service more than $1,030,000 of qualified section 179 GO Zone property in 2006.

Expensing for Certain Demolition and Clean-Up Costs

Taxpayers typically must capitalize any losses or expenses related to the demolition and add the losses or expenses to the taxpayer’s basis in the land. The facts and circumstances of clean up costs incurred by a taxpayer such as the removal of debris dictate whether such costs may be expensed or must be capitalized and added to the taxpayer’s basis in the underlying property.

Under the Act, however, taxpayers may deduct 50% of any qualified GO Zone clean-up cost. Qualified GO Zone clean-up costs include any amounts paid or incurred after August 27, 2005 and before December 31, 2008 (that would otherwise be capitalized), for the removal of debris from, or the demolition of structures on, real property that is located in the GO Zone which is (1) held by the taxpayer for use in a trade or business or for the production of income, or (2) inventory held primarily for sale to customers in the ordinary course of business.

Extension of Expensing for Environmental Remediation Costs

The Act allows taxpayers to expense qualified environmental remediation expenditures (as defined in Internal Revenue Code section 198(b)) paid or incurred after August 27, 2005 and before January 1, 2008, in connection with a qualified contaminated site located in the GO Zone. The Act also treats petroleum products in the GO Zone as hazardous substances.

The pre-Act law allowed taxpayers to expense qualified environmental remediation expenditures paid or incurred before January 1, 2006.

Increased Expensing for Small Timber Producers

The pre-Act law allowed taxpayers other than trusts and estates to deduct up to $10,000 ($5,000 if married filing separately) of reforestation costs.

The Act increases the maximum reforestation amount related to qualified timber property located in the GO Zone that a taxpayer may elect to expense by the lesser of (1) $10,000 ($5,000 if married filing separately), or (2) the amount of reforestation expenses paid or incurred by the taxpayer with respect to such qualified timber property during the specified portion of the taxable year.

The increased deduction does not apply to publicly traded corporations, real estate investment trusts or large timber producers (i.e. taxpayers that hold more than 500 acres of qualified timber property at any time during the tax year).

2. How will the net operating loss changes work?

Increase of Net Operating Loss Carryback Period

A net operating loss (“NOL”) may generally be carried back 2 years and carried forward 20 years. The Act allows taxpayers to carry back NOLs 5 years instead of 2 years if the losses are “qualified GO Zone losses.” A qualified GO Zone loss means the lesser of:

• The excess of the (i) taxpayer’s NOL for the tax year, over (ii) the loss for the tax year the qualifies for a 10 year carryback period (see discussion related to public utilities below); or
• The aggregate amount of the following deductions to the extent that they are taken into account in computing the taxpayer’s NOL for the taxable year:

(i) Qualified Gulf Opportunity Zone casualty losses, which include casualty losses caused by Katrina of certain business property located in the GO Zone that are deductible under section 165 of the Internal Revenue Code.

(ii) Certain moving expenses paid by employers for employees, including amounts paid or incurred by an employer after August 27, 2005 and before January 1, 2008 for an employee who lived in the GO Zone before August 28, 2005, was displaced from his home by Katrina and is employed by the taxpayer/employer in the GO Zone after the expenses are paid or incurred.

(iii) Temporary housing expenses paid by employers after August 27, 2005, and before January 1, 2008, to temporarily house employees who are employed in the GO Zone.

(iv) Deductions for depreciation or amortization with respect to any qualified GO Zone property.

(v) Deductions allowable for repair expenses (including debris removal) paid or incurred after August 27, 2005 and before January 1, 2008 with respect to any damage attributable to Katrina.

Increase of NOL Carryback Period for Small Timber Producers

The Act provides a 5 year carryback period (instead of a 2 year carryback) for timber losses related to qualified timber property which is located in the GO Zone. The increased carryback period is available to taxpayers owning less than 500 acres of timber, any part of which is located in the GO Zone. This provision is not applicable to publicly traded corporations or real estate investment trusts.

Increase of NOL Carryback Period for Public Utilities

The Act allows taxpayers with casualty losses associated with public utility property caused by Katrina to elect a 10 year NOL carryback period for GO Zone public utility casualty losses. A GO Zone public utility casualty loss is any casualty loss of public utility property attributable to Katrina that is allowed as a deduction under Internal Revenue Code section 165.

3. Can you give a rundown of the major tax credit changes?

Increase in Rehabilitation Credit

The Act increases the rehabilitation credit under Code section 47 for qualified expenditures paid or incurred after August 27, 2005, and before January 1, 2009, from 10% to 13% with respect to any qualified rehabilitated building and from 20% to 26% with respect to any certified historic structure located in the GO Zone.

Application of New Markets Tax Credit to Investments in Community Development Entities Serving GO Zone

The Act provides for an additional $300 million for 2005 and 2006 and an additional $400 million for 2007 to be allocated among qualified community development entities to make qualified low-income community investments within the GO Zone. A qualified community development entity is eligible for an allocation of the additional credit limitations only if a significant mission of such entity is the recovery and redevelopment of the GO Zone.

Housing Tax Benefits

The Act allows qualified employees to exclude from their gross income up to $600 per month for the value of lodging provided by qualified employers. A “qualified employee” is an individual who had a principal residence in the GO Zone on August 28, 2005, and who performs substantially all employment services I the GO Zone and for the qualified employer that provides the lodging. A “qualified employer” is an employer with a trade or business located in the GO Zone.

Qualified employers are allowed a credit equal to 30% of the amount which is excludable from its qualified employees’ gross incomes.

Education Tax Benefits

The Act increases the Hope Scholarship Credit and the Lifetime Learning Credit for students who attend eligible educational institutions located in the GO Zone for any taxable year beginning in 2005 or 2006.

For 2005, the Hope credit is increased to 100% of the first $2,000 in qualified tuition and related expenses and 50% of the next $2,000 of qualified tuition and expenses. The maximum Hope credit for a student in the GO Zone in 2005 is $3,000 per student. For 2006, the Hope credit is increased to 100% of the first $2,200 in qualified tuition and related expenses and 50% of the next $2,200 of qualified tuition and expenses. The maximum Hope credit for a student in the GO Zone in 2005 is $3,300 per student.

The Lifetime Learning Credit is increased from 20% of the first $10,000 in qualified tuition and related expenses to 40% of the first $10,000 of such expenses for a maximum credit of $4,000.

4. How will the bill lower the cost of capital for businesses in the 40 counties to which it applies in Mississippi?

The bill, through provisions such as the bonus depreciation provision and the section 179 provision, allows taxpayers to recover their capital expenditures much quicker. Recovery of such expenditures immediately helps to take the sting out of the costly expenditures that are necessary to get businesses operating again.

5. What are some of the other act changes in relation to bonding and tax credits?

I have not reviewed the bond provisions in the new bill. Please see item #3 above regarding certain tax credits.

6. Can you give me a comment on any provisions that stand out as particularly beneficial or interesting to business owners.

The 50% bonus depreciation provision is a big deal. Specifically, the 50% bonus depreciation now applies to nonresidential real property and residential rental property. Prior laws did not allow bonus first-year depreciation for buildings.

The increased section 179 deduction and the ability of taxpayers to immediately expense demolition and clean-up costs will benefit business owners in the GO Zone since it is likely necessary for those taxpayers to purchase section 179 property (tangible personal property used in a trade or business) and to incur clean-up costs to get their businesses going again.

The ability of taxpayers to carry back their NOLs for 5 years as opposed to 2 years will enable some taxpayers to utilize operating losses immediately in lieu of having to carry them forward to a year when they have sufficient income to absorb the losses.

7. What are the time limits for new property investments to qualify for the provisions in the bill?

Each provision of the bill has its own time period. Several provisions relate to expenses paid or incurred after August 27, 2005, and before January 1, 2008.

It is important to note that as part of the compromise between the House and Senate the Act’s provisions discussed above do not apply to (1) any property that is used in connection with any private or commercial golf course, country club, massage parlor, hot tub facility, suntan facility, or any store the principal business of which is the sale or alcoholic beverages off premises, or (2) any gambling or animal racing property.