Don Warrant, CPA
Director | Tax Practice
Technical Amendments, Federal Disaster Declarations and COVID-19 filing extensions and their impact
The timing for several important provisions of the Opportunity Zones program have been extended due to the COVID-19 emergency. We have summarized some of the key points related to the extensions and also the technical amendments below.
Extension of Deadlines
On Friday, April 10, the IRS released Notice 2020-23 which extended certain deadlines for federal tax-related obligations during the period April 1, 2020 through July 14, 2020. The extension provides that, due to the COVID-19 emergency, taxpayers that are required to make certain tax payments, file certain tax forms, or take certain time-sensitive actions during this period, are granted an extension of time until July 15, 2020 to pay, file or take such actions.
The extension specifically provides that the 180-day re-investment period applicable to Opportunity Zone (“OZ”) investors is a time-sensitive action covered by the notice. Therefore, if an investor’s 180-day re-investment period began on a date between October 5, 2019 and January 17, 2020, the re-investment period ends on July 15, 2020.
Federally Declared Disaster
If a Qualified Opportunity Zone Business (“QOZB”) is located in a Qualified Opportunity Zone (“QOZ”) within a federally declared disaster area, the QOZB may receive up to an additional 24 months to consume its working capital assets, if it otherwise meets the Working Capital Safe Harbor (“WCSH”) requirements. All 50 states have received this declaration and therefore, QOZBs may extend their existing WCSH period(s) for an additional 24 months.
A QOZB is a trade or business that meets certain requirements and is owned by a Qualified Opportunity Fund (“QOF”) under a two-tier structure. The WCSH does not apply to a QOF that chooses to operate a trade or business in an OZ directly instead of a two-tier structure.
In addition, a QOF may receive up to an additional 12 months (up to 24 months in total) to reinvest any proceeds from asset sales or return of capital from a QOZB.
Technical Amendments to the Final Regulations
On April 2, 2020, the IRS released technical corrections amending the final regulations released in December 2019. The changes impacting the WCSH and the 6-month cure period are provided below.
Working Capital Safe Harbor
Each year, certain tests are applied to determine if a business is a QOZB. Under these tests, the value of tangible property, intangible property, and nonqualified financial property (“NQFP”) are determined as of the last day of the 6-month period during the year, and the last day of the tax year. The QOZB may not hold more than 5% of its assets in NQFP on each test date.
Under the WCSH, a QOZB may exclude a reasonable amount of working capital from nonqualified financial property. The WCSH requirements are as follows:
- The amounts are designated in writing for the development of a trade or business in a QOZ, including when appropriate, the acquisition, construction, and/or substantial improvement of tangible property in such zone.
- There is a written schedule consistent with the ordinary start-up of a trade or business for the expenditure of the working capital assets. Under the schedule, the working capital assets must be spent within 31 months of the receipt by the business of the assets.
- The working capital assets are used in a manner that is substantially consistent with the written schedule. If consumption of the working capital assets is delayed by waiting for governmental action the application for which is complete, that delay does not cause a failure of this requirement.
In addition, at least 70% of tangible property held by the QOZB on each test date must be QOZB property. The term QOZB property means tangible property acquired by purchase from an unrelated person after Dec. 31, 2017, the original use of the property in the QOZ commences with the QOF or QOZB, and during 90% of the holding period, substantially all of the use of such property was in the QOZ. In addition, QOZB property includes leased property when the lease commenced after 2017. Specific exceptions are provided for property that will be substantial improved by the QOZB, and property meeting certain vacancy periods prior to its acquisition by the QOZB.
The technical amendments provide that tangible property acquired in accordance with the WCSH is treated as QOZB property during the WCSH period(s), for purposes of the 70% tangible property test. In addition, the technical amendments added a safe harbor for reasonable amounts of working capital and property on which such amounts are being expended. During the WCSF period(s), the QOZB satisfies the QOZB property requirements however, such property is not QOZB property for any other purpose.
Debt as Working Capital
The technical amendments revised Example 4 which confirm that a QOZBs reasonable amount of working capital includes debt.
Example 4. Multiple applications of working capital safe harbor to tangible property
(1) Facts. QOF A forms a domestic C corporation B to develop a large mixed-use real estate development that will consist of commercial and residential real property, owning almost all of the equity of B in exchange for cash. To raise additional working capital for the mixed-use real estate development, B also will borrow cash under a new revolving credit agreement with an unrelated lender. B has a master written plan for the completion of the commercial and residential real property over a 55-month period. The plan provides that the commercial real property will be completed over a 30-month schedule and subsequently, the residential real property will be completed over a 25-month schedule. The plan further provides that a portion of the commercial real property is unable to be used in a trade or business after the completion of the commercial real property since that portion of the commercial real property will be unusable during the residential construction phase. Pursuant to B's original master plan for the completion of the real estate development, QOF A acquires additional equity in B for cash after the completion of the commercial development phase, and B commences use of those working capital assets for residential development phase.
(2) Analysis. B's use of the cash for the commercial and residential phase qualified for the working capital safe harbor described in paragraph (d)(3)(v) of this section. In addition, all of B's commercial real property developed pursuant to B's original master plan is treated as qualified opportunity zone business property under paragraph (d)(3)(vi)(D) of this section.
6-Month Cure Period
The final regulations provide a one-time, 6-month cure period in which a QOZB can cure a defect that caused an entity to fail to qualify as a QOZB on a testing date. During that 6-month cure period, the QOF can treat the entity as QOZ property. The technical amendments provide that, if the failure occurred on the last testing date of the taxable year, then the QOF must file its Federal income tax return “not earlier than” when the cure is achieved correcting the regulations which provided “not later than” when the cure is achieved.
In addition, the technical amendments clarify that the one-time, 6-month cure period is allowed for each trade or business activity of a QOZB and not for each QOF.
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