The 2017 Tax Cuts and Jobs Act (TCJA) created the federal “Opportunity Zones” (“OZ”) program, a new tax incentive program for investments in low-income communities. In order to utilize the benefits of this new program, the law requires that taxpayers invest capital gains into a new type of investment vehicle known as a “Qualified Opportunity Fund” (“QOF”).
For additional observations, insights and discussion, read this blog post: "How Does Opportunity Zone Business Investment Work?"
To maintain QOF status, a fund must invest at least 90 percent of its assets in Qualified Opportunity Zone (“QOZ”) property. The statute identifies three types of assets that are QOZ property:
- Original issue stock in a corporation that is (or will be) a QOZ business, acquired after Dec. 31, 2017;
- A capital or profits interest in a domestic partnership interest that is (or will be) a QOZ business, acquired after Dec. 31, 2017; and
- QOZ business property.
Proposed Opportunity Zone Regulations
On October 29, 2018, the IRS and Treasury Department published the first set of proposed regulations (74 pages) which provided guidance regarding gains eligible for deferral, the types of taxpayers eligible to elect gain deferral, investments in a QOF, 180-day rule for deferring gain by investing in a QOF, attributes of included income when gain deferral ends, and special rules.
On May 1, 2019, the IRS and Treasury Department published a second set of proposed regulations (169 pages) which provided guidance regarding Qualified Opportunity Zone (“QOZ”) business property, the treatment of leased tangible property, QOZ business, special rules for section 1231 gains, relief from the 90 percent asset test, the amount of an investment for purposes of making a deferral election, events that cause inclusion of deferred gain, and consolidated return provisions.
These proposed regulations provide potential fund sponsors and administrators with additional insight into OZ program operational rules.
In addition, the IRS updated their “Opportunity Zones Frequently Asked Questions.”
Answers to a few key questions regarding the OZ program are provided below.
What does “Substantially All” mean for Opportunity Zones?
The term “substantially all” appears in several parts of the statute. The proposed regulations define this term as follows:
- For use of QOZ business property, at least 70 percent of the property must be used in a QOZ.
- For the holding period of QOZ business property, tangible property must be QOZ business property for at least 90 percent of the QOFs or QOZ business’s holding period.
- A corporation or partnership must be a QOZ business for at least 90 percent of the QOFs holding period.
What does “Six month Exception” mean for Opportunity Zones?
The proposed regulations allow a QOF to apply the 90 percent asset test without taking into account any investments received in the preceding 6 months when such amounts are held in cash, cash equivalents, or debt instruments with terms of eighteen months or less.
What does “One Year to Re-Invest” mean for Opportunity Zones?
The proposed regulations provide a QOF with a “reasonable period of time” to reinvest the return of capital from qualified investments by allowing one year from the distribution, sale, or disposition of QOZ stock, partnership interest or business property to re-invest the proceeds into new qualified property. During this time, the amounts must be held in cash, cash equivalents, or debt instruments with terms of eighteen months or less.
What does “At Least 50 Percent of Gross Income” mean for Opportunity Zones?
The statute requires that at least 50 percent of the gross income of a QOZ business must be derived from the OZ in order for it to be a QOZ business. The proposed regulations provide 3 safe harbors and a facts and circumstances test for determining whether sufficient income is derived from a trade or business in a QOZ for purposes of this test. Businesses only need to meet one of these safe harbors to satisfy this test.
- At least 50 percent of the services performed (based on hours) for such business by its employees and independent contractors (and employees of independent contractors) are performed within the QOZ;
- At least 50 percent of services performed (based on amounts paid) for such business by its employees and independent contractors (and employees of independent contractors) are performed within the QOZ; and
- The tangible property and the management or operational functions performed for the business in a QOZ are each necessary to generate 50 percent of the gross income of the trade or business.
Connect with the Opportunity Zones Program Specialists at Freed Maxick
The proposed opportunity zone investment regulations answer many questions that were holding back QOF investments by taxpayers, especially in connection with the QOF exit rules. Taxpayers and fund sponsors should connect with opportunity zone advisors who are well versed on the proposed regulations and the remaining unanswered questions as they contemplate making a QOZ investment, becoming a fund sponsor, or creating their own self-managed fund.
If you’re considering a QOF investment, becoming a fund sponsor, or establishing your own self-managed fund, schedule a no cost or obligation discussion with our opportunity zone consultants by clicking on the button or contact Don Warrant, CPA, Tax Director at Don.Warrant@freedmaxick.com to discuss further.