Second Set of Regulations on Qualified Opportunity Zone Funds Released
On April 17, 2019, the Internal Revenue Service (“IRS”) and the United States Department of the Treasury issued the second set of highly anticipated regulations regarding the Qualified Opportunity Zone Program (the “QOZ Program”). The IRS guidance is 169 pages in length and answers a number of questions that remained unanswered after the first set of proposed regulations on the QOZ Program was issued in October of 2018.
The newly proposed regulations give Qualified Opportunity Funds (“QOFs”) interested in investment in Qualified Opportunity Zones (“QOZs”) additional leeway to invest their capital by providing a more flexible timeline for investing, a one-year grace period to sell QOZ property and reinvest the proceeds without penalties, and a six month window from when funds receive money to purchase assets in QOZs.
Other issues addressed in the newly proposed guidance include:
- The definition of the term “substantially all” in each of the various places it appears in Section 1400Z-2 of the Internal Revenue Code of 1986, as amended (the “Code”), defined generally as either a 70-percent or a 90-percent threshold, depending on the context;
- The definition of the phrase “original use” in Code Section 1400Z-2(d)(2)(D)(i)(II), generally providing that the “original use” of tangible property acquired by purchase commenced on the date when the property was first placed in service in the QOZ for purposes of depreciation or amortization;
- The treatment of vacant property under the “original use” test, providing that a building or other structure vacant for at least 5 years prior to being purchased by a QOF or QOZ business will satisfy the “original use” requirement;
- The treatment of inventory for purposes of determining whether substantially all of the tangible property used in a trade or business of a QOF was in a QOZ, generally allowing investors to qualify for the tax breaks even if a QOZ business focuses on exported goods or services, or the domestic market outside the QOZ;
- The treatment of leased tangible property used by a QOZ business, generally allowing leased tangible property to be treated as QOZ business property for purposes of satisfying the 90 percent asset test applicable to QOFs and the “substantially all” requirement;
- Clarification of the 50 percent gross income test of a QOZ business, providing for three safe harbors and a facts and circumstances test for determining whether sufficient income is derived from a trade or business in a QOZ;
- Critical pro-QOF revisions to the working capital safe harbor initially introduced in the October 2018 regulations;
- Added flexibility to include more than one investment in a QOF, allowing investors to get the tax benefits of the QOZ Program if they held their stake in the QOF for at least 10 years, even if the fund didn’t own the assets for a full decade;
- A list of transactions that will cause the inclusion of gain that an investor has elected to defer under the QOZ Program, including a clarification of the meaning of the term “sold or exchanged” in Code Section 1400Z-2(b)(1), the treatment of partnership distributions in the ordinary course of business, including debt-financed distributions, and transfers of property by gift or by reason of death, to name a few;
- Clarification of the “holding period” requirements for purposes of section 1400Z-2, including when the holding period properly commences and certain actions that will cause the holding period to terminate and other situations in which an investor’s holding period in an acquired QOF can be transferred to an acquiring QOF; and
- Anti-abuse rules designed to empower the Secretary and the Commissioner to prevent tax results inconsistent with the intent of the QOZ Program.
The proposed regulations do not address either the administrative rules under Section 1400Z-2(f) that apply to QOFs that fails to maintain the 90 percent asset test that funds must meet to preserve their status as QOFs, or any of the information reporting requirements applicable to taxpayers. Neither do the proposed regulations answer the concerns expressed by the United States Environmental Protection Agency with regard to the applicability of the QOZ Program to brownfields.
CSG’s Qualified Opportunity Zone Group is closely reviewing this latest set of proposed regulations, and will provide an updated and more detailed summary of the rules shortly. In the meantime, CSG stands ready to assist you and answer any questions you may have concerning existing or potential investments in QOFs.