On April 17th, the IRS released the long-awaited 2nd round of proposed regulations for the Qualified Opportunity Fund program. In addition to providing some clarity on the below items mentioned in our previous blog, the proposed regulations covered and provided clarification on the following:
- Definition of “substantially all” and “original use” throughout the Opportunity Zone (OZ) Regulations:
- With respect to leased or owned tangible property, the regulations state that 70% is the bar for determining whether an OZ business has used substantially all of its tangible property within the Qualified Opportunity Zone within the meaning of §1400(Z)-2(d)(D)(i)(III).
- October regulations stated that the property must be treated as Qualified Opportunity Zone property for “substantially all” of the Qualified Opportunity Fund’s (QOF) holding period. As per these proposed regulations, “substantially all” is defined as 90%.
- Proposed regulations provide that “original use” of tangible property acquired by purchase commences when that person or prior person first places that property in service for purposes of depreciation and amortization.
- Proposed regulations state that the building or structure be vacant for at least 5 years prior to being purchased by a QOF or OZ business in order to satisfy the original use requirement.
- Leased tangible property is allowed to be a qualified OZ business as long as it meets certain qualifications.
- Treatment of OZ property that straddles non-census tracts
- Defining “substantial portion” with regards to intangibles in qualified OZ business
- Working Capital Safe Harbor- Written designation for the planned use of working capital has been expanded to include the development of the trade or business in the Qualified Opportunity Zone. The 31-month safe harbor period will not be violated if delay is due to government, provided that the application is submitted in the original 31 month period.
- 12/31 gains qualify for deferral if its 12/31 gains exceed the 12/31 losses. Date for the 180 day investment period starts on the last day of the taxable year.
- Only the capital interest related to the GPs interest in the QOZ is eligible for exclusion from capital gains after the 10-year holding period.
- List of inclusion events for triggering the deferral gain
- Holding period for the eligible investment
- Debt financed distributions will now allow taxpayers to take deductions to the extent of their debt basis. This distribution will not be taxable unless the distribution exceeds their respective share of the debt. This will allow taxpayers to take advantage of appreciation of the QOZ business. Any distribution in excess of the debt might trigger gain from the inclusion event.
As included in our previous blog, the proposed regulation also addressed the following items. We have highlighted a few key items that were further clarified:
- Extending the 180 day period for capital gains recognized during 2018 through the first 180 days of 2019.
- Removing the requirement that 50% of the gross income of a qualified Opportunity Zone business is derived from the active conduct of a business in the qualified Opportunity Zone. The proposed regulations address this by stating that the QOZ must pass one of the following three safe harbors:
- 50% of the services performed (based on hrs.) are performed in the Opportunity Zone
- At least 50% of the services performed for the business by employees and independent contractors are performed (based on amounts paid in the QOZ business)
- Trade or business may satisfy the 50% gross income test if 1) tangible property of the business is in the qualified Opportunity Zone 2) if the management of operations performed for the business in the QOZ is necessary to generate 50% of the trade or business income
- Eliminating the requirement for GAAP reporting to test 90% and 70% requirements and allow an election to use unadjusted cost basis. Proposed regulations state that the QOF must value its assets (90% asset test) by using an applicable GAAP financial statement or alternative valuation method. The alternative valuation method determines the value of tangible property leased by a QOF or OZ business based on a present value of the tangible property.
- Introduction of a new requirement that tangible property is substantially improved based on the aggregate tax basis of the overall tax basis of the tangible property acquired (not including land) instead of application occurring for each separate item acquired. The substantial improvement requirement will be on an “asset by asset” basis. The Treasury Department understands that calculating on an “asset by asset” basis is difficult and time consuming, and is considering allowing the aggregation of the assets to comply with the substantial improvement requirement.
- Provide clarity around whether suspended passive losses associated with a property sold in connection with the gain deferred in the QOF investment. The suspended loss would be triggered when the gain is recognized. However, in relation to the QOF, the gain would be deferred and partially excluded.
- Extending the 31-month safe harbors of operating cash if events occur that are beyond the company’s control. As stated above, the proposed regulations state exceeding the 31-month period does not violate the safe harbor if the delay is due to waiting for government action and the application is completed within the 31-month period.
- Allowing continued tax-free appreciation and permitted deferred gain upon reinvestment of sales proceeds from the sale of investment in the zone business, operating entity or zone property. Proposed regulations state that as long as the QOF reinvests the proceeds received from the sale or disposition from the QOZ property into another QOZ within a one-year window, it will not incur a penalty. Gain realized by the QOF will still pass-through to the investors.
- Allowing for the sale of qualified assets or interests in operating partnerships to qualify for the 10-year basis step up. Under new regulations, taxpayers holding an interest in a QOF partnership interest or QOF qualifying stock of an S-Corp may make an election to exclude the capital gain from the disposition of QOZ property provided the disposition occurs after the 10-year holding period.
- Allowing remediation and demolition costs to be included within the “substantial improvement” and allow for additional time within 31 months when demolition is included. In addition, if a property is demolished, that the IRS would consider it “original use”.
- Allowing QOF investors 12 months to invest the capital gain proceeds rather than the proposed 6 months.
- Request that all QOF reporting be simple and unobtrusive.
- Allowing for a change in the status of vacant land and property (utilized for more than 1 year) to qualify as original use within an opportunity zone. Proposed regulations state that the building or structure be vacant for at least 5 years prior to being purchased by a QOF or OZ business in order to satisfy the original use requirement.
- Allowing for the grantor of a grantor trust to make an election to defer gain election. In addition, if the grantor dies, before a ten year hold period, the estate is allowed to make an election for tax-free appreciation. The proposed regulations state that the termination of the grantor trust status by reason of the grantor’s death is not considered an inclusion of deferred income.
Within a few months of these proposed regulations, the Treasury will address the administrative rules if a QOF fails to meet the 90% test as well as information requirements of an “eligible taxpayer”.
The Treasury is looking for comments on these proposed regulations by no later than 60 days after they are printed in the Federal Register. The public hearing will be held in the following location:
New Carrolton Federal Building
5000 Ellin Road
Lanham, Maryland, 20706
Electronic submissions should be submitted via www.regulations.gov.
To learn more about Opportunity Zones, visit our resource center. There you will find an overview of the program, insight into what we’ve been seeing in the marketplace and how one of our clients, Midas Hospitality, is taking advantage of the program’s benefits.
Alternative Investments, Asset Management, Real Estate & Property Management