On December 19, 2019, the Treasury Department released final regulations on the Qualified Opportunity Zone (QOZ) program first enacted in the Tax Cuts and Jobs Act of 2017. Final regulations provide additional safe harbors and relief mechanisms, and they resolve many previously unanswered questions with respect to qualified opportunity funds (QOFs) and qualified opportunity zone businesses (QOZBs).
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Key developments include the following:
- New 62-Month Period for “Start-Up” QOZBs. A QOZB now has 62 months from its first capital infusion to get up and running as a QOZB, provided, inter alia, that each infusion of working capital independently satisfies the existing 31-month working capital safe harbor and later capital infusions are contemplated in the initial 31-month plan.
- New One-Time Cure. If a QOF discovers a QOZB status failure, the QOZB generally may cure the failure before the next QOF asset test without causing asset test failures for the QOF. This “cure” accommodation may only be used once per QOZB.
- Increased Exit Flexibility. Final regulations permit a QOF interest holder to exclude all gain (including ordinary recapture gain) from the direct or indirect sale of non-inventory property upon achieving a 10-year holding period, thus bringing parity to “QOF sale,” “QOZB sale,” and “asset sale” exit structures. In addition, final regulations permit deferred gain accelerated by reason of certain “inclusion events” (such as a distribution of asset sale proceeds before 2026) to be rolled into another QOF within 180 days, provided that the holding period is restarted.
- Increased Investment Flexibility. Final regulations sanction a purchase of a non-QOF entity that is eligible to elect QOF status as a means of making a capital gain rollover if the buyer makes the QOF election. In addition, it is clarified that a QOF or QOZB does not have to itself develop an asset, but can purchase an asset immediately prior to the placed-in-service date and satisfy the “original use” requirement.
- “Parking Lot” Not Enough. Expanding on the application of the “anti-abuse” rule, final regulations go much further than the proposed regulations in requiring meaningful business development by a QOZB. Notably, pursuant to an example, a parking lot business (without further development plans and with an intent to benefit principally from speculative land investment over the 10-year holding period) is insufficient to avoid the anti-abuse rules even where the lot is repaved, additional improvements are made, and employees are hired.
- Aggregation Methods Approved. Limited asset aggregation is now permitted in asset testing under several new methods, which generally permit aggregation only within contiguous QOZ regions and/or within the same trade or business. For example, a hotel could be “substantially improved” taking into account new investments in mattresses, furniture, etc. The proposed regulations had only sanctioned an asset-by-asset method.
- Additional QOZB Guidance. There is additional guidance regarding matters such as the treatment of inventory, a prohibition on leasing more than de minimis property to a “sin business,” the location of the “use” of intangible property, the requirement to avoid “mere triple net” leases, and other technical qualification requirements.
- More Property Treated as Vacant. The five-year vacancy period required to treat rehabilitation assets as “original use” (and therefore not requiring “substantial improvement”) is now shortened to one year, but only for property that was already vacant at the time the QOZ was designated.
- Certain “Force Majeure” Delays Permitted. In addition to tolling a QOZB working capital plan for delays attributable to government action (as permitted under proposed regulations), final regulations permit the working capital plan additionally to be tolled for delays attributable to federally declared disasters.
- Self-Constructed Property Guidance. Final regulations confirm that self-constructed property in a QOZ can qualify as a good asset, but clarify that the materials and supplies used in the construction must be good assets. QOZBs hiring “related party” construction contractors should take note of this requirement and ensure that beneficial ownership of materials and supplies does not pass through a related party.
- Certain Structuring Confirmed. Final regulations confirm certain of Jackson Walker’s structuring recommendations to clients under earlier proposed regulations, including: (1) the desirability of holding carried interest (or promote) separately from any capital gain rollover; and (2) the requirement for QOZBs to avoid holding interests in any lower-tier tax-regarded entities.
- QOF Decertification Guidance. Final regulations permit voluntary decertification as a QOF (which is an inclusion event for deferred gain), and reserve on possible involuntary decertification.
- Real Property Repurchase Options Disallowed. Real property of a QOZB that is intended to be good QOZB property can no longer be the subject of a repurchase option (nor can there be any plan, intention or expectation to repurchase).
- “Section 1231 Trap” Eliminated. Gains from the disposition of “section 1231 property” may now be rolled over within 180 days of the closing date (instead of 180 days after the last day of the tax year). The requirement to wait until the end of the tax year under the proposed regulations had been widely considered a trap for the unwary.
- Expanded Timing Flexibility for Pass-thru Gain Rollover. There is a new election to start the 180-day clock for rolling over gains realized in pass-thru entities on the due date of the pass-thru entity’s tax return. Final regulations also retain the existing elections to start the clock on the closing date or, alternatively, on the last day of the tax year.
- Continued Reliance on Proposed Regulations. Taxpayers generally may choose between the final regulations and the earlier proposed regulations (applied consistently) for the 2020 tax year and earlier years.
Stay tuned for an upcoming webinar featuring Argyrios Saccopoulos, Brian Dethrow, and John Ransom discussing the final regulations regarding the QOZ program. If you would like to receive an email invitation to register for the webinar, click here.
ADDITIONAL QOZ GUIDANCE:
>> Explaining Qualified Opportunity Zones
>> Tax Benefits of Real Estate Development/Investment with “Qualified Opportunity Funds” [PDF]
>> Treasury Releases Additional Qualified Opportunity Zone Guidance (Authors: Brian Dethrow & Argyrios Saccopoulos; April 26, 2019)
>> QOZ Interactive Map
>> Tax Reform Guidance: Regulations
Argyrios C. Saccopoulos regularly represents buyers, sellers, and joint venture partners in M&A and real estate transactions, including federal income tax considerations of debt financings, merger agreements, and dealings in stock, partnership interests, and blocker structures. Argyrios has extensive experience counseling fund sponsors and investors on federal income tax aspects of fund formations and investments. Argyrios advises clients on the formation, qualification, and operations of real estate investment trusts, including their use in captive fund structures, and has previously advised some of the largest publicly listed REITs in the United States in REIT compliance matters. Additionally, Argyrios advises clients endeavoring to qualify for the new “qualified opportunity zone” tax incentive structures implemented as part of the Tax Cuts and Jobs Act.
The opinions expressed are those of the author and do not necessarily reflect the views of the Firm, its clients, or any of its or their respective affiliates. This article is for informational purposes only and does not constitute legal advice.