Opportunity zone investors finally got what they were asking for: relief. On June 4, 2020, the U.S. Treasury Department and Internal Revenue Service (IRS) issued guidance (Notice 2020-39) intended to help investors who are financing opportunity zone developments as they navigate the economic effects of the coronavirus pandemic.
Essentially, the guidance extends some deadlines for investing in qualified opportunity funds (QOFs) and relaxed some investment requirements to help ease the burden QOF investors faced during the ongoing situation.
What is a qualified opportunity zone?
Established as part of the Tax Cuts and Jobs Act (TCJA) of 2017, the qualified opportunity fund program created a process for designating certain low-income communities and qualifying contiguous census tracts as qualified opportunity zones (QOZs). In return for investing in these designated zones, taxpayers can utilize three federal income tax incentives:
- Temporary deferral of capital gains, to the extent the gains are reinvested in a QOF;
- Partial exclusion of previously deferred gains when certain holding period requirements in a QOF are met; and
- Permanent exclusion of post-acquisition gains from the sale of an investment in a QOF held longer than 10 years.
What relief does the guidance provide QOZ investors?
180-day investment standard
Under typical circumstances, an investor must invest capital gains from the sale of any property to an unrelated party in a QOF in order to receive the federal tax incentives outlined above. Generally, the taxpayer must make the investment within 180 days of the sale date.
Notice 2020-39 extends the 180 day deadline to December 31, 2020 for those periods that were set to close between April 1 and December 31, 2020. This is a notable change from previous guidance (Notice 2020-23) which had extended the deadline to July 15, 2020.
QOF 90% qualification
A QOF must hold 90% of its assets in qualified opportunity zone property. Most often the assets of a QOF consist of interests in a qualified opportunity zone business. In any event, taxpayers are subject to a 90% asset test on a semiannual basis, typically June 30 and December 31 of each year. If the QOF fails to maintain this minimum investment standard, they may be subject to penalties.
However, Notice 2020-39 now provides penalty relief under the reasonable cause provisions for any QOF that fails to meet this 90% investment standard on any testing date that falls between April 1 and December 31, 2020. Even though there will not be penalties assessed during this time period, a QOF that fails to meet this standard should still look to remedy the failed test as quickly as possible.
Substantial improvement period
Most QOFs hold interests in entities designed to qualify as qualified opportunity zone businesses. One requirement of a qualified opportunity zone business is that 70% of the business’ tangible property must be qualified opportunity zone property. In other words, the QOF must purchase the property from an unrelated party after December 31, 2017, and either (i) the original use of the property in the qualified opportunity zone must commence with the qualified opportunity zone business, or (ii) the qualified opportunity zone business must substantially improve the property within 30 months of acquisition of the property.
The notice, however, suspends the period between April 1, 2020 and December 31, 2020 for purposes of determining whether a qualified opportunity zone business has met the 30-month timetable for substantially improving a property. For example, if a QOF acquired property January 1, 2020, the 30-month period would have ended on June 30, 2022, but could now be extended nine (9) months to March 31, 2023.
Working capital safe harbor
Qualified opportunity zone business projects that satisfy the requirements of the 31-month working capital safe harbor under the final regulations have up to an additional 24 months in which to expend their working capital because of the pandemic. The working capital safe harbor provides qualified opportunity zone businesses with a safe harbor for treating an amount of working capital as reasonable under section 1397C(e) if certain requirements are satisfied.
Although this relief is automatic, a QOF must accurately complete all lines on Form 8996, Qualified Opportunity Fund, filed for each affected tax year.
Other implications of Notice 2020-39
Keep in mind that due to the pandemic, QOFs that received distributions of QOF stock or partnership interests as a return of capital or realized proceeds from a sale of that stock, partnership interest, or qualified opportunity zone property have an additional 12 months in which to reinvest those amounts in the manner intended before the pandemic.
Notice 2020-39 modifies Notice 2020-23.
How can Squar Milner help?
As we all continue to work through the impact of COVID-19 on our businesses and financial strategies, Squar Milner has a robust team of professionals prepared to help you optimize your tax strategies under the current conditions.
We offer a skilled Real Estate industry practice dedicated to the concerns and challenges specific to those investing in real estate and qualified opportunity zones. If you have questions or seek advice on how to address the latest qualified opportunity zone guidance, please contact your Squar Milner tax advisor or reach out today.
Disclaimer: This material has been prepared for informational purposes only, and is not intended to substitute for obtaining accounting, tax, or financial advice from a professional tax planner or financial planner. All information is provided “as is,” with no guarantee of completeness, accuracy, timeliness or of the results obtained from the use of this information.
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