The April 2019 US Treasury regulations published provide a clearer roadmap for the creation of Opportunity Zone Funds. The new federal government program provides substantial capital gains tax relief for longer term investors in Opportunity Zones covering all fifty states and US territories. Key concepts central the Opportunity Zone program include:
Qualified Opportunity Zones. 8700 primarily low wealth census tracts certified by US Treasury as an Opportunity Zone in all fifty states and U.S. territories are eligible for capital gains tax reductions.
Opportunity Funds.Certified by the US Treasury, a partnership or corporation needs to be formed to make investments in a Qualified Opportunity Zones with at least 90% of its assets in targeted businesses where substantially all of the tangible assets of each such business are used in a Qualified Opportunity Zone.
Opportunity Zone Business.A company locating in a Qualified Opportunity Zone with at least 50% of the gross income earned, measured by the services performed (hours or amounts paid) by its employees and independent contractors performed within the qualified opportunity zone, or the tangible property of the business that is in a qualified opportunity zone and the management or operational functions performed for the business in the qualified opportunity zone in a Qualified Opportunity Zone.
Opportunity Zone Investment. Capital gains invested after 12/31/2017 gains a temporary capital gains tax deferral reinvested in an Opportunity Fund–recognized on the earlier of the date on which the opportunity zone investment is sold or December 31, 2026 with a step-up in capital gains basis up to 15% of the original gain from taxation; and a permanent exclusion the federal capital gains tax from the sale or exchange of an investment in a qualified opportunity zone fund, if the investment is held for at least 10 years, and an investor must invest proceeds from a sale or exchange of assets to an unrelated party into a Qualified Opportunity Fund within 180 days from the date of such sale or exchange.
An original set of Treasury regulations was released in October 2018 that provides some answers as to how the program would operate but they also created substantial questions. The April 2019, 21 new US Treasury rules for the Opportunity Zone program provided essential insight into how fund managers, investors and business can utilize this important new program.
These Treasury rules cover a wide range of topics including:
- Clarifying the 10-year exit rules for investors;
- Expanding opportunities to use some leased property;
- Providing 12 months for an Opportunity Fund to reinvest ‘‘interim gains,’’ but require investors to pay tax currently on such gains;
- Establishing that ‘‘carried interests’’ does not qualify for the benefits of the OZ program;
- Loosening restrictions on the original use and substantial improvement requirements;
- Permitting refinancing proceeds to be distributed to Opportunity Fund investors;
- Defining transactions called ‘‘inclusion events’’) where deferred gain will be recognized
- prior to December 31, 2026;
- Creating safe harbors for the all-important 50% gross income test;
- Allowing new capital received by an Opportunity Fund to be excluded from the 90% asset test for six months;
- Defining the term ‘‘substantially all’’ to be 90% when used to define a holding period and 70% when it refers to use of assets, and define ‘‘substantial portion,’’ concerning intangible property as 40%;
- Expanding the 31-month safe harbor provided in the first set of proposed regulations for the acquisition, construction and improvement of tangible property to include development of a trade or business, so that it can be used by both real estate and non-real estate in an Opportunity Zone Business;
- Providing that delay due to waiting for governmental action for a completed application will not invalidate the safe harbor;
- Confirming that a triple net lease of real estate does not constitute a qualifying trade or business;
- Permitting a taxpayer acquiring an interest in an Opportunity Fund from another investor to make a gain deferral election to the extent that the acquirer has timely capital gains;
- Permitting a consolidated subsidiary to be an Opportunity Fund but treat this fund as an unconsolidated subsidiary for non-QOF tax purposes—thus creating a major disincentive to use this tool;
- Making optional the use of the ‘‘applicable financial statement’’ requirements from the October, 2018 rules;
- Extending the start of the 180-day period to invest gains constituting net §1231 gains to the last day of the taxable year, since a taxpayer will not know the net gains and losses from §1231 transactions until then;
- Approving ‘‘feeder funds’’ that would allow formation of a fund to hold an Opportunity Fund interests does not serve the same purpose;
- Clarifying real property that straddles an Opportunity Zone boundary will qualify if the square footage located within the OZ is substantial as compared to the square footage outside the Opportunity Zone, and the property within and without the OZ are contiguous; and
- Creating anti-abuse rule empowering the IRS to recast a transaction if it finds that a significant purpose of the transaction is to achieve a tax result.
These rules are open to comment but can be relied upon for Opportunity Zone transactions. Please contact Dave Robinson, firstname.lastname@example.org, if you wish to impact these proposed Treasury regulations.