New York and New Jersey businesses participating in the Opportunity Zone Program have some breathing room when it comes to satisfying key deadlines. In response to the COVID-19 pandemic, the Internal Revenue Service (IRS) is providing relief to both investors and Qualified Opportunity Funds.
Opportunity Zone Program
As discussed in greater detail in prior articles, the Opportunity Zone tax initiative was established under the 2017 Tax Cuts & Jobs Act, which was signed into law on December 22, 2017. The program aims to encourage investors to direct capital into new projects in certain low-income rural and urban communities in exchange for federal capital gains tax advantages. In New Jersey, 75 municipalities have been awarded the “opportunity zone” designation
The program’s key tax benefit is that taxpayers can defer paying federal taxes on capital gains (including those from real estate sales) invested in Qualified Opportunity Funds (QOFs). The program offers three distinct tax incentives: Reinvested capital gains are deferred from taxation until exit from a Qualified Opportunity Fund or December 31, 2026, whichever comes first; the original capital gains reinvested in Qualified Opportunity Fund investments held for the long term receive a reduction in capital gains tax liability, discounted by 10 percent at the 5-year mark and by an additional 5 percent at the 7-year mark; and any new gains from Qualified Opportunity Fund investments held for at least 10 years are permanently excluded from the capital gains tax. These Fund investments can be held through as late as 2047 without losing tax benefits.
Any federal taxpayer, including individuals, businesses, and corporations, can invest in a Qualified Opportunity Fund (QOF). The key requirement is that the investments must consist of capital gains reinvested during the 180-day period beginning on the date of the sale or exchange giving rise to the gain.
The purpose of the QOF is to invest in “qualified opportunity zone property.” The term is specifically defined as tangible property used in a trade or business of the qualified opportunity fund and located in a qualified opportunity zone if: (i) the original use of such property in the qualified opportunity zone commences with the qualified opportunity fund or, (ii) if the property is used, the qualified opportunity fund, during any 30 month period beginning after the date of the acquisition of such property, incurs costs with respect to such property that exceed the fund’s basis at the start of the 30 month period. Regulations adopted by the Treasury Department further provide that cash and other working capital assets held for up to 31 months can qualify as qualified opportunity zone business property, so long as: certain conditions are satisfied.
IRS Deadlines Extension
In June, the IRS issued guidance to assist QOFs and their investors in response to the ongoing COVID-19 pandemic. Notice 2020-39 provides relief from certain requirements under section 1400Z-2 of the Internal Revenue Code (Code) and the Treasury’s implementing regulations. Below is a brief summary of the relief granted by the IRS:
180-Day Investment Requirement for QOF Investors
If the last day of the 180-day investment period within which a taxpayer must make an investment in a QOF in order to satisfy the 180-day investment requirement falls on or after April 1, 2020, and before December 31, 2020, the last day of that 180- day investment period is automatically postponed to December 31, 2020.
90-Percent Investment Standard for QOFs
A QOF must hold at least 90 percent of its assets in “qualified opportunity zone property,” determined by the average of the percentage of qualified opportunity zone property held by that QOF as measured (i) on the last day of the first 6-month period of the taxable year of the QOF, and (ii) on the last day of the taxable year of the QOF. Under the IRS guidance, in the case of a QOF whose (i) last day of the first 6-month period of the taxable year or (ii) last day of the taxable year falls within the period beginning on April 1, 2020, and ending on December 31, 2020, any failure by that QOF to satisfy the 90-percent investment standard for that taxable year of the QOF is automatically deemed due to reasonable cause. In addition, any such failure does not prevent qualification of an entity as a QOF or an investment in a QOF from being a qualifying investment. As such, the QOF will not be liable for the statutory penalty under section 1400Z-2(f) due to such a failure during this period.
30-Month Substantial Improvement Period
QOFs or qualified opportunity zone businesses that acquire existing tangible property must substantially improve that property within 30 months from the acquisition date. Notice 2020-39 provides that for purposes of the substantial improvement requirement with respect to property held by a QOF or qualified opportunity zone business, the period beginning on April 1, 2020, and ending on December 31, 2020, is disregarded in determining any 30- month substantial improvement period.
Working Capital Safe Harbor for Qualified Opportunity Zone Businesses
The Treasury’s regulations provide that cash and other working capital assets held for up to 31 months can qualify as qualified opportunity zone business property, so long as: 1. the cash and other working capital assets are held for the acquisition, construction and/or substantial improvement of tangible property in an opportunity zone; 2. there is a written plan that identifies the cash and other working capital as held for such purposes; and 3. the cash and other working capital assets are expended in a manner substantially consistent with that plan.
Under the IRS guidance, Qualified Opportunity Zone Business projects that meet the requirements of the 31-month working capital safe harbor now have up to an additional 24 months in which to expend their working capital.
12-Month Reinvestment Period for QOFs
Under the Treasury regulations, a QOF that sells or disposes of some or all of its qualified opportunity zone property or receives a return of capital from such property can reinvest the proceeds into other qualified opportunity zone property within 12-months after the disposition or distribution. Pursuant to Notice 2020-39, 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 COVID-19 pandemic.
How We Can Help
The extended timeframes aim to ensure that projects continue to move forward during the pandemic. It may also encourage additional businesses to take advantage of the Opportunity Zone Program.
With a multi-disciplinary team of affordable housing, real estate, tax and corporate attorneys, Scarinci Hollenbeck is uniquely qualified to help New Jersey investors navigate the new program and realize its benefits. To discuss potential opportunities for your business, we encourage you to contact us today.
If you have questions, please contact us
If you have any questions or if you would like to discuss the matter further, please contact me, Don Pepe, or the Scarinci Hollenbeck attorney with whom you work, at 201-896-4100.