Businesses seeking to participate in the Opportunity Zone Program must first understand the requirements in order to protect their interests. While the regulations are still evolving, the U.S. Tax Cut and Jobs Act of 2017 and the U.S. Treasury’s proposed regulations both shed light on the meaning of the term “qualified opportunity zone property” (“QZP”).
The definition is important given that qualified opportunity funds (QOF) must hold at least 90 percent of their assets consisting of either newly issued stock, partnership interests, or business property in opportunity zone property.
Qualified Opportunity Zone Business Property
Tangible property must meet several requirements to qualify as QZP. First, the property must be tangible. Second, the property may not be acquired from a related party or via decedent or gift. Additionally, the original use of the property must commence with the QOF investing in the property. Alternatively, the QOF must "substantially improve” the property within 30 months of the date of acquisition. Finally, during “substantially all” of the period during with the QOF holds the property, “substantially all” of the property’s use must be in a QOZ.
Properties used for certain types of businesses, referred to as “sin businesses” are not eligible as QOZ properties. Sin businesses include private or commercial golf courses, country clubs, massage parlors, hot tub facilities, sun tanning salons, racetracks or other facilities used for gambling, or stores for which the principal business is the sale of alcoholic beverages for consumption off premises (liquor stores).
Substantial Improvement Test
Under the Treasury’s proposed rules, QOZ business properties are considered having been substantially improved by a QOF if the taxpayer doubles the property’s adjusted basis after purchase and during any 30-month period while the QOF holds the property.
Notably, the Internal Revenue Service (IRS) advised in Rev. Rul. 2018-29 that land does not need to satisfy the substantial improvement or original use test to qualify as opportunity zone business property. In addition, the value of land is not factored when assessing if a building has been substantially improved.
Original Use Test
In their proposed regulations, the Treasury and IRS did not define the term “original use,” but rather sought comments on what metrics would be appropriate for determining whether tangible property has “original use” in an opportunity zone. The agencies posed the following questions:
Should the use of tangible property be determined based on the property’s physical presence within an opportunity zone, or based on some other measure? What if the tested tangible property is a vehicle or other movable tangible property that was previously used within the opportunity zone but subsequently acquired from a person outside the opportunity zone? Should some period of abandonment or under-utilization of tangible property erase the property’s history of prior use in the opportunity zone? If so, should such a fallow period enable subsequent productive utilization of the tangible property to qualify as “original use”? Should the rules appropriate for abandonment and underutilization of personal tangible property also apply to vacant real property that is productively utilized after some period? If so, what period of abandonment, underutilization, or vacancy would be consistent with the statute?
“Substantially All” Requirement
In its proposed rules, the Treasury did not define the meaning of “substantially all” in the regulation that to qualify as a QOF, substantially all of a partnership’s or corporation’s tangible property owned or leased must be qualified opportunity zone property. This issue is expected to be addressed in the next round of regulations.
The Treasury’s proposed opportunity fund rules include a safe harbor provision for QOFs that hold equity interests in QOZ businesses that acquire, construct, or rehabilitate tangible business property, which includes both real property and other tangible property used in a business operating in an opportunity zone. The safe harbor allows QOZ businesses to treat cash as a qualifying asset for the purposes of the 90% asset test for a period of up to 31 months. To do so, businesses must satisfy the following conditions: (i) a written plan must be in place that identifies the financial property as property held for the acquisition, construction, or substantial improvement of tangible property in the opportunity zone (ii) there must be a written schedule consistent with the ordinary business operations of the business that the property will be used within 31-months; and (iii) the business must substantially comply with the schedule.
Exploring Opportunity Zone Investments
Time is of the essence for entities seeking to reap the full benefits of the Opportunity Zone Program. Scarinci Hollenbeck and its diverse team of affordable housing, real estate, tax and corporate attorneys stand ready to help New Jersey investors navigate the new program and realize its benefits. To discuss potential opportunities for your business,.
If you have questions, please contact us
If you have any questions or if you would like to discuss the matter further, please contact Jeff Cassin, or the Scarinci Hollenbeck attorney with whom you work, at 201-806-3364.,