The Internal Revenue Service (IRS) recently published its much-anticipated final regulations on Qualified Opportunity Funds. The regulations build on prior guidance and provide additional information on how an entity becomes a qualified opportunity fund (QOF) or qualified opportunity zone (QOZ) business, and the requirement that a QOF or QOZ business engages in a trade or business. As described by the IRS, the final regulations retain the general approach of the proposed regulations but provide additional guidance and clarity to the rules regarding QOZ business property.
Evolving Opportunity Zone Program
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.
Since taking effect, the Internal Revenue Service (IRS) has issued two rounds of proposed regulatory guidance for Qualified Opportunity Funds — the first on October 19, 2018, and the second on April 17, 2019. The final set of IRS regulations will combine the first and second rounds of guidance, as well as provide clarification on issues that remain unresolved. Not surprisingly, the final regulations are expected to top 500 pages in length.
The IRS submitted the final regulations to the White House Office of Management and Budget (OMB) on December 6, 2019. The OMB concluded its review on December 17, 2019, and the IRS published them on its website on December 19, 2019. They will not take effect, however, until they are officially published in the Federal Register.
Final IRS Regulations
The final opportunity zone regulations are 544 pages in length. Among the wide range of topics covered, the IRS final regulations provide guidance regarding how to determine the qualification requirements and levels of new investment in Opportunity Zones. The regulations also clarify the types of gains that qualify for Opportunity Zone investments, as well as gains that may be excluded from tax after a 10-year holding period.
Given that it is impossible to summarize the regulations in one article, below is a brief summary of several key questions the IRS has addressed:
- Investment periods: The final regulations amend the proposed regulations’ general rule that only capital gain may be invested in a Qualified Opportunity Fund (QOF) during the 180-day investment period by clarifying that only eligible gain taxable in the United States may be invested in a QOF. The proposed regulations only permitted the amount of an investor’s gains from the sale of business property that were greater than the investor’s losses from such sales to be invested in QOFs, and required the 180-day investment period to begin on the last day of the investor’s tax year. The final regulations allow a taxpayer to invest the entire amount of gains from such sales without regard to losses and change the beginning of the investment period from the end of the year to the date of the sale of each asset. Partners in a partnership, shareholders of an S corporation, and beneficiaries of estates and non-grantor trusts have the option to start the 180-day investment period on the due date of the entity’s tax return, not including any extensions. This change addresses taxpayer concerns about potentially missing investment opportunities due to an owner of a business entity receiving a late Schedule K-1 (or other form) from the entity.
- Nonresidents: The final regulations provide that nonresident alien individuals and foreign corporations may make Opportunity Zone investments with capital gains that are effectively connected to a U.S. trade or business. This includes capital gains on real estate assets taxed to nonresident alien individuals and foreign corporations under the Foreign Investment in Real Property Tax Act rules.
- Substantial improvement test: QOFs and QOZBs can take into account purchased original use assets that otherwise would qualify as qualified opportunity zone business property if the purchased assets: are used in the same trade or business in the Qualified Opportunity Zone (QOZ) or a contiguous QOZ for which a non-original use asset is used; and improve the functionality of the non-original use assets in the same QOZ or a contiguous QOZ. In certain cases, the final regulations permit a group of two or more buildings located on the same parcel(s) of land to be treated as a single property. In these cases, any additions to the basis of the buildings in the group are aggregated to determine satisfaction of the substantial improvement requirement. Thus, a taxpayer need not increase the basis of each building by 100% as long as the total additions to basis for the group of buildings equals 100% of the initial basis for the group.
- Vacancy requirement: The final regulations reduce the five-year vacancy requirement in the proposed regulations to a one-year vacancy requirement if the property was vacant for at least one year prior to the QOZ being designated and remains vacant through the date of purchase. For other vacant property, the proposed five-year vacancy requirement is reduced to three years. In addition, property involuntarily transferred to local government control is included in the definition of the term vacant, allowing it to be treated as original use property when purchased by a QOF or QOZB from the local government.
- Brownfield sites: The final regulations provide that both the land and structures in a Brownfield site redevelopment are considered to be original use property as long as the QOF or QOZB make investments into the Brownfield site to improve its safety and compliance with environmental standards.
- Large C Corporations: The final regulations provide an election for a consolidated group of C Corporations to treat a lower-tier QOF C Corporation as a member of the consolidated group if: Only other members of the consolidated group hold 100% of the QOF member’s stock, and the QOF member complies with special intergroup transaction rules to remain a member of the group. The regulations also provide alternative retroactive elections for a consolidated group that had formed a QOF C Corporation before the May 1, 2018 deadline, proposed regulations to elect to treat the QOF C Corporation as: always having been a QOF partnership; or never having been a member of the consolidated group.
We encourage businesses involved in opportunity zone investment to review the full IRS regulations and contract experienced counsel with any questions. Look for further blogs from Jeff Cassin and for more on Qualified Opportunity Zones.
If you have questions, please contact us
If you have any questions or if you would like to discuss the matter further, please contact Jeffrey Cassin, Stephanie Edelstein, or the Scarinci Hollenbeck attorney with whom you work, at 201-806-3364.