On April 17, 2019, the IRS released additional guidance (Reg-120186-18) related to gains that may be deferred as a result of a taxpayer’s investment in a qualified opportunity fund (“QOF”), as well as special rules for an investment in a QOF held by a taxpayer for at least 10 years. The guidance also provides updates to previously issued proposed regulations.
Find DMJ’s overview on Qualified Opportunity Zones here.
Additional Guidance Provided by the New Regulations
- QOFs have six months from the time new capital is received from investors to deploy the capital into qualified property. Investors and QOFs now have up to one year to invest in qualified opportunity zone property. The investor has 180 days from the date the gain being deferred is realized to invest that gain into a QOF, and then the QOF has another 180 days to invest in qualified property.
- Original use requirement for tangible property commences on the date the property is first placed in service for depreciation or amortization.
- Regarding vacant buildings/structures, if the structure has been vacant for at least the prior five years, the original use requirement is considered to be met when placed in service by the QOF or Qualified Opportunity Zone Business (QOZB). No substantial improvement is required.
- The 31 Month Working Capital Safe Harbor, introduced by the initial proposed regulations, has been expanded by the new regulations to allow startup businesses to hold excess cash, that typically would not count towards the 90% of qualified assets in a QOZ, so long as the business has a written plan to deploy the cash into qualified property within 31 months. The previous regulations only allowed this safe harbor to real estate development.
- Unimproved land meets original use requirements and does not need to be “substantially improved”, as long as the land is used in an active trade or business. Land held for investment does not qualify.
- Owning and leasing residential or commercial real property does qualify as conducting an active trade or business. Owners should avoid triple-net leases as the IRS has held that these arrangements do not typically rise to the level of conducting an active trade or business.
- Investments into a QOF can be cash or property.
- Investors will get special tax treatment if they hold their investment in a QOF for at least 10 years, even if the QOF did not own the asset(s) for 10 years.
- For operating businesses, the guidance provides three new safe harbors for measuring the 50% gross income test. These tests include; employee hours conducted inside an opportunity zone, amounts paid to employees inside an opportunity zone, or equipment stored and operational functions are performed inside an opportunity zone.
- Leased property qualifies if the lease is entered into after December 31, 2017. Improvements made by a lessee are considered purchased property and satisfy the original use requirement.
- Section 1231 gains do qualify for deferral. The 180-day window to reinvest a Section 1231 gain in a QOF begins on the last day of the taxable year.
- QOFs have 12 months to reinvest interim gains.
- There is no penalty if an investor dies and passes the investment to their heirs.
If you have additional questions regarding the new regulations or investing in qualified opportunity zones, please contact Drew Haddock of DMJ at email@example.com .