By Kaitlin Corkran & Stephanie Mercado
On April 17, 2019, the IRS released the second round of proposed regulations for the Opportunity Zone tax incentive program (the OZ Program). This highly anticipated release built on the guidance issued in October 2018 and provided some necessary clarity regarding qualified Opportunity Zone investments in operating companies and real estate projects.
- Qualified Opportunity Fund (QOF) Rules
- Form of Investment: To qualify for the OZ Program, an investment in a QOF must be made by transferring cash or property to the QOF. An investment in a QOF made in the form of services rendered will not qualify for the OZ Program.
- 6 Months to Invest: A QOF has six (6) months after receiving an investment from a taxpayer to invest in Qualified Opportunity Zone Property (QOZP), so long as the investment is held in cash, cash equivalents or debt instruments with a maturity of 18 months or less.
- 12 Months to Reinvest: At least 90 percent of a QOF’s assets must be QOZP. If a QOF sells QOZP in exchange for cash, the QOF will have a reasonable time—12 months—to reinvest the cash in new QOZP for purposes of compliance with the 90 percent test.
- Investments in Operating Business
- Measuring Gross Income: A Qualified Opportunity Zone Business (QOZB) must derive at least 50 percent of its gross income from active conduct in a qualified Opportunity Zone (OZ). The second round of proposed regulations provide safe harbors and a “facts and circumstances” test to measure the gross income of a QOZB.
- Inventory in Transit: To qualify as Qualified Opportunity Zone Business Property (QOZBP), substantially all of the use of the property must be in a qualified OZ. Inventory does not fail to be used in a qualified OZ solely because the inventory is in transit from a vendor to a facility in a qualified OZ or from a facility in a qualified OZ to a customer outside the qualified OZ.
- Substantial Improvement of Property Other Than Real Property: QOZBP must have its original use in a qualified OZ with a QOF or QOZB, or the QOF or QOZB must substantially improve the QOZBP. The determination of whether property is substantially improved will be made on an asset-by-asset basis.
- Investments in Real Estate
- Distribution of Financing Proceeds: In connection with a financing or refinancing of a real estate project that qualifies for the OZ Program, an investor may receive a nontaxable distribution without losing the OZ benefits, so long as (i) the distribution occurs more than 90 days after the closing of the loan and 2 years after the initial investment, (ii) the amount of the distribution does not exceed the investor’s tax basis in the QOF or QOZB (taking into the allocation, if any, of the loan to the investor), and (iii) the distribution is not a disguised sale of the investor’s interest in the QOF or QOZB.
- Substantial Improvement of Unimproved Real Property: Unimproved real property does not need to be substantially improved to qualify as QOZBP. However, it must be used in the active conduct of the QOZB to qualify as QOZBP and cannot be held by the QOZB for investment.
- Vacant Buildings and Original Use: If a building located in a qualified OZ has been vacant for five (5) or more years, its prior use is disregarded and the QOF’s or QOZB’s use, as applicable, of the real property will be considered the original use for OZ purposes.
Additional KJK Client Alerts will be published over the next two weeks providing an in-depth analysis of the issues referenced above. For more information, contact Kaitlin Corkran at klc@kjk.com or 216.736.7223, Stephanie Mercado at smmercado@kjk.com or 216.736.7272, or reach out to any of our Economic Development professionals.
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