10 Clarifications To The $100B Opportunity Zone Program
On Friday, Oct. 19, 2018, the Internal Revenue Service and Department of Treasury published proposed regulations providing long-anticipated guidance related to the opportunity zone program set forth in the Tax Cuts and Jobs Act that Treasury Secretary Steven Mnuchin predicted would result in $100 billion in capital investment.
As with any new statute and its related regulations and revenue rulings, practitioners need time to absorb, interpret and debate the meaning and nuances of the new guidelines. Moreover, the proposed regulations are in draft form and subject to public comment and possible amendment until early next year. That said, at least 10 takeaways are clear at the outset, which are outlined below.
- First, investors may invest in opportunity zones during the next 10 years. The designation of opportunity zones is set to expire on Dec. 31, 2028, which previously led many practitioners to question whether an investment in any year after 2018 could satisfy the 10-year hold period. The proposed regulations clarify that investors may receive the benefit of a 10-year hold notwithstanding that the designation of one or more qualified opportunity zones may cease to be in effect.
- Second, investors may hold opportunity zone assets until up to Jan. 1, 2048. The proposed regulations permit an investor to make the basis step-up election even after Dec. 31, 2028, when each of the qualified opportunity zone designations will have expired. Any investment in an opportunity zone must be exited prior to Jan. 1, 2048, subject to additional legislation.
- Third, the draft regulations may be relied upon. The regulations are “proposed” and the IRS and Treasury have solicited public comment to the regulations by mid-December and plan to discuss such comments at a public hearing scheduled for Jan. 10, 2019. Although the regulations are not “effective” until the Treasury adopts them as “final regulations,” the proposed regulations note that investors may rely on the regulations as long as the rules are applied “in their entirety and in a consistent manner.” The IRS has stated, generally, that “[i]f there are no final or temporary regulations currently in force addressing a particular matter, but there are proposed regulations on point, the [IRS] generally should look to the proposed regulations to determine the IRS’s position on the issue … [and] should not take a position in litigation or advice that would yield a result that would be harsher to the taxpayer than what the taxpayer would be allowed under the proposed regulations.”
- Fourth, the proposed regulations establish a safe harbor for working capital. For the better part of 2018, numerous would-be investors nationwide sat idly by because the opportunity zone statute included a stringent asset test that left practitioners and investors uncertain about how to raise capital for a long-term project and simultaneously meet the so-called “90 percent asset test,” which requires cash to be deployed in less than six months. The proposed regulations include a safe harbor providing that a qualified opportunity zone business that acquires, constructs or rehabilitates tangible business property may hold cash or cash equivalents for up to 31 months.
- Fifth, land value need not be included in calculating “substantial improvement.” The opportunity zone statute defines “qualified opportunity zone business property” as, among other things, property in an opportunity zone that the qualified opportunity fund substantially improves. According to the statute, a property is “substantially improved” if, during any 30-month period after the date of acquisition of such property, the qualified opportunity fund invests sufficient capital to double the original adjusted basis of the property. Many practitioners believed that, in the case of a real estate investment, very few existing structures would qualify and that the most likely type of qualifying investment would be the development of raw land. The proposed regulations clarify, however, that the opportunity zone fund need not include the value of the land in the “substantial improvement” calculation. This clarification allows investment in existing dilapidated infrastructure that may not have otherwise qualified under the opportunity zone statute.
- Sixth, the Treasury and IRS committed to publish details regarding the reinvestment of capital by a qualified opportunity fund. The opportunity zone statute previously provided that the secretary of the treasury may propose regulations setting forth “a reasonable period of time to reinvest the return of capital from investments in qualified opportunity zone stock and qualified opportunity zone partnership interests, and to reinvest proceeds received from the sale or disposition of qualified opportunity zone property.” The proposed regulations state that “soon-to-be-released” regulations will define the “reasonable amount of time” that a fund must bring itself into compliance with the 90 percent asset test after, for example, selling qualified opportunity zone property, and clarify the federal income tax treatment of any gains that the qualified opportunity fund reinvests.
- Seventh, entities are eligible investors. The proposed regulations clarify that various types of investors may participate in the opportunity zone program, including individuals, C corporations, real estate investment trusts, partnerships and certain other pass-through entities (e.g., limited liability companies). Moreover, a partnership may elect to defer all or part of any capital gain by investing in a qualified opportunity fund. If such an election is made, that portion of deferred gain will not be included in the distributive shares of the partners.
- Eighth, investors may diversify their investment in more than one qualified opportunity fund. Prior to the publication of the proposed regulations, the statute ambiguously stated that no election could be made “with respect to a sale or exchange if an election previously made with respect to such sale or exchange is in effect.” Many practitioners wondered whether this language was meant to thwart diversification among various opportunity zone funds. The proposed regulations clarify that the term “eligible gain” means that portion of gain to which no election has previously been made.
- Ninth, the regulations set forth the process for deferring capital gains. The proposed regulations state that investors may defer capital gains by election by attaching Form 8949 to their federal income tax returns for the taxable year the gain would have otherwise been recognized.
- Tenth, numerous additional regulations will be issued in future months. The proposed regulations provide that the Treasury Department and IRS are working to propose additional guidance in the “near future”, which will include:
o The meaning of “substantially all” as it applies to various sections of the opportunity zone statute;
o Certain transactions that may trigger the inclusion of gain that has been deferred;
o The “reasonable period” for a qualified opportunity fund to reinvest proceeds from the sale of qualifying assets without paying a penalty;
o Administrative rules regarding a qualified opportunity fund’s failure to maintain the required 90 percent investment standard; and
o Information-reporting requirements.
In the coming weeks and months, the Treasury, the IRS, lawyers and accountants will work to sort out the specifics related to the implications of the recently published proposed regulations, the amended regulations and the soon-to-be-released regulations. In the meantime, however, the opportunity zone statute and the proposed regulations provide significant guidance to investors seeking to invest capital gains and take advantage of the opportunity zone program.
-By Jacob Werrett