Opportunity Funds - Proposed Regulations and Guidance Issued

Summary

The 2017 tax reform act created substantial tax incentives for investment in designated economically distressed areas known as “Opportunity Zones.”  On October 19, Treasury and the IRS released its much anticipated guidance regarding Qualified Opportunity Funds (QOF), including proposed regulations, a revenue ruling, and a draft IRS form.  

 

Details

Listed below are the key takeaways from the guidance:

• Only short-term and long-term capital gains are eligible for deferral. 
• The tax attributes of the initial gain invested into the QOF are preserved. 
• The 180-day rule for deferring gain by investing in a QOF for certain capital gains is re-defined. Some capital gains such as sale of capital assets do not provide a specific date for the deemed sale. The proposed regulations state the first day of the 180-day period is the date to which the gain would be recognized for federal income tax purposes.
• Partnerships may elect to defer all or part of a capital gain, but to the extent the partnership does not elect to defer the capital gain, all or any portion of the partner’s distributive share can be elected to be deferred by the individual partner. In this case the 180-day period would begin on the last day of the partnership’s taxable year, effectively giving them an 18-month window.  S corporations are given the same treatment.
• Elections to defer the capital gain will be made on IRS Form 8949 and attached to the federal income tax return for the tax year in which the gain would have been recognized.
• An appreciated qualified opportunity zone (QOZ) investment can be sold on or before December 31, 2047, without federal taxation, if the taxpayer has held the investment for at least 10 years. 
• Self-certification of an entity as a QOF will be made on IRS Form 8996, for both the initial certification and annual compliance testing for the 90-Percent Asset Test.
• Clarification is provided on becoming a QOF in a month other than the first month of a taxable year. This is to assist taxpayers in the applicable six-month testing periods with the 90-Percent Asset Test.
• In determining the 90-Percent Asset Test, a QOF with financial statements must use the asset value on its financials.  Funds without financials must use the cost basis of the assets. 
• Pre-existing entities may qualify as a QOF.
• Clarity is established on non-qualified financial property (i.e., cash as working capital), which provide a safe harbor for QOF investments. This enables relief as to the 90-Percent Asset Test when qualified property has either not been acquired or developed at the six-month testing period.        
  • In other words, as long as the QOF has a written plan stating its intentions to invest the funds for the acquisition, construction or substantial improvements in the Opportunity Zone, the “working capital” will be deemed eligible property to satisfy the 90-Percent Asset Test.
• The IRS released Revenue Ruling 2018-29 simultaneously with the proposed regulations, which define the original use requirements.
• The threshold to determine a QOZ business is clarified to which “substantially all” (as required by 1400Z-2(d)(3)(A)(i)) means at least 70 percent.
• Investors may sell or exchange a QOZ investment and roll over the deferred gain into a new QOZ investment.
• The eligible entities are classified to be either corporations or partnerships for federal income tax purposes, which are created and organized in the 50 United States, the District of Columbia or U.S. possessions.

 

BDO Insights

These regulations are only proposed, and are subject to further revisions based on comments received by Treasury during the comment period.  However, Treasury has stated that taxpayers may rely upon many of these proposed rules, providing that the taxpayer applies the rules in their entirety and in a consistent manner. 
Although the guidance is welcome and answers many questions, the preamble to the proposed regulations states that Treasury is working on additional regulations to address other issues.  As such, this is the first step of a larger regulatory project that should provide greater certainty in the near future. 

BDO intends to release a more detailed alert with examples in the near future.