While impeachment discussions continue to garnering most of the headlines, Representatives Ron Kind, D-Wis., Mike Kelly, R-Pa., and Terri Sewell, D-Ala., introduced legislation in the House to establish a reporting framework, disclosure requirements and a penalty structure for qualified opportunity funds (QOFs).
Read more on our new Opportunity Zones blog.
Busy times continue in the Opportunity Zone world now that we have gotten past the clarion call of 2018 partnership rollovers into Qualified Opportunity Funds and Qualified Opportunity Zone Businesses that occurred on or before June 28, 2019. In our little corner of the world, deals are getting closed and new engagements happening, in particular on the business side of the ledger and some on the community impact side as well. Interesting and exciting stuff.
Based on my conversations with friends and colleagues at KPMG (thanks team for your continued excellent efforts) regarding the various states and their conformity with the federal OZ program – as of July 14th, 39 states for corporations and 33 states for individuals have elected to follow form with Pennsylvania being the latest to join the hit parade as of last week:
For Corporations:
— 39 states currently are conforming (rolling or updated state IRC conformity; AZ and MN are recent changes; AZ retroactively conforms starting TY18; HI conforms starting in TY19; IA conforms starting in TY19; MN might be retroactive but DOR guidance has not been issued yet)
— 2 states didn’t update IRC conformity
(CA, NH)
— 1 state updated IRC conformity but decoupled from IRC 1400Z (NC)
For Individuals:
— 33 states currently conforming (rolling or updated state IRC conformity; AZ and MN are recent changes; AZ retroactively conforms starting TY18; HI conforms starting in TY19; IA conforms starting in TY19; MN might be retroactive but DOR guidance has not been issued yet)
— 1 state didn’t update IRC conformity (CA)
— 1 state updated IRC conformity but decoupled from IRC 1400Z (NC)
— 6 states where IRC conformity is different for personal income tax or only have selective IRC conformity (AL, AR, MA, MS, NJ, PA) of which three do not conform (AL, MA, MS), one conforms (NJ), one will conform (PA for TYB 1/1/20), and one conforms but only with respect to QOZs located within this state (AR)
Check it out and let us know if you have any questions or need help on your various deals and transactions.
Brad A. Molotsky, Duane Morris LLP
On April 17th the Department of Treasury released a second set of proposed regulations for the Opportunity Zone legislation (the first set of regulations was released in October, 2018) which is intended to encourage economic growth and investment in designated distressed communities (qualified opportunity zones) by providing Federal income tax benefits to taxpayers who invest new capital in businesses located within qualified opportunity zones through a Qualified Opportunity Fund.
The 169 pages of proposed new regulations provide much needed guidance to encourage the future use of the opportunity zone tax benefit and specifically provide guidance for opportunity zone businesses. The following are the highlights of the proposed regulations:
1. Reinvestment of Proceeds from a sale or disposition. A qualified opportunity fund (“QOF”) has 12 months from the time of the sale or disposition of qualified opportunity zone property or the return of capital from investments in qualified opportunity zone stock or qualified opportunity zone partnership interests to reinvest the proceeds in other qualified opportunity zone property before the proceeds would not be considered qualified opportunity zone property with regards to the 90-percent asset test.
2. Real Property straddling an Opportunity Zone and a Non-Opportunity Zone. A business that purchases real property straddling multiple census tracts, where not all of the tracts are designated as a qualified opportunity zones may satisfy the opportunity zone business requirements if the unadjusted cost of the real property inside a qualified opportunity zone is greater than the unadjusted cost of real property outside of the qualified opportunity zone.
3. Safe Harbors for the Fifty Percent (50%) Income Test for Qualified Opportunity Zone Businesses (“QOZBs”).
The proposed regulations provide three safe harbors and a facts and circumstances test for determining whether sufficient income is derived from a trade or business in a qualified opportunity zone for purposes of the 50-percent test.
a. The first safe harbor requires that at least fifty percent (50%) of the services performed (based on hours) for such business by its employees and independent contractors (and employees of independent contractors) are performed within the qualified opportunity zone.
b. The second safe harbor provides that if at least fifty percent (50%) of the services performed for the business by its employees and independent contractors (and employees of independent contractors) are performed in the qualified opportunity zone, based on amounts paid for the services performed, the business meets the fifty percent (50%) gross income test.
c. The third safe harbor provides that a trade or business may satisfy the fifty percent (50%) gross income requirement if: (1) the tangible property of the business that is in a qualified opportunity zone and (2) the management or operational functions performed for the business in the qualified opportunity zone are each necessary to generate fifty percent (50%) of the gross income of the trade or business.
d. Finally, taxpayers not meeting any of the other safe harbor tests may meet the fifty percent (50%) requirement based on a facts and circumstances test if, based on all the facts and circumstances, at least fifty percent (50%) of the gross income of a trade or business is derived from the active conduct of a trade or business in the qualified opportunity zone.
Note that the seventy percent (70%) tangible property test that requires that seventy percent (70%) of the tangible property of the QOZB be located within the Opportunity Zone continues to be operative for QOZBs.
4. Working Capital Plans – the 31 Month Test. The following two changes were made to the safe harbor for working capital.
a. First, the written designation for planned use of working capital now includes the development of a trade or business in the qualified opportunity zone as well as acquisition, construction, and/or substantial improvement of tangible property.
b. Second, exceeding the 31-month period does not violate the safe harbor if the delay is attributable to waiting for government action the application for which is completed during the 31-month period.
5. Measurement Periods. To help startup businesses the proposed regulations allow a qualified opportunity fund to satisfy the ninety percent (90%) without taking into account any investments received in the preceding 6 months provided those new assets being held in cash, cash equivalents, or debt instruments with term 18 months or less. This flexibility is intended to alleviate concerns with a QOF receiving additional capital gain funds right before a testing period and not being able to deploy the funds prior to the testing period.
6. Exclusion Elections. A taxpayer that is the holder of a direct qualified opportunity fund partnership interest or qualifying qualified stock of a qualified opportunity fund S corporation may make an election to exclude from gross income some or all of the capital gain from the disposition of qualified opportunity zone property reported on Schedule K-1 of such entity, provided the disposition occurs after the taxpayer’s 10-year holding period.
7. Continued OZ treatment after Death. Neither a transfer of the qualifying opportunity fund investment to the deceased owner’s estate nor the distribution by the estate to the decedent’s legatee or heir would result in the loss of the opportunity fund investment benefit.
8. Vacant Property. Where a building or other structure has been vacant for at least five (5) years prior to being purchased by a qualified opportunity zone business or qualified opportunity zone business, the purchased building or structure will satisfy the original use requirement.
9. Leased Property – QOZBs; Original Use; Related Party Permissions; Anti-Abuse Rules. Leased property may be treated a qualified opportunity zone business property if the following two general criteria are satisfied.
a. First, leased tangible property must be acquired under a lease entered into after December 31, 2017.
b. Second, substantially all of the use of the leased tangible property must be in a qualified opportunity zone during substantially all of the period for which the business leases the property.
The proposed regulations, however, do not impose an original use requirement with respect to leased tangible property and do not require leased tangible property to be acquired from a lessor that is unrelated. However, the proposed regulations provide one limitation as an alternative to imposing a related person rule or a substantial improvement rule and two further limitations that apply when the lessor and lessee are related.
a. First, the proposed regulations require in all cases, that the lease under which a qualified opportunity fund or qualified opportunity zone business acquires rights with respect to any leased tangible property must be a “market rate lease.”
b. Second, if the lessor and lessee are related, a qualified opportunity fund or qualified opportunity zone business at any time make not make a prepayment to the lessor relating to a period of use of the leased tangible property that exceeds 12 months.
c. Third, the proposed regulations do not permit leased tangible personal property to be treated as qualified opportunity zone business property unless the lessee becomes the owner of tangible property that is qualified opportunity zone business property and that has a value not less than the value of the leased personal property. This acquisition of this property must occur during a period that begins on the date that the lessee receives possession of the property under the lease and ends on the earlier of the last day of the lease or the end of the 30-month period beginning on the date that the lessee receives possession of the property under the lease.
d. Finally, the proposed regulations include an anti-abuse rule to prevent the use of leases to circumvent the substantial improvement requirement for purchases of real property (other than unimproved land). In the case of real property (other than unimproved land) that is leased by a qualified opportunity fund, if, at the time the lease is entered into, there was a plan, intent, or expectation for the real property to be purchased by the QOF for an amount of consideration other than the fair market value.
It is also worth noting that improvements made by a lessee to leased property satisfy the original use requirement and are considered purchased property. Thus, a tenant in a building can also satisfy the QOZB tests noted under the OZ Act.
10. Intangible Assets. For purposes of determining whether a substantial portion of intangible property of a qualified opportunity zone is used in the active conduct of a trade or business, the term “substantial portion” means at least 40 percent.
11. Unimproved Land. Unimproved land that is within a qualified opportunity zone and acquired by purchase is not required to be substantially improved if it is used in a trade or business of the QOF or the QOZB.
12. Investments Held by Funds. Funds have been provided with additional flexibility to hold more than one investment within a fund if they are structured appropriately.
13. Inventory. Inventory in transit to a QOZB within an OZ will be treated as tangible property that counts for purposes of the seventy percent (70%) test for QOZBs even if it is not within the OZ so long as it is on the way.
14. Debt Financed Distributions. Guidance has been provided under the new regulations regarding refinancing and distributions to partners/members which would permit appreciated portions of the property that have been refinanced to be distributed to the partners or members of the QOF on a tax free basis so long as the distribution is not in excess of the investors basis.
We will continue to review the new regulations and intend to issue additional commentary on it. In the interim, feel free to contact us to discuss any questions you have or transactions you are considering in this space.
Brad A. Molotsky and Art Momjian, Co-Heads, The Opportunity Zone Team – Duane Morris LLP
Continued high interest and activity on the Opportunity Zone fronts on many levels this past week. Conversations, closings and connections continue at a torrid pace – including a packed IMN conference in NYC this past week with many of the national and regional luminaries in attendance. By way of a quick update on a few fronts, courtesy of our friends at Novogradac for their recon:
Federal – On March 12th, the Office of Information and Regulatory Affairs (OIRA) received the 2nd tranche of regulatory guidance for review from the Internal Revenue Service (IRS) concerning the opportunity zones (OZ) incentive. OIRA is a division of the White House Office Management of the Budget. The proposed IRS rule is expected to address what types of property qualify as qualified OZ business property, steps an OZ business must take to be qualified, the penalty for a qualified opportunity fund’s failure to meet the 90% investment standard and more. After a mandated review of at least 10 days, the OMB is expected to release the guidance to be published in the Federal Register. The first tranche of guidance was reviewed for 36 days before it was published.
Vermont – H 442 introduced in the Vermont Legislature would make investments made in Opportunity Zones eligible to apply annually for the state Downtown and Village Center Tax Credit, which is twice as often as other projects are allowed to apply and would expand eligibility under the program only for OZ investments. The Downtown and Village Center Tax Credit covers between 10 percent and 50 percent of eligible rehabilitation expenses and has a $2.4 million statewide annual cap. If enacted, the bill would go into effect July 1.
Ohio – Gov. Mike DeWine said that his proposed 2020-2021 budget will call for a 10% state income tax credit to attract investment to opportunity zones. DeWine will propose a nonrefundable credit using existing tax credit availability to create the new credit.
At this point 31 states have “followed form” and are offering some level of state capital gains relief to those who follow the federal opportunity zone rules and invest in businesses or real estate pursuant to the federal OZ rules and regulations. New Jersey is moving ahead with a bill to become the 32nd state.
I look forward to seeing some of you on the 25th at our discussion in Baltimore on OZs. If of interest, drop me an email as space is limited. Best regards.
– Brad A. Molotsky, Esq.
Governor Jared Polis announced the formation of a dedicated office within the Office of Economic Development and International Trade (OEDIT) to cultivate active investment in Colorado’s 126 federally designated Opportunity Zones.
“Colorado has earned national recognition for our thoughtful and inclusive approach designating Opportunity Zones, and we are committed to ensuring that we realize the maximum potential,” said Governor Jared Polis. “It’s vital that we continue to build on this momentum and collaborate with communities and investors to make these opportunities a reality to create good jobs.”
The new team will be led by recently named Opportunity Zone Program Director Jana Persky and charged with engaging stakeholders to facilitate active investment in designated Colorado tracts. The office will provide procedural guidance and technical knowledge to enable communities to secure much-needed investment and is funded through an Economic Development Commission allocation.
The office is partnering with the Colorado Department of Local Affairs (DOLA) to support communities in developing Opportunity Zone strategies, with the goal of attracting capital to projects that will have a positive community impact.
“DOLA has been working in partnership with local communities and leaders and OEDIT to identify where their designated areas can achieve its full potential,” said DOLA Executive Director Rick Garcia. “Through the Opportunity Zone program, equitable distribution will be possible in some of our rural areas of the state which will provide them with the opportunity to continue along the path towards economic innovation throughout Colorado.”
To help facilitate Opportunity Zone investments, the office will offer grants to support economic modeling, prospectus development, and other technical assistance needed to help community-oriented projects come to fruition.
OEDIT, in conjunction with Startup Colorado and the Blackstone Entrepreneurs Network, has also launched CO-Invest.co to connect investors and opportunities – including opportunity zones – to leverage the speed and reach of technology to further facilitate the investment opportunities.
Great to see communities, the State and its economic development teams working hand in glove to deliver great resources and tools to the market place to assist those interested in appropriate investment that is desired by the applicable communities. Way to go CO!
While I am sure there is some logical explanation, I am a bit puzzled at the moment having just read a blurb from Novogradac regarding a tax bill in New York State –
According to the report, New York State Sens. Michael Gianaris and Jessica Ramos introduced a bill that would eliminate state tax incentives for capital gains when investing in federal qualified opportunity zones (OZs).
Yes, you read that correctly – eliminate state incentives for investing in the OZ…hmm aren’t we trying to incent people to invest in low and moderate income areas Senators?
S.B. 3401 would be effective for tax years beginning on and after Jan. 1, 2018. The bill, designed to eliminate a NY state incentive to participate in the OZ incentive, was assigned to the Senate Budget and Revenue Committee.
While I can totally appreciate that some might be frustrated by what looks like the rich getting richer regarding certain large companies being incented to come to the New York and receive the benefits of not only a federal incentive in deferral and reduction of capital gains but to then add New York local and state benefits as well might seem like too much, but these benefit to companies like Amazon and Google and others should be weighed in the context of job creation, economic multiplier effect to the local economy and local job creation for local zip codes and for folks who live in the area. I look forward to hearing from the Senators’ on their rational for eliminating the benefit – maybe too much of a good thing? Should be interesting to say the least.
p.s. congrats to our friends Joe Scalio, Rich Blumenreich, and Ruth Tang, in case you have not heard about it or seen it, but they were all named to the Top 50 in OZs nationally – a worthy honor – have a super weekend!
In Secretary Mnuchin’s speech at the US Conference of Mayor’s Winter Meeting, he stated:
“…We plan to issue shortly a second set of Opportunity Zone proposed regulations that will provide additional certainty for both businesses and investors. We will clarify, as we have already indicated in the press, that income is not the same as revenues for the requirement that 50% of a zone’s business gross income must come from active conduct of business in the Opportunity Zone. We are also reviewing appropriate safe harbor rules for meeting the test based on where services are performed and where the tangible property is located to create additional opportunity”
While not yet Treasury’s official position, it appears as though these comments indicate Treasury’s inclination to loosen the requirements rather than tightening them.
Per CRE Model, if the regulations ultimately allow Qualified Opportunity Zone Businesses to satisfy the 50% gross income test by locating in an Opportunity Zone without requiring them to derive that income from transactions that take place within the Opportunity Zone, then this would enable many businesses that otherwise would not qualify to consider locating within the Opportunity Zone.
Under the October regulations, retail properties are likely to see increased interest from QOZB tenants because they will (in most cases) more easily source 50% of their income from inside the Opportunity Zone. However, many office and industrial tenants are likely to have wider trade areas that could disqualify them. If Treasury expands the requirement to only require that the activity that generates the income must take place inside an Opportunity Zone, then these property types are likely to see increased tenant interest.
Feel free to contact our OZ team at Duane Morris if you have any questions or other concerns on this or any other OZ topics – Brad A. Molotsky
On October 19, the U.S. Treasury Department issued proposed regulations for the federal Opportunity Zone tax incentive program created under the 2017 Tax Cuts and Job Act.
These regulations were highly anticipated by the real estate development and fund creation communities, which have been eagerly awaiting clarity from Treasury since the creation of the Opportunity Zone program earlier this year.
The program could become the most impactful federal incentive for equity capital investment in low-income and distressed communities ever. It offers significant capital gains tax benefits for taxpayers who invest in projects and businesses in low-income areas, allowing investors to delay, reduce and potentially eliminate capital gains taxes on appreciated assets or business located in and on Qualified Opportunity Zone investments.
Qualified Opportunity Zones are census tracts located in all 50 states in a low-income community. A detailed interactive map by state identifying the applicable opportunity zones is available, https://eig.org/opportunityzones.
As Forbes magazine indicated, there is likely $6 trillion of capital gains in the U.S. that represent potential available investment capital that could use this program to drive investment into applicable Qualified Opportunity Zone businesses or real estate.
The program is not limited to any specific product type nor does it mandate any job creation requirements as part of the investment in a Qualified Opportunity Zone. Thus, the program is applicable to any type of investor with capital gains from the sale of personal property or real property and to developers/owners of all property types including multi-family rental, retail, hotels, industrial, commercial, office, industries, self-storage, assisted-living, affordable housing, etc.
General Overview:
Under the Opportunity Zone program, individuals and other entities can delay paying federal income tax on capital gains until as late as December 31, 2026 – provided those gains are invested in Qualified Opportunity Funds investing 90 percent of their assets in businesses or tangible property located in a Qualified Opportunity Zone. In addition, the gains on investments in Qualified Opportunity Funds can be federal income tax-free if the investment is held for at least 10 years. These tax benefits could reduce the cost of capital for these projects, making them more viable, especially when paired with other development incentives like the New Markets Tax Credit or Low-Income Housing Tax Credit.
Specifically, appreciation on investments within Qualified Opportunity Funds that are held for at least 10 years are excluded from gross income. Thus, the longer one has an investment within a Qualified Opportunity Fund within an Opportunity Zone, the more one can reduce its capital gain – either by 10 percent or 15 percent, and if one stays in the zone for 10 years or more and the property or qualified business appreciated in value, the appreciation is not subject to capital gains tax at the federal level. The regulations as proposed give the investor/owner until December 31, 2047 to sell the business or property in order to take advantage of the no capital gains to be paid on the sale of appreciated assets rules.
Additionally, owners of low tax basis properties can sell their properties and defer the capital gains to the extent the gains are invested in a Qualified Opportunity Zone, which will likely attract investor capital that is looking to defer capital gains, thereby making the Qualified Opportunity Zones potentially more valuable than non-Qualified Opportunity Zone properties.
Deadlines:
While the benefits of the program can be advantageous, investors and developers seeking to capitalize on the Opportunity Zone program need to move quickly in order to take full advantage of the tax benefit as demand increases and the time period diminishes.
In other words, as the program only lasts until 2026, the seven-year ability to reduce capital gains by 15 percent will disappear if investments are not made by 2019 and the five-year ability to reduce capital gains by 10 percent will disappear if not made by 2021. Therefore, if one is interested in maximizing the value of the program and its value to investors, investors and developers need to move quickly to commence development and acquisitions in order to maximize the time periods available to invest their capital gains inside the program windows provided within the program.
Additionally, in order to defer short- and long-term capital gains realized on the sale of property, the capital gain portion of the sale or disposition has to be reinvested within 180 days in a Qualified Opportunity Fund.
Also important to note that gains are required to be recognized on the earlier of a disposal of the Qualified Opportunity Fund investment or by December 31, 2026, and are reduced over time.
The basis of the Qualified Opportunity Zone investment increases by 10 percent of the deferred gain if the investment is held for five years from the date of reinvestment and by 15 percent of the deferred gain if the investment is held for seven years from the date of reinvestment. In other words, the gain on which capital gains is paid is reduced to 85 percent of the original gain.
While the recently announced regulations provided clarity on specific time period for self-certification as an Qualified Opportunity Zone fund, for what constitutes a Qualified Opportunity Zone business and for what structures now qualify as Qualified Opportunity Zone Funds (i.e., limited partnerships, C-corporations, limited liability companies, REITs, RICs, etc.), investors need to be aware that certain rules regarding related parties and original use property still need to be clarified by Treasury in additional regulations.
In Southern New Jersey
In Southern New Jersey, the program will drive investment from all types of developers and investors seeking to place their capital gains into funds and seeking to place applicable businesses into Qualified Zones in order to potentially defer and reduce applicable capital gains. Developers will seek to purchase land in order to build with their own capital and/or equity from Opportunity Zone investment vehicles in order to utilize cheaper sources of capital and drive development returns.
Atypical real estate investors who are looking to defer and reduce capital gains may not be looking for typical real estate like returns due to the fact that they will be able to defer and reduce their capital gains via the Opportunity Zone program which will likely create a healthy dynamic for capital flows. Sectors such as multifamily, warehouse, self-storage, grocery anchor retail, and assisted living will see substantial interest from investors and developers.
In Camden County, areas such as Cinnaminson, Pennsauken, Deptford, Camden, Pine Hill, Glassboro and Lindenwold will likely be hot spots for focused/targeted Opportunity Zone investment. In Atlantic County, parts of Atlantic City, Pleasantville, the Atlantic City International Airport, Somers Point and in Cumberland County a large swath of Vineland has been designated as an Opportunity Zone and will likely see interest for focused/targeted Opportunity Zone investment.
As Confucius once said, it is good to live in interesting times. Not a day goes by without an article or post online regarding Opportunity Zones and the ability to utilize them for development and capital gains deferral.
Now is the time to optimize your capital gains deferrals and reductions if you have them vis-à-vis the sale of personal property or real property. Interested investors are already focusing on deploying capital in New Jersey and elsewhere in substantially improving various asset classes and in creating funds to deploy in investing in various asset classes.
Brad Molotsky is a real estate attorney and partner in Duane Morris’ New Jersey and Philadelphia offices. He advises clients on commercial leasing (including a specialty in cannabis leasing), acquisitions, opportunity zone fund creation and fund deployment, financing, public private partnerships and real estate joint ventures. He can be reached at BAMolotsky@duanemorris.com.
A bill in the Nebraska Legislature would give priority to federal opportunity zones (OZs) in the allocation of state Affordable Housing Trust Fund and other state programs.
As crafted, LB 87 would add OZs to already existing statewide enterprise zones in receiving priority for allocation of precious housing trust fund assistance. T
The bill would similarly prioritize OZs to receive Job Training Cash Fund, Site and Building Development Fund and Business Innovation Act assistance.
The legislation was referred to the Urban Affairs Committee and is likely to see movement in the coming weeks. This type of OZ together with other incentives at the state level is also seeing similar movement in Ohio and California for different types of incentives for job creation and housing.
If interested, give us a call at Duane Morris where we continue to track and execute on Opportunity Zone related matters for our clients and friends.
On October 19, the U.S. Treasury Department issued the much-anticipated proposed regulations for the federal Opportunity Zone (OZ) tax incentive program created under the 2017 Tax Cuts and Job Act, as well as related Revenue Ruling 2018-29.
The guidance indicates that a second set of proposed regulations will be issued later in the year that will address issues such as defining “original use,” the treatment of assets sold by a Qualified Opportunity Fund (QOF) and logistical issues with respect to the movement of tangible assets of a QOF business in and out of an Opportunity Zone.
Read the full text of this Alert on the Duane Morris LLP website.
