Now that we have all had a chance to celebrate a Merry Christmas, a Happy Kwanzaa or a Happy Hanukah, and have had the chance to digest 544 pages of final OZ regs – what, you say you have not really studied the new final regs yet – can’t be the case :) !
Read more in our new Opportunity Zones blog.
On December 19, 2019, the U.S. Treasury Department and the IRS issued final regulations implementing the Opportunity Zones tax incentive. According to the IRS press release, the final rules seek to provide clarity for Opportunity Funds and their eligible subsidiaries in determining qualification and levels of new investment in Opportunity Zones. They also provide guidance regarding the types of gains that qualify for Opportunity Zone investments, as well as gains that may be excluded from tax after a 10-year holding period.
Read more on our new Opportunity Zones blog.
Despite the laments that I have heard of late at various conferences and read in various articles, Opportunity Zones are, in our little slice of the world, very busy, very active and, per both Novogradac and Bisnow, OZ Funds who are focused on raising third party equity have seen a marked increase in funds under management in the last few months and have raised approximately $4.5B to date. While this is indeed less than the $6T of unrealized capital gains estimated to be available to invest, it is still a very sizable sum of money.
Read more in our new Opportunity Zones blog.
On Friday, December 6th, the IRS/Treasury delivered to the White House’s Office of Management and Budget (OMB) , approximately 500+ pages of final regulations for Opportunity Zones. Hey now!
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!
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
As 2019’s first full week moves towards a close (well, so what if we are working tomorrow or Sunday :)), wishing all fellow P3, public-private partnership and Opportunity Zone participants and those delving into the area, a Happy and a Healthy New Years.
2019 looks to be a busy year in the #OpportunityZone space. With one of the key benefits of the federal program (i.e., a 7-year investment time period with related 15% reduction in invested capital gains) expiring at the end of this coming year, many clients and prospects are extremely focused on deploying capital gains capital into this space in 2019.
My prediction is that if 2019 is anything like the number of calls and conversations and meetings we have been hosting and fielding in the 4th quarter of 2018, it will be a very robust, active and busy year in the OZ space. Having closing multiple deals in the 4th quarter for family office owners, developers and having many on-going conversations regarding Qualified Opportunity Zone businesses and funds, I am very excited for 2019 and all it will bring.
Have a fabulous January and I look forward to speaking with you about OZs and P3s in 2019!
-Brad A. Molotsky
