Opportunity Zones Evolving Regulations

Under the Opportunity Zone program, investors can defer tax on any prior gains by investing them in a qualified opportunity fund. On February 14, the Internal Revenue Service (IRS) held an initial public hearing to discuss the regulations and guidance for investing in Qualified Opportunity Zone (QOZ) funds.

Many investors had high hopes for this hearing anticipating that it would clear up ambiguities around the following concepts: what constitutes “Original Use”, re-investing proceeds, in addition, OZones, type of gains that can be deferred, deferral timing, specific guidelines on 50% gross income test, specifications on the 30-month substantial improvements policy and finally, how the QOZ program can work with other tax credits.

The hearing took over five hours as the IRS sought feedback on the proposed regulations. Over 200 people attended, with most expressing concern that the lack of clarity is preventing investment. The hearing also featured two dozen speakers discussing concerns with the current QOZ rules and providing suggestions on improvement.  Some of these changes to the program include[1]:

• Extending the 180-day period for capital gains recognized during 2018 through the first 180 days of 2019.
• Removing the requirement that 50% of the gross income of a qualified opportunity zone business is derived from the active conduct of a business in the qualified opportunity zone.
• Eliminating the requirement for GAAP reporting to test 90% and 70% requirements and allow an election to use an unadjusted cost basis.
• Introduction of a new requirement that tangible property is substantially improved based on the aggregate tax basis of the overall tax basis of the tangible property acquired (not including land) instead of application occurring for each separate item acquired.
• Provide clarity around whether suspended passive losses associated with a property sold in connection with the gain deferred in the QOF investment.  The suspended loss would be triggered when the gain is recognized. However, in relation to the QOF, the gain would be deferred and partially excluded.
• Extending the 31-month safe harbors of operating cash if events occur that are beyond the company’s control. 
• Allowing continued tax-free appreciation and permitted deferred gain upon reinvestment of sales proceeds from the sale of investment in the zone business, operating entity or zone property.
• Allowing for the sale of qualified assets or interests in operating partnerships to qualify for the 10-year basis step up. 
• Allowing remediation and demolition costs to be included within the “substantial improvement” and allow for additional time within 31 months when demolition is included. In addition, if a property is demolished, that the IRS would consider it “original use”.
• Allowing QOF investors 12 months to invest the capital gain proceeds rather than the proposed 6 months.
• Request that all QOF reporting be simple and unobtrusive.
• Allowing for a change in the status of vacant land and property (utilized for more than 1 year) to qualify as original use within an opportunity zone.
• Allowing for the grantor of a grantor trust to make an election to defer gain election.  In addition, if the grantor dies, before a ten year hold period, the estate is allowed to make an election for tax-free appreciation. 

On March 12, 2019, the U.S. Treasury Department submitted the second set of proposed regulations to the Office of Information and Regulatory Affairs (“OIRA”), a division of the White House Management of the Budget. We walk you through those regulations in Opportunity zones evolving regulations: Part 2. Investors and sponsors hoped that the new regulations would answer the outstanding questions that were raised after the first set of regulations was released in October 2018.