The Department of the Treasury published Final Regulations for the Qualified Opportunity Zone (QOZ) program on January 13, 2020. While the new Final Regs do not answer all the questions that were raised by the Proposed Regulations released in October 2018 and April 2019, they do provide much that will be welcomed by taxpayers who have made, or are looking to make, QOZ investments.
To review: The QOZ program, introduced as part of the Tax Cuts and Jobs Act enacted in 2017, creates tax incentives for investment in more than 8,700 Opportunity Zones nationwide — including 168 in the State of Arizona. The City of Phoenix alone features one-quarter of the state’s Qualified Opportunity Zones.
Like most tax credit programs, the QOZ regime is a bewildering alphabet soup of structuring and entity acronyms. To simplify, however, the key predicate for the program is a Qualified Opportunity Fund (QOF). An eligible investment entity (a partnership or corporation for federal income tax purposes) will qualify as a QOF if 90 percent or more of its assets (on average) are composed of one or both of the following: (i) a “QOZ Business Property” and/or (ii) interests in an eligible entity that qualifies as a “QOZ Business.”
Once qualified as a QOF, the program’s benefits include gain deferral and gain elimination for taxpayers who do three things: recognize capital gain from the sale of an asset to an unrelated person; invest an amount equal to all or part of the capital gain in to a QOF within 180 days after the gain is recognized (with certain exceptions for pass-through entities; and elect to treat the investment as a QOZ investment.
For those who toe these marks, the gain deferral and gain elimination benefits of the program are significant. A qualified taxpayer may defer rolled-over gain until the taxpayer disposes of its QOF interest; has a defined inclusion event as to that interest; or December 31, 2026 — whichever is earliest. In addition, a qualified taxpayer may eliminate 10 percent of its rolled-over gain by holding its QOF interest for at least five years on or before December 31, 2026; may eliminate an additional 5 percent of its rolled-over gain by holding its QOF interest for at least seven years on or before December 31, 2026; and may eliminate all gain on disposition if it holds the QOF interest for at least 10 years (provided the disposition occurs on or before December 31, 2047).
Investors who have so far stayed on the sidelines should recognize that, while some potential traps remain unresolved, the new Final Regs represent a promising maturation of QOZs in a fashion that should encourage new investment under the program. Among other propitious developments, the new Regs (among other things) do the following:.
- Establish helpful guidelines for rolling over capital gains recognized on installment sales;
- Resolve issues on the treatment of gain under Internal Revenue Code § 1231 (concerning depreciable property and real property used in a trade or business and held from more than a year);
- Clarify the events that will end deferral and cause a QOF investor’s gain to be recognized;
- Offer guidance on how a QOF may reinvest proceeds from the sale of a QOZ Business Property;
- Clarify what constitutes “straddle property” (i.e., property that is both in and out of a QOZ);
- Provide guidance on what kind of activity satisfies program requirements for the “active conduct of a trade or business” (including as to triple-net leased property); and
- Begin to map out anti-abuse rules.
A wide variety of wise minds ranging from the Roman philosopher Seneca to University of Texas football coach Darrell Royal are credited with the observation that “luck is what happens when preparation meets opportunity.” Whoever coined the phrase, though, he or she evidently foresaw the QOZ program. While Congress laid the groundwork for great opportunity in the 2017 tax act, it’s the Treasury Department that continues to frame out that opportunity. With promulgation of the Final Regs, considerable potential advantage exists for those who will invest the time and care required to seize it.
Michael Ostermeyer is a partner in the Phoenix office of Ballard Spahr, who represents owners and users of commercial, industrial, and institutional real estate, as well as equity investors in all classes, and maintains a special expertise in privately-financed public infrastructure.
For more detailed comment on Qualified Opportunity Zone Final Regs, see Ballard Spahr’s comprehensive overview.
