IRS Issues Updated Opportunity Zone Guidance

Investors who have been eagerly awaiting further clarification on Opportunity Zones may finally get answers to some of their critical questions. In a long-awaited guidance document, the Internal Revenue proposed additional regulations and cleared up confusion on some others.

How many questions will be answered? That’s not clear yet. In the hours after the Internal Revenue Service issued its guidance, accountants and lawyers all over the country were frantically reviewing the 169-page tome to see if it gives their clients, many of whom are fund sponsors lining up capital and projects, the certainty they need to commit to Opportunity Zone investments. 

“It’s a mix of user-friendly changes and some technical elaborations, but it is combined with some tightening up the framework,” said attorney Steven Meier, a partner at Seyfarth Shaw, after briefly reviewing the document.

One area that was eased, Meier said, was the 90 percent asset test rule for Opportunity Zone funds. Previously, the IRS said an Opportunity Zone fund had to hold 90 percent of its assets in qualified Opportunity Zone properties and they had to certify that twice a year. In other words, an opportunity zone fund would have to deploy all of its capital within six months. With the new regulations, opportunity zones now have a year with which to deploy their capital into qualified opportunity zone investments, Meier said.

But the rules were also tightened in at least one other area.  According to the guidance, the ownership interest that fund sponsors get for setting up the fund will not qualify as Opportunity Zone investments.

“Opportunity Zone benefits apply to the cash investment and not to the carried interest that has been earned for services,” Meier said.

Michael Greenwald, CPA, a partner at Friedman LLP, noted that the IRS clearly listened to the the comments it received after the first round of guidance and  took “tax-payer” friendly positions on the qualified asset and gross income tests. It also provided “straightforward guidance” on how to value leased assets and how to treat unimproved land for the purposes of the asset test. 

The IRS is expected to accept feedback on these proposed regulations in advance of a third round of guidance.

“These are still just proposed regulations. We are now almost 14 months into this provision, which is a short time frame given the nature of the gain deferral period,” said Greenwald. “You have to hold the asset for five years and then two more to get the full 15 percent basis step-up. Investors, promoters, and advisors can get some comfort from them but would be helped more to have final guidance.”

REAL ESTATE REACTS

Just two hours after the regulations dropped, a planned discussion on Opportunity Zones took place at the ULI Spring Meeting conference in Nashville, Tenn. Ryan McCormick, senior vice president & counsel at The Real Estate Roundtable, said they were not surprised with the new guidelines, which he called extremely favorable to businesses and investors.

“If you look at where the program has been headed since it was enacted, it’s pretty clear the administration would put its back into it and make it successful,” said McCormick.

One point in the regulations that jumped out most to Orla O’Connor, a tax principal at KPMG, was further clarification of the 31-month working capital safe harbor, which said that there would be no harm to investors if they failed to meet the timeline because they were waiting for government action.

“So if you’re waiting for awhile after filing your application, you would still qualify,” said O’Connor at the ULI panel in Nashville. “I think that is very welcome relief.”

O’Connor also noted that the new regulations alluded to additional guidelines on reporting requirements. In a predecessor bill from 2016 that was never signed into law, the regulations contained detailed reporting requirements. But when the Opportunity Zones program was signed into law through the tax reform package, those reporting requirements were stripped.

“I think people want to see some reporting to measure the impact of the program,” said O’Connor. “There have been a lot of debates on how to do that.”

Definitions and Details

In releasing the guidance, the IRS highlighted its clarification of the “substantially all” requirements for the holding period and the use of tangible business property. The IRS noted:

• For use of the property, at least 70 percent of the property must be used in a qualified opportunity zone.
• For the holding period of the property, tangible property must be qualified opportunity zone business property for at least 90 percent of the QO Fund’s or qualified opportunity zone business’s holding period.
• The partnership or corporation must be a qualified opportunity zone business for at least 90 percent of the QO Fund’s holding period.

The IRS also noted that they have identified situations in which deferred gains may become taxable if an investor transfers their Opportunity Fund interest. Transferring interests by gift may be taxable. Transferring by inheritance or, upon death, to an estate or revocable trust would not be.

Despite yesterday’s guidance issuance, investors who want to stake a claim in opportunity zones are in for the long haul. A third round of clarifications will be issued at a later date, and, even if all questions are answered then, the regulations still have to be approved.