On April 9, the Internal Revenue Service (IRS) issued Notice 2020-23 (the IRS Notice), which, among other things, provides certain taxpayers with additional time to invest “eligible gain” into a qualified opportunity fund (QOF).
By way of background, Section 1400Z-2 of the Internal Revenue Code, as amended (the Code) permits taxpayers to defer recognizing (and in some cases, to permanently exclude from gross income a portion of) certain types of realized gains if they invest the amount of their gain into a QOF within a 180-day period. The QOF then must invest substantially all of its funds, either directly or indirectly, in qualifying property located in certain designated low-income communities known as opportunity zones (OZs). In addition to the gain deferral/partial exclusion benefits, a taxpayer that invests in a QOF also has the ability to exclude from gross income any appreciation of its QOF investment if it holds such interest for at least 10 years.
Under the IRS Notice, any person performing certain time-sensitive actions due to be performed on or after April 1, 2020, and before July 15, 2020 (each, a Specified Time-Sensitive Action), is entitled to an extension of the applicable deadline until July 15, 2020. The 180-day investment period for investing eligible gain into a QOF is deemed a Specified Time-Sensitive Action in the IRS Notice. Accordingly, if the end of a taxpayer’s 180-day period for investing eligible gain into a QOF falls on or after April 1, 2020, and before July 15, 2020, such taxpayer now has until July 15, 2020, to invest that eligible gain into a QOF.
In addition to helping taxpayers that are seeking to invest their eligible gains into a QOF, this extension also could provide QOFs with additional time to meet their deadlines. Specifically, a QOF must have 90% of its assets held in qualified opportunity zone property (QOZP) every year based on an “average” test. This average is determined by looking at the property held by the QOF on the last day of the first six-month period of the QOF’s tax year and the last day of the QOF’s tax year. When determining its percentage on a testing date, however, a QOF can disregard any cash that it received in the prior six months (provided certain requirements are met). Thus, by extending the deadline for a taxpayer to invest eligible gain in a QOF, in certain circumstances this delay could provide the QOF with significant additional time to invest in QOZP in order to be able to meet its “90% test” as well.
As an illustration, Individual A sold property to an unrelated party on October 15, 2019, and realized capital gain of $100,000. Under Section 1400Z-2, Individual A has 180 days from that date (i.e., until April 12, 2020) to invest $100,000 cash into a QOF in order to take advantage of the tax benefits of investing in QOFs described above. The IRS Notice, however, now gives Individual A until July 15, 2020, to invest $100,000 into a QOF to take advantage of the OZ program. Furthermore, assuming the QOF receives the eligible gain dollars in early July 2020, and that accordingly the beginning of the QOF’s first tax year is now deferred until July 2020, its first testing date for purposes of the 90% test will be Dec. 31, 2020 (i.e., rather than Sep. 30, 2020). Thus, because the QOF will have received the $100,000 investment from Individual A within six months of that testing date, it can ignore that cash for purposes of the 90% test on that date. And since the QOF’s next testing date would now not be until the end of June 2021 (as opposed to year-end 2020), the modest extension for Individual A has provided the QOF with an additional six months to invest in qualifying property.
While helpful for certain taxpayers, please note that this extension would not serve to provide any additional time for investors in calendar year flow-through entities that had eligible gain allocated to them by such flow-through entity in 2019. This is because, under the final OZ Treasury Regulations, investors already could elect to start their 180-day investment period beginning on the due date of the flow-through entity’s tax return on which the eligible gain would have been reported (i.e., March 15, 2020). Thus, those investors already would have until Sept. 11, 2020 to invest their allocable share of the flow-through entity’s eligible gain (i.e., well past the July 15, 2020 time period provided by the IRS Notice).
Notwithstanding the extension provided by this IRS Notice, industry professionals have requested that the IRS allow more expansive extensions and relief in connection with various OZ deadlines. BakerHostetler will continue to monitor legislative and regulatory developments and provide updates on any further guidance from the IRS concerning the OZ program.
