Latest Proposed Regulations Provide Needed Guidance on the Working Capital Safe Harbor

Sullivan & Worcester

Nestled within the new proposed regulations issued by the IRS on April 12 (the "Proposed Regulations") that mainly address foreign investors is needed relief for current Opportunity Zone projects.

Under the statute, a Qualified Opportunity Zone Business ("QOZB") must hold less than 5% of its assets as "nonqualified financial property," which includes various financial instruments but does not include (i) reasonable amounts of working capital held in cash, (ii) cash equivalents, or (iii) short-term debt. The current Opportunity Zone regulations (the “Regulations”) provide a "working capital safe harbor" that treats working capital as reasonable for the purposes of the statute if certain requirements are met. In general, the working capital must be subject to a written schedule for its expenditure within 31 months (the "Written Plan"). Further, the working capital must be spent in a manner that is substantially consistent with the Written Plan. Under certain circumstances, overlapping Written Plans can be utilized to extend the safe harbor period to a total of 62 months. Finally, if a QOZB is located in a federally declared disaster zone, it can receive up to 24 additional months to spend the working capital.

Left unaddressed in the Regulations is a situation that has become common in the post-pandemic world: What if the project changes or is terminated such that the Written Plan can no longer be followed? The Proposed Regulations address this situation. According to the Proposed Regulations, a QOZB can revise the Written Plan and remain in compliance with the statute so long as the new Written Plan is adopted within 120 days of the end of a federally declared disaster. The QOZB remains, however, subject to the original 31-month time period, plus an additional 24 months due to the federally declared disaster.

On March 13, 2020, President Trump declared a nationwide emergency pursuant to Sec. 501(b) of Stafford Act to avoid governors needing to request individual emergency declarations, and this designation of a nationwide federally declared disaster is still in place. Consequently, as a result of the Proposed Regulations, a QOZB can revise or replace its Written Plan to account for the current state of its business. Presumably, a QOZB can now pivot from one project to another, which is welcome relief in these uncertain times. Additionally, even though the Proposed Regulations are not final, they indicate that they can be relied upon for tax years beginning with 2020.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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