Responding to the Pandemic, IRS Loosens Opportunity Zone Requirements

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The IRS recently offered relief to Qualified Opportunity Fund investors, waiving a penalty and pushing back some investment deadlines. This new guidance comes as investment in opportunity zones slows, stymied by brisk coronavirus-related headwinds. A recent survey of investors conducted by the Economic Innovation Group, which helped design the program before it was tucked into the 2017 federal tax law, found that 52% of respondents say the pandemic is having a “negative impact” on their operations.

The program was designed to incentivize investment in economically distressed census tracts and to spur the development of new housing, businesses, and jobs. Under its terms, investors who sell stock or other investments can defer paying capital gains taxes for up to seven years so long as they reinvest the proceeds in projects located in any of the nearly 9,000 federally designated opportunity zones. You can find a map of the zones here. After 10 years, investors can sell their qualified opportunity zone property and pay no tax on the profits. Some states have moved to bolster the program with tax incentives of their own. In Wisconsin, for example, investors can defer paying state income and franchise taxes on their investments when they are reinvested in qualified opportunity zone property.

To enjoy those tax breaks, participating investors must comply with a labyrinthine regulatory scheme, most of which is not altered by the new IRS guidance. Instead, this guidance provides relief to investors in two specific ways.

First, the guidance temporarily softens rules dictating the allocation of fund assets. The law imposes penalties on funds that fail to demonstrate, in semi-annual tests, that they hold at least 90% of their assets in qualified opportunity zone property. The new guidance allows funds who flunk the tests from April 1, 2020, through the end of the year to avoid paying a penalty, excusing such failure for “reasonable cause.” The question of what kinds of property count toward that 90% is also addressed in the guidance. Property is treated as qualified opportunity zone property if it meets several requirements, one of which mandates the property be “substantially improved” within 30 months of its acquisition. The new guidance provides that April 1, 2020 through December 31, 2020 will not count toward that deadline.

The guidance also extends three compliance periods:

  • Under the terms of the law, investors must invest capital gains income in Qualified Opportunity Funds within 180 days of selling the assets. The new guidance extends that period to December 31, 2020 for investors whose 180th day fell on or after April 1, 2020.
  • The guidance confirms the national emergency declaration, announced on March 13, 2020, automatically grants investors a 24-month extension to expend their working capital and reinvest proceeds in opportunity zone property.
  • The guidance grants funds that sell off either opportunity zone property or stock an additional 12 months (24 total) to reinvest the proceeds in opportunity zone property, at which time the proceeds will be treated as opportunity zone property when calculating the 90% investment standard.

The full IRS guidance can be found here.

A special thank you to our summer clerk, Lucas Sczygelski, for his assistance in writing this post.

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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