The Treasury Department has now released a second round of proposed regulations on the Qualified Opportunity Zone (“QOZ”) provisions under Internal Revenue Code Section 1400Z-2.
Real estate developers, fund sponsors, and property owners have been awaiting further guidance on the new Qualified Opportunity Zone ("QOZ") provisions included in last December’s Tax Cuts and Jobs Act, since the IRS issued an initial set of proposed regulations on Friday, October 19, 2018. Our advisory regarding those initial proposed QOZ regulations can be found here. The newly released proposed regulations, issued April 17, 2019, address various issues raised or unaddressed by the initial proposed regulations.
While the QOZ rules generally will be effective only after they are issued as final regulations, taxpayers may rely on the proposed regulations, with certain exceptions, in the meantime, so long as they rely on the rules in their entirety and in a consistent manner. Of particular note, the proposed rules related to the gains eligible for exclusion after the required 10 year holding period may not be relied on until the regulations are final. Also, a taxpayer cannot rely on the proposed rules allowing unimproved land to qualify as QOZ business property if the QOF or the QOZ business intends not to improve the land by more than an “insubstantial amount” within 30 months after the date of purchase. It is uncertain what constitutes an “insubstantial amount” for this purpose.
Proposed Treasury Regulations, §1.1400Z2(d)-1 Qualified Opportunity Funds.
Key guidance in the new proposed regulations provides increased flexibility regarding the disposition of either interests or underlying property in QOFs held for more than 10 years for purposes of excluding gain, exclusion of cash investments received in the last 6 months when applying the 90% asset test, and inclusion of leased property among qualifying QOZ property (and exclusion thereof from the original use requirements).
These and other salient topics addressed in the new proposed regulations include:
The proposed regulations provide that a QOZ investment may be transferred to a grantor trust without triggering an inclusion of the deferred gain. Further, if a QOZ investment is held by a grantor trust, the death of the grantor is not considered an inclusion event under the new guidance. Finally, the new rules clarify that upon the death of a taxpayer holding a QOZ investment, the deferred gain is not triggered when the investment is distributed to a beneficiary by the estate of the taxpayer, and that such beneficiary steps into the shoes of the decedent for purposes of determining the holding period of the QOZ investment.
If a significant purpose of a transaction is to achieve a tax result that is inconsistent with the purposes of the QOZ rules, the IRS can recast a transaction (or series) for federal tax purposes to achieve results consistent with the purposes of section 1400Z-2. The test for whether a tax result is inconsistent with the QOZ purposes is one of facts and circumstances.