The Internal Revenue Service just issued regulations about qualified opportunity zone funds, answering many of the questions raised by the legislation itself. And for the most part, the answers are positive for investors and developers.
Can I use an LLC?
Yes. Although the legislation provides that a QOZF must be a “corporation or a partnership,” the regulations confirm that a limited liability company treated as a partnership for tax purposes (or any other entity treated as a partnership for tax purposes) qualifies.
How do I calculate rehabilitation costs?
To qualify as “qualified opportunity zone business property,” either the original use of the property must begin with the QOZF or the QOZF must “substantially improve” the property. The statute says that to “substantially improve” the property, the QOZF must invest as much in improving the property as it paid for the property in the first place.
The regulations carve out an important exception: in calculating how much the QOZF paid for the property, the QOZF may exclude the cost of the land. Thus, a QOZF that buys an apartment building for $2,000,000, of which $1,500,000 was attributable to the cost of the land, is required to spend only $500,000 on renovations, not $2,000,000.
What kind of interest must an investor own?
To obtain the tax deferral, an investor must own an equity interest in the QOZF, not a debt instrument. Preferred stock is usually treated as an equity interest.
Are short-term capital gains covered?
Yes, all capital gains are covered. Ordinary income — for example, from depreciation recapture — is not.
Do all the assets of the business have to be in the Qualified Opportunity Zone?
A business can qualify as a “qualified opportunity zone business” only if “substantially all” of its tangible assets are located in the qualified opportunity zone. The regulations provide that “substantially all” means at least 70%. That means that 30% of the assets of the qualified opportunity zone business can be outside the qualified opportunity zone.
Note: Don’t get confused. To qualify as a QOZF, the fund itself must have invested 90% of its assets in “qualified opportunity zone property.” One kind of of “qualified opportunity zone property” is a “qualified opportunity zone business.” The 70/30 test applies in determining whether a business is a “qualified opportunity fund business.” So if a QOZF owns assets directly, 90% of those assets must be in the qualified opportunity zone. But if the QOZF invests in a business, then only 70% of the assets of the business must be in the qualified opportunity zone.
Note: Many QOZFs will own property through single-member limited liability companies. When applying the 70% test and the 90% test, bear in mind that a single-member limited liability company is generally not treated as a “partnership” for tax purposes, but rather as a “disregarded entity.” For tax purposes, assets owned by the single-member limited liability company will be treated as owned directly by the QOZF.
What happens in 2028 – when the program ends?
The qualified opportunity zone program ends in 2028. Nevertheless, the regulations allow investors to continue to claim tax benefits from the program until 2048.
How long can the QOZF wait to invest?
Suppose a QOZF raises $5M today. When does the money have to be invested?
The regulations provide that under some circumstances, you can wait up to 31 months to invest. But this is one area where more guidance is needed.