The update clarifies that working capital will not be treated as Qualified Opportunity Zone business property for any purpose.
On April 1, 2020, the Treasury Department and the IRS released an update of correcting amendments to the final Opportunity Zone regulations issued in December 2019. This Alert summarizes the key clarifications provided by the update.
Working Capital Plan Safe Harbor Clarifications
Working Capital
The update clarifies that working capital will not be treated as Qualified Opportunity Zone business property for any purpose. However, the update also provided that the QOZ business will be treated as meeting the QOZ business property requirements for the duration of the working capital safe harbor. This clarification is a very taxpayer-favorable change from prior statements made by government representatives at some recent conferences. While cash for this purpose would still not be counted as meeting the QOZ business property requirements while it is in a QOZ business account (until it is spent on qualifying business property), the fact that the cash is in the QOZ business account pursuant to a working capital plan would enable the QOZ business to not be disqualified while it is spending the cash per its working capital plan. Thus, for example, a QOZ business will not be disqualified during the safe harbor period if it has nonqualified property (e.g., land acquired from a related party).
62-Month Safe Harbor
The update locationally reorganized the working capital safe harbor to put the 62-month safe harbor rule together with the remainder of the specific rules for applying the working capital safe harbor to the section 1397C requirements.
Debt as Working Capital
The language of example No. 4 has been modified to more clearly indicate that working capital includes debt as well as contributed equity as permissible. The language also clarifies that salaries paid during the startup period are appropriate uses of funds within the working capital plan as would be interest paid to a lender under a loan.
Federally Declared Disasters
Working Capital Safe Harbor
For federally declared disaster areas, which now applies to all 50 states, the language of the final regulations stated that a QOZ business may receive up to 24 months to consume its working capital assets. The update changes the language “receive up to” to “receive not more than,” clarifying that a QOZ business can receive an extension for the duration of the disaster but not more than 24 months. There is still some discussion amongst the commentators on this point, but the language makes clear that this 24-month period is not an automatic extension period, rather, the period the IRS may grant is not more than 24 months. Thus it is likely that some additional time period may be granted but it should not be assumed it will be the entire 24 months. Note also, this only applies to QOZ businesses that have a working capital plan, not to Qualified Opportunity Funds who do not have working capital plans.
QOF Reinvestment Period
For the 12 additional months for a QOF to reinvest proceeds that is delayed due to a federally declared disaster, the language providing that a QOF may receive “up to” 12 months is replaced with language providing that a QOF may receive “not more than” 12 months. Similar to the above point, the language provides some additional time for reinvestment, but all 12 months are not automatic.
Cure Periods for QOF/QOZB
Date for Filing
The update fixed language that had required a QOF to file a tax return “not later” than when a cure is achieved for a QOZ business that failed to qualify as such and replace it with “not earlier than.” This change provides a much more flexible time period for filing.
Trade or Business
The update clarifies that a QOZ business can receive only one cure per trade or business (rather than one cure per QOF).
Effective Date
The update modifies statements previously made by certain government representatives that the election to apply the final regulations was “all or nothing.” Thus, the update confirms that one can opt into the proposed regulations and the final regulations on a provision-by-provision basis.
Reporting Requirements
The update expanded the description of what must be reported by eligible taxpayers (presumably to maintain flexibility to modify Form 8997 in the future). Pressure and interest continues to exist in both the House and the Senate to require additional taxpayer reporting regarding various performance criteria of OZs.
Time Periods
Last week, the IRS issued additional guidance under Notice 2020-23 that gives some additional relief for those that realized capital gains during the period October 4, 2019, and January 17, 2020. Investors with eligible capital gains realized during this period will now have until July 15, 2020 to invest their eligible capital gains into an Opportunity Zone Fund. The result is that their 180-day window for investment has been extended until July 15 – just note, this does not affect all potential capital gains investments, the guidance only provides additional time for those that fall within the October 4, 2019, to January 17, 2020 time period.
For Further Information
If you have any questions about this Alert, please contact Brad A. Molotsky, any of the attorneys in our Opportunity Zones Group or the attorney in the firm with whom you are regularly in contact.
Disclaimer: This Alert has been prepared and published for informational purposes only and is not offered, nor should be construed, as legal advice. For more information, please see the firm's full disclaimer.