Due Date for Qualified Opportunity Funds and Investors Extended by IRS
A current IRS Notice builds on prior efforts to provide taxpayer relief by further extending the due date for what is known as the 180-day investment requirement. This Notice could make a significant impact on the operations of qualified opportunity funds (QOFs) and their investors.
As background, a taxpayer with a capital gain from the sale of property to an unrelated person can elect to exclude that gain from their gross income so long as they meet the 180-day investment requirement. This requirement stipulates that the gain must be invested in a QOF within a 180-day period beginning on the date of such sale or exchange.
IRS regulations adjust the 180-day investment period starting date based on certain situations. For example, gains passing to an owner from a pass-through entity where the entity does not elect to invest in a QOF would have the 180-day period begin on the last day of the tax year.
Under prior Notice 2020-23, when the 180-day investment period falls between April 1, 2020 and July 14, 2020, the 180-day investment period deadline was extended to July 15, 2020.
This current Notice provides additional relief. Where the last day of the 180-day investment period falls between April 1, 2020, and December 30, 2020, the last day of the period is extended to December 31, 2020. Note that relief provided in this current Notice is automatic.
Failing the QOF 90% Investment Standard – Reasonable Cause Must Be Proven
Under the requirement, a QOF must hold at least 90% of its assets in qualified opportunity zone (QOZ) property. The percentage itself is determined by averaging the percentage of QOZ property held by the QOF on semi-annual testing dates (i.e., the “90% Investment Standard”). If the 90% Investment Standard is not satisfied, the QOF will be required to pay a penalty. That said, such a penalty will not be imposed if it can be proven that said failure was due to reasonable cause.
Under the current Notice, failure to satisfy the 90% Investment Standard Test for the QOF tax year will be considered traceable to reasonable cause where either semi-annual testing date falls between April 1, 2020 and December 31, 2020. The failure also does not prevent the qualification of the entity as a QOF—nor does it prevent an investment in the QOF from being a qualifying investment.
24-Month Extension Provided to the Working Capital Safe Harbor Period
By law, no more than 5 percent of the assets of a qualified opportunity zone business (QOZB) can be considered “nonqualified financial property.” Excluded from the definition of nonqualified financial property by the Internal Revenue Code is reasonable amounts of working capital that are held in cash, cash equivalents or debt instruments with a term of 18 months or less.
QOZ regulations provide a safe harbor for taxpayers treating working capital as reasonable in cases where there is a written schedule consistent with the ordinary startup of a trade or business for the expenditure of the working capital assets within 31 months of the receipt by the business of the assets. Under certain circumstances, this working capital safe harbor period can increase to a maximum 62-month period.
The regulations also provide that a QOZB which is located in a QOZ within a federally declared disaster area can have its working capital exception period extended by an additional 24 months. Under the new Notice, it is confirmed that these projects will have up to an additional 24 months to expend their working capital.
Suspension of the 30-Month Substantial Improvement Period
QOZB property is required to satisfy an “original use requirement” (i.e., the first use of the property in the QOZ is by the taxpayer)—or it must be substantially improved (i.e., “substantial improvement property”). A property is considered to be substantially improved if, during any 30-month period beginning after the date of acquisition, additions are made to the basis of such property that exceed the adjusted basis of the property at the beginning of that 30-month period.
The current Notice provides that the period between April 1, 2020 and December 31, 2020 is suspended for determining the 30-month substantial improvement period.
12-Month Reinvestment Period
QOZ regulations stipulate that if a QOF sells some or all of its QOZ property, or if it receives a distribution that is treated as a return of capital, the QOF can then reinvest such proceeds during a 12-month period in QOZ property and treat the proceeds as qualifying property for the 90% investment standard. The regulations provide for an extension of up to an additional 12 months where the reinvestment is delayed due to a federally declared disaster.
The current Notice provides that if the 12-month reinvestment period includes January 20, 2020 (i.e., the date of the disaster identified in the President’s Major Disaster Declaration), then the QOF receives an additional 12 months to make the reinvestment, where the proceeds are invested in the manner originally intended before January 20, 2020.
As mentioned earlier, this Notice could significantly impact the operations of QOFs and their investors, so it’s wise to consult with your tax professional.
For more information on this topic, please contact our team at (334) 472-9490 or via email at [email protected].