The IRS released guidance on June 4 (Notice 2020-39
) providing broad relief for several key opportunity zone compliance requirements due to COVID-19 and its effect on the economy. The relief will provide significant flexibility for qualified opportunity zone funds (QOFs) and their investors, including rules that will:
- Provide automatic penalty relief for any 90% asset test dates between April 1, 2020, and year-end
- Extend any deadline for the 180-day period for investing in a QOF occurring on or after April 1, 2020, until the end of the year
- Disregard the period between April 1, 2020, and the end of the year as part of any 30-month period for substantially improving qualified property
- Extend the 31-month working capital safe harbor by 24 months
- Double the 12-month period for a QOF to reinvest the proceeds from selling qualified property
The administrative relief should help many QOFs navigate an increasingly difficult investment and economic environment. Congress is also considering statutory changes that could spur more investment, such as allowing taxpayers to invest without gain to defer. But the program remains controversial with Democrats, and any statutory changes may run into opposition. Details on the relief are described below.
Opportunity Zones were created by the Tax Cuts and Jobs Act to encourage investment in specific geographic areas. Taxpayers investing in QOFs can defer and even exclude capital gain if the funds and taxpayers meet certain requirements. In order to make a qualifying investment, taxpayers must generally contribute to a QOF within 180 days after the sale or exchange that creates the capital gain the taxpayer will elect to defer. Notice 2020-39 provides that if the deadline for any 180-day period occurs on or after April 1, 2020, and before Dec. 31, 2020, then the deadline will be Dec. 31, 2020.
QOFs are required to perform semi-annual testing to ensure than 90% of the fund’s assets are qualified, and face penalties for failing to meet the standard. These penalties can be waived for reasonable cause, and the IRS relief provides that the penalties for any failure for a testing date between April 1, 2020, and Dec. 31, 2020, will be deemed to be for reasonable cause. Penalties will be effectively waived automatically, so the relief seems to essentially remove the need to comply with any of the operational rules through the end of the year.
The relief also addresses the substantial improvement requirements. In order for non-original use business property to qualify under the rules, it generally must be substantially improved over a 30-month period. Notice 2020-39 provides that the period between April 1, 2020, and Dec. 31, 2020, will be disregarded as part of any 30-month period, potentially extending window for substantial improvement by up to eight months.
The guidance also clarifies important relief for the working capital safe harbor already contained in the existing regulations. Qualified opportunity zone businesses (QOZBs) are generally afforded a 31-month safe harbor for spending working capital that would otherwise violate the ban on holding more 5% of more of property in nonqualified financial property. The final regulations provide that QOZBs located within a federally declared disaster “may receive an additional 24 months to consume its working capital assets.” Although the entire country was declared a disaster zone, the final regulations did not provide any additional guidance on how and whether taxpayers had to establish any delays are due to the actual disaster. Notice 2020-39 provides that the extra 24 months will automatically apply in full to any working capital assets by any QOZB held before Dec. 31, 2020.
Finally, the guidance extends the 12-month period for reinvesting the proceeds from selling qualified property for purposes of the asset tests. Notice 2020-39 provides that for any 12-month period that includes Jan. 20, 2020, the period will be extended to 24 months.
The current economic environment has created significant challenges for QOFs, particularly as most of the activity has focused on real estate investment. The administrative relief is fairly generous, especially the automatic penalty waiver that relieves QOFs of immediate compliance responsibility. The guidance should provide helpful flexibility for many QOFs and investors, and the tax incentives remain some of the most powerful ever offered by lawmakers to spur investment in specific geographic areas.
For more information, contact:
Washington National Tax Office
+1 202 861 4144
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