The Tax Cuts and Jobs Act’s powerful new investment tool, the Opportunity Zone program, was intended to enable companies to make smart, potentially profitable investments in troubled economic areas. The economic downturn brought about by COVID-19 may, at first glance, appear to dissuade businesses from investment now in economically challenged areas. But recent law changes to the program in the wake of COVID-19 should continue to spur interest in this type of investment.
Regarding recent changes, “Overall, I would say this is kind of as good as we could have hoped,” said Grant Thornton Managing Director Dustin Stamper, on the various COVID-related rules and incentives to the Opportunity Zone program. Stamper discussed at some length the ramifications of these changes in a recent webcast “TEI Virtual Midyear Conference: Qualified Opportunity Zones – Benefits and Burdens” which is available here
To recap, the mammoth tax reform bill enacted at the end of 2017 created this incentive to invest in one of the 8,764 Census-defined “distressed communities” in the United States, now defined as Qualified Opportunity Zones (QOZs).
Investing in business opportunities within these areas provides three major benefits: 1) A taxpayer can defer any type of capital gain from gross income from a sale or a prior investment in a QOZ; 2) Reducing a deferred gain by 10% if a Qualified Opportunity Funding (QOF) is obtained by Dec. 31, 2021, and held for five years; and 3) the ability to permanently exclude the appreciation of a QOF investment through a step-up basis to the fair market value of the investment, held 10 years, which is then sold or exchanged.
While final regulations appeared in the beginning of 2020, the economic climate changed drastically when COVID-19 led to a worldwide economic recession as businesses that relied on close human contact such as restaurants and sporting events were forced to suspend operations. In response, Congress approved a number of major stimulus packages, capped by the CARES Act.
The IRS also responded by loosening reporting and qualification requirements for many programs, including the Opportunity Zone program. In June, the IRS decided to adjust
these parameters of the program in five major ways:
- The initial 31-month working capital safe harbor period was extended another 24 months, for a possible total of 55 months. Because another 31-month safe harbor period can be “stacked” to follow the initial safe harbor period, the additional 24-month extension (which can only be applied once) can provide a maximum safe harbor period of 86 months.
- Penalties have been eliminated for failing what is known as the “90% test,” meaning that at least 90% of QOFs must be held, on average, in a QOZ property, determined though semi-annual tests. This penalty is eliminated if the last day of the fund’s tax year is between April 1 and Dec. 31, 2020, or if the last day of the first six-month period falls between those dates. “It’s extremely generous,” added Stamper, “though you do still have to put down whether you failed to pass the asset test – essentially putting the IRS on notice.”
- The IRS extended the deadline for the 180-day investment period to Dec. 31, 2020, for any 180-day period that ends between April 1, 2020, and Dec. 30, 2020. As determined in the QOZ final regulations published earlier this year, when a gain is made through a pass-through entity, there are several options on when to begin the 180-day period.
- In the final rules, property in a QOZ needed to be improved in a 30-month period for it to be qualified. But given the shock to the economy, the June adjustments allowed that the period between April 1 and Dec. 31, 2020, may be excluded from that 30-day period. “We’ve certainly seen a lot of projects’ time schedules slow down as a result of some of the economic challenges we’re facing,” Stamper said.
- The IRS also extended the 12-month safe harbor period to 24 months for QOFs receiving a return of capital from a business property in a QOZ, or proceeds from the sale of such property, between Jan. 20, 2019, and Jan. 20, 2020, to be reinvested in QOZ properties so as to satisfy the 90% asset test.
Even with these fixes, the continuation of the spread of COVID-19 nationally threatens to continue to thwart economic growth, which puts Congressional leaders in the spotlight to deliver more relief. More taxpayer-favorable assistance could be available in the near future for the Opportunity Zone program as well, though the program itself has not escaped criticism. Investigations have been opened with the Governmental Accounting Offices into allegations that some areas designated for Opportunity Zones are in neighborhoods that already attract significant investment.
As Stamper said, future legislation involving Opportunity Zones may be just as likely to include more reporting requirements and restrictions as it would include enhancements to the benefits or increased flexibility. But for now, the use of Opportunity Zones for investment purposes remains a possibility that businesses should consider.
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