The Latest Updates on Opportunity Zone Investments by Arkadiy (Eric) Green, CPA
Like so much of 2020, the Qualified Opportunity Zone (QOZ) program suffered under the weight of the COVID pandemic. In response, the IRS relaxed certain deadlines and requirements taxpayers must meet to yield the program’s generous tax savings. A second round of relief was issued by the IRS in early 2021, and a bill making its way through Congress calls for a two-year extension of the program, which would allow qualifying taxpayers to defer recognition of capital gains until the end of 2028.
As a reminder, the Tax Cuts and Jobs Act introduced the QOZ program to incentivize private investment and spur business development and job creation in more than 8,700 economically distress communities throughout the U.S. Effective for tax years beginning in 2018, the program allows investors to defer (until the end of 2026) and reduce taxes on capital gains they reinvest into one or more Qualified Opportunity Funds (QOFs) within 180-days following the gain recognition date. Investors who meet other requirements, including a 10-year QOF holding period, may qualify for complete capital gains tax exemption on the future disposition of their QOF investments.
Extension of 180-Day Investment Period
Under the IRS’s most recent guidance, investors whose 180-day reinvestment period ended between April 1, 2020, and March 31, 2021, now have until March 31, 2021, to reinvest capital gains into a QOF and qualify for tax deferral. This effectively means taxpayers that recognized eligible gains on or after Oct. 4, 2019, now have until March 31, 2021, to reinvest those gains into QOFs. Previous guidance had extended the 180-day investment period to Dec. 31, 2020. This extended reinvestment deadline also applies to certain taxpayers that were reported capital gains on 2019 SchedulesK-1 from flow-through entities, such as partnerships, S corporations, and limited liability companies taxed as partnerships or S corporations.
Further Suspension from the Asset-Testing Requirements
To qualify for tax deferral, QOFs must conduct two semi-annual tests (typically conducted on June 30 and December 31) to ensure that they hold at least 90 percent of their assets in qualified opportunity zone property (QOZP), including direct investment in qualified opportunity zone business property (QOZBP) or investments in other companies treated as qualified opportunity zone businesses (QOZBs). Typically, QOFs that fail this test are subject to penalties. However, the IRS’s latest guidance automatically waives penalties for QOFs that fail to meet the 90 percent asset test between April 1, 2020, and June 30, 2021. Previous guidance had extended this asset test suspension period until Dec. 30, 2020.
Further Extension of the 30-Month Substantial Improvement Period
The original language of the QOZ program required QOFs or QOZBs to “substantially improve” certain real property within 30 months of acquisition. As a result of the pandemic’s ongoing disruptions, the IRS will disregard the period between April 1, 2020, and March 31, 2021, for purposes of determining a QOZB’s 30-month substantial improvement period. Therefore, QOZBs generally can add an additional 12 months to their substantial property improvement timelines.
IRS Notice 2021-10 extends the 12-month period during which a QOF must reinvest proceeds from return of capital, sales or dispositions of QOZ property up to an additional 12 months (for a maximum total reinvestment period of not more than 24 months), provided that the QOF’s original reinvestment period included June 30, 2020, and that it satisfies certain regulatory requirements. Notice 2021-10 also adds up to an additional 24 months to the standard 31-month working-capital safe harbor available for QOZBs under the final QOZ regulations, as long as the QOZB satisfies certain regulatory requirements.
The Future of QOZs Under a New Administration
According to the U.S. Department of Housing and Urban Development, the Opportunity Zone program has been successful, attracting approximately $75 billion in private sector funding and creating at least 500,000 new jobs in designated QOZs. Last month, the House of Representatives introduced the Opportunity Zones Extension Act of 2021, which would extend the bipartisan-sponsored program through the end of 2028. However, it is important to note that President Joseph Biden campaigned on a promise to “reform” the QOZ program to ensure it lives up to its intended purpose. At present time, one can expect those reforms to focus solely on more stringent compliance standards and reporting requirements, rather than a complete revamp of the program. This, combined with the IRS’s recent guidance extending QOZ deadlines, makes now an ideal time for investors to meet with their advisors and plan for tax efficient investments in Opportunity Zones.
About the Author: Arkadiy (Eric) Green, CPA, is a director of Tax Services with Berkowitz Pollack Brant Advisors and CPAs, where he works with real estate companies, commercial and residential developers, property management companies, real estate investors and high-net-worth individuals to structure investments and complex transactions for maximum tax efficiency. He can be reached at the CPA firm’s Boca Raton, Fla., office at (561) 361-2000 or via email at firstname.lastname@example.org.