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George F. Bearup, J.D. Senior Legal Trust Advisor

23-May-22

Qualified Opportunity Zone Investments- Changes on the Horizon (Good and Bad)

Take-Away: A bill has been filed in Congress, with bipartisan support that would renew some benefits to an investment in a Qualified Opportunity Fund, but it would also increase the reporting requirements with such investments, with corresponding penalties for the failure to report with respect to the Fund.

Background: The 2017 Tax Act adopted incentives to encourage private investment in low-income communities, designated as Qualified Opportunity Zones. [IRC 1400Z-1 and I400Z-2.] Among the incentives provided by the two new Tax Code sections are: (i) deferral of capital gain investment in a Qualified Opportunity Fund (a Fund) held until December 31, 2026; (ii) elimination of 10% of the deferred capital gain  if the eligible interest in the Fund is held for 5 years; (iii) elimination of an additional 5% of the deferred capital gain if the investment in the  Fund was made on or by December 31, 2019 and the investment has been held for 7 years; and (iv) availability of an election to adjust the basis of an eligible investment interest in a Fund on the date of its sale or exchange to fair market value if the eligible investment interest has been held for at least 10 years.

IR-2022-79: Because of the lack of transparency with respect to investments in Funds and the activities of such Funds, on April 12, 2022 the IRS alerted the public through a Notice that some investors may need to take additional actions with regard to their Fund investments. Letters will be sent by the IRS to the Fund investors to advise them that in order to maintain a qualifying investment in a Qualified Opportunity Fund,  the investor may have to file an amended tax return or seek an Administrative Adjustment Request with a completed Form 8997.

Proposed Opportunity Zone Transparency, Extension and Improvement Act: This proposed bill, apparently with considerable bipartisan support in Congress, contains several important features:

  • Early Sunset for Some Zones: Opportunity Zone census tracts with a Median Family Income (MFI) at or above 130% of the national MFI would not retain their Opportunity Fund status. However,  a high MFI Zone with a poverty ratio of 30% or higher for its non-student population would remain a Qualified Opportunity Zone. States would be allowed to seek a determination from the Department of Treasury, to add or remove tracts from Qualified Opportunity Zones in like of his change in eligibility.
  • Brownfield Sites Included in Zones: Some zero populations census tracts would be eligible for Qualified Opportunity Fund designation. To qualify, these tracts must be zero population, they must be adjacent to a current Qualified Opportunity Zone on at least one side, they must be formerly used for industrial purposes, and they must contain a ‘brownfield’ site as determined by the EPA or comparable state authority.
  • Increased Information Reporting: More reporting requirements would be imposed on Funds in order for the government (Treasury) to determine if the Qualified Opportunity Fund is achieving its purported purpose of enhancing development and job growth in low-income communities.
  • Gain Deferral Period Extended: The capital gain deferral period would be extended from December 31, 2026 to December 31, 2028, while the holding period to qualify for the additional 5% elimination of deferred capital gain would be reduced from 7 years to 6 years. The elimination of an additional 5% of the deferred capital gain investment in Funds that has been held for 7 years has been unavailable for investments made in Funds made after December 31, 2019. This proposed extension of the deferral period to December 31 2028, combined with a reduction in the holding period for the elimination of an additional 5% of the deferred capital gain from 7 years to 6 years would revive the availability of the additional 5% elimination of deferred capital gain. Consequently, if the passes in its current  form, an investor could qualify if the investment is made in the Fund on or before December 31, 2022.
  • Feeder Fund: A Qualified Opportunity Fund would be allowed to be organized as a ‘feeder fund’ that may invest in other Qualified Opportunity Funds so long as there is only one Qualified Opportunity Fund to Qualified Opportunity Fund transaction before capital is deployed into a Qualifying Opportunity Zone Property or Business.
  • State Dynamism Fund: A $1 billion State and Community Dynamism Fund would be established in order to provide states and territories with the technical assistance, capacity building, and financial support to drive capital to projects and businesses in underserved communities.
  • Penalties: Penalties would be imposed for the failure to comply with the various ‘new’ reporting requirements. Example: There would be a penalty of $500 per day for non-compliance by the Fund, with a $10,000 limit unless the total assets of the Fund for the tax year exceed $10 million- in which case a $50,000 limit to the penalty applies. If there is an intentional disregard of the ‘new’ reporting requirements, then the penalty jumps to $2,500 per day with a limit of $50,000, or a penalty limit of $250,000 for a large Qualified Opportunity Fund.

Conclusion: Obviously, there are many attractive inducements to invest in a Qualified Opportunity Zone, and Fund. Apparently the IRS feels the need for more information with regard to such Zones and Funds, and the proposed bill is in response to that need. It is nice to see, though, the bill’s effort to extend the benefits of the gain deferral and to induce Qualified Opportunity Fund investments before the close of 2022.