April 24, 2019

Updated Opportunity Zone Guidance Issued

Last week, just a few days after tax season ended, the IRS released their second round of proposed regulations for the tax reform’s Opportunity Zone Program. This program, which was passed as part of the Tax Cuts and Jobs Act of 2017, incentivizes taxpayers to fund investments in economically depressed areas by offering significant tax credits. Late last year, the IRS released their initial set of proposed regulations. These regulations were helpful, but they did not answer every question investors had, and many taxpayers were hesitant to invest in a qualified opportunity zone (QOZ) without more information. Fortunately, this second round of proposed regulations delves even deeper and addresses most taxpayers’ questions. Wilson Lewis has provided a summary of a few notable changes below.

“Original Use” Requirement

The Opportunity Zone Program provides incentives for investments only when the “original use” of those investments commence in the QOZ during the program’s time period. This “original use” stipulation will be met on the date when the property owner first places the property in service in the opportunity zone for purposes of depreciation or amortization, or when anybody first uses the property in the opportunity zone that would allow them to take depreciation or amortization if they were the property owner. Additionally:

• Used tangible property can satisfy the “original use” requirement as long as the property had not been used in a qualified manner in the past by the taxpayer or any other individual.
• Real property that has been vacant for five years will satisfy the “original use” requirement once it is purchased and placed in use by a qualified opportunity fund (QOF) or by a “QOZ Business.”

QOZ Businesses

The regulations released in 2018 stated that businesses located in an opportunity zone that is funded by a QOF could be considered “QOZ Businesses” and therefore eligible for the credit. The stipulation was that the businesses must hold at least 70% of their tangible property within one or more opportunity zone. The new regulations add to this definition, saying that at least 40% of a QOZ Business’s intangible property must also be used in an opportunity zone. Technology-heavy companies may have a difficult time meeting this requirement because it can be challenging to prove where intangible assets, like patents and trademarks, are actually being used.

QOZ Businesses must also be able to prove that at least 50% of their income is generated from actively participating in a trade or business within the opportunity zone. The new regulations will take all the facts and circumstances into account when determining if a QOZ Business satisfies this test, but they also provide for three safe harbors that guarantees their program eligibility. If a business meets one or more of these tests, they will be considered a QOZ Business.

1. More than half of the services that are performed – either by their employees or by independent contractors– are performed within the opportunity zone as measured by hours worked.
2. More than half of the services that are performed – either by their employees or by independent contractors– are performed within the opportunity zone as measured by compensation dollars.
3. The tangible property and management operations that are needed to generate at least half of the gross income are located within the opportunity zone.

QOZ Property

Land and leased property were two types of property that taxpayers had more than just a few questions about. The new proposed regulations clarify that land can only be qualified property if a QOF uses the land in their trade or business. Investment alone is not a qualified use.

Leased property that is used in a QOZ will qualify for the incentive as long as it is used in the qualified zone for “substantially all” of the lease period. Leased property is exempt from the “original use” requirement, which will make it easier for taxpayers to qualify their leased property for the program. Not only that, but under certain circumstances, taxpayers can purchase leased property from related parties and still qualify for QOZ incentives. The regulations provide the specific stipulations related parties must follow to receive the credit.

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The update is quite comprehensive and extends beyond what was covered above. Topics such as how QOFs should reinvest proceeds from qualifying property into another, the definition of substantially all and how to handle gifts of property in a QOZ were also covered. While these new regulations are not final, the IRS has stated taxpayers can rely on the information provided in the release. If you have questions about the recent changes or need assistance with a QOZ issue, Wilson Lewis can help. For additional information call us at 770-476-1004 or click here to contact us. We look forward to speaking with you soon.