The 544-page Final Regulations are a compendium of two previous regulations and public comments on the rules.

The U.S. Department of Treasury released the final Opportunity Zone Treasury Regulations last week. According to Russell J. Stein at Partridge Snow & Hahn LLP, the much-anticipated regulations are extensive and provide clarity into the working of the Opportunity Zone tax rules.

Opportunity zones provide tax advantages to investors who channel the proceeds of a capital gain (for example, the sale of a stock or a business) through a qualified fund into an eligible project in a designated zone.

Taxpayers may defer tax on eligible capital gains by making an investment in a qualified opportunity fund. Further, all capital gains on the investment in the opportunity zone itself are tax-free if held for ten years.

The tax incentive aims to direct investments towards the development of low-income communities. There are 8,700 opportunity zones available to investors for this purpose.

Opportunity Zones: Investing deadlines remain unchanged

The regulations released last week do not change certain key investment deadlines, however.

“To be eligible for the full 15% exclusion from income of the deferred capital gains, the deadline is December 31,” says Stein. Therefore, an investor must invest in a QOF by December 31, 2019, next week.

After that date, the exclusion drops to 10%. However, the investor should not divest for at least five years before December 31, 2026.

Opportunity Zones Regulations: Key points highlighted

1. Clarification on when the 180-day investing period starts: The 180-day period for investing eligible business property gains (i.e., under section 1231) begins on the date of the sale or exchange, not on December 31^st. Investors may invest gains from installment sales as and when received.  (This no longer links to the original transaction creating the installment sale).
2. More on Section 1231: Investors can invest gross Section 1231 gains even if they have net Section 1231 losses. This clarification means that the entire amount of the capital gains from investments can be invested, not just amounts that are greater than the losses.
3. Determination of whether the “substantial improvement test” is met: Where there are multiple buildings inside one zone or contiguous zones, these can be treated as a single property for the determination of the “substantial improvement test.”
4. Sell one property out of many: Qualified funds can sell individual properties without having to sell the entire fund.
5. Vacant property rules: Property vacant for at least three years before purchase by a qualified fund (or at least one year if the property was vacant before the zone was designated as such and remained vacant upon the purchase) can now qualify as original use property. It does not need to pass the substantial improvement test.
6. Non-residents: Investors may plow only capital gains taxable in the United States into a qualified fund. However, nonresident foreign individuals and corporations can still make opportunity zone investments.

Working capital safe harbor

Cash, cash equivalents, and short-term debt instruments are working capital. The regulations allow a “reasonable” amount of such working capital in a qualified opportunity zone business. This “safe harbor” working capital was allowed for 31 months. Based on representations, this period has been extended to 62 months. The change allows for more time for developers to obtain permits, zoning, and other project requirements. It also allows for multiple cash infusions during the overall allowed time span.

“Sin” businesses

The regulations exclude certain “sin” businesses (such as liquor stores or spas) from the definition of a permitted active trade or business (a “qualified opportunity zone business”). However, a legitimate and qualified business, for example, a hotel, may now have less than 5% of its property leased to a “sin business” and remain permitted under regulations. The IRS defines these as a private or commercial golf course, country club, massage parlor, hot tub facility, suntan facility, racetrack or other facility used for gambling, and liquor stores.

However, there could be further clarifications and guidelines in time to come.

Meanwhile, real estate investors would be grateful for the enhanced clarity on opportunity zones – a possibly lucrative avenue for investments.

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