IRC Section 1031 Exchanges and Qualified Opportunity Funds: COVID-19 Impact on Real Estate Deferral Provisions
March 25, 2020
By Lisa Knee
UPDATED: 4/10/2020, 2:15 PM
While some tax deadlines have been extended, uncertainty still exists in real estate deferral provisions such as IRC Sec. 1031 exchanges and qualified opportunity funds.
Thankfully, the IRS automatically extended, in Notice 2020-18, the upcoming April 15 tax filing deadline to July 15. This applies to any individual, trust, estate, partnership, association, company or corporation with a federal tax payment or return due on April 15. We are still waiting on many states to address or conform to extended deadlines. However, there are other timed provisions of the Internal Revenue Code that may not or have not been extended to date.
For starters, IRC Sec. 1031 exchanges have been common in the real estate industry, especially in a period where there has been significant appreciation. The fundamentals and background on 1031 exchanges can be found in our article on “The Basics of 1031s”. With respect to completing a successful 1031 exchange and deferral, there are a few safe harbor timelines that are generally followed for conventional exchanges and even more stringent ones for forward exchanges. Here are a few relevant timed deadlines:
- Within 45 days of the sale of relinquished property, replacement property must be identified.
- Within 180 days of the sale of relinquished property, replacement property must be acquired.
The IRS has been granting extensions for IRC Sec. 1031 exchanges due to the numerous weather related disasters, such as hurricanes and wild fires, in the past few years. In Rev. Proc. 2007-56, the IRS sets forth guidelines in which some of these deadlines can be extended. In the event that the investors are affected by a federally declared disaster, act of terror or military action, an extension of time is provided. In order to be granted an extension, the IRS either needs to issue a notice or other guidance to provide relief. Please be aware, the IRS has yet to issue a notice and it is unclear whether President Trump declaring disaster zones for states is sufficient.
If a notice is issued, the timeline for the exchange is extended by the later of 120 days or the date in the IRS tax relief notice, but not beyond the due date (including extensions) for filing the tax return for the year of transfer or one year. UPDATE: The IRS issued Notice 2020-23 on April 9, 2020 which grants relief with respect to specified time-sensitive actions. This Notice addresses the concerns raised above with respect to the 45-day identification period and the 180-day exchange period. The notice provides an automatic extension until July 15, 2020 BUT only if your exchange deadlines were in the period April 1 - July 15, 2020. Unfortunately, this notice does not help if the deadlines were in February and March. There may be additional guidance offered in light of the stay at home orders.
In order for Rev. Proc. 2007-56 to apply, the following as well as other qualifications must be met:
- The relinquished property must have been transferred on or before the date of the federally declared disaster AND the exchanger must be an affected taxpayer as defined OR have difficulty meeting the exchange deadlines due to one of the disaster reasons indicated in the revenue procedure.
- The exchange agreement must also explicitly provide for an extension in the event of a federally declared disaster.
Secondly, the Tax Cuts and Jobs Act of 2017 (TCJA) provided for another significant tax benefit and deferral for the real estate community with the enactment of the qualified opportunity zone (“QOZ”) program. This program has received a tremendous amount of press and interest. Please see our dedicated resource page for the basic rules and comprehensive analysis of the program. Investors and qualified opportunity fund (“QOF”) managers need to be cognizant of timed deadline provisions in this recently enacted provision, especially the following:
- Investors have 180 days from the sale of capital gain property from an unrelated party to make an investment in a QOF. UPDATE: The IRS issued Notice 2020-23 which grants investors whose deadline falls between April 1 and July 15, 2020 automatic relief of the 180 day investment requirement.
- Fund managers must comply with an asset test -- 90% of the QOF’s assets must be in qualifying assets at the QOF level (there is additional testing at the qualifying opportunity zone business level). This test is performed semi-annually.
- The relief provisions do provide a six-month period to cure a defect that caused an entity to fail to qualify as a qualified opportunity zone business. This period corresponds to both the testing period for a QOF and a qualified opportunity zone business (“QOZB”). Be wary…the final regulations specify that a QOZB can only utilize the cure period once.
- A “working capital safe harbor” allows a QOZB to hold cash, cash equivalents or debt instruments for up to 31 months prior to investing in qualifying assets.
- If a QOZB is located in a QOZ within a federally declared disaster, the QOZB may receive up to an additional 24 months to utilize its working capital assets. Exceeding the 31-month period does not violate the safe harbor if the delay is attributable to waiting for government action, the application for which is completed during the 31-month period.
Without an explicit extension from the IRS or the declaration of federally declared disaster zone, if not met, these provisions could provide unintended consequences for investors and funds looking to make investments that are intended to revitalize communities and create jobs.
Both provisions provide unique tax deferral opportunities for taxpayers and the real estate community. We will be waiting for guidance from the IRS to see if additional extensions are provided. Due to the complex requirements with these timing deadlines, we recommend professional guidance.