Qualified Opportunity Funds: Final(?) QOZ Guidance
March 02, 2020
In this inaugural podcast of Breaking Ground, real estate insights, Ken Weissenberg, Tax Partner and Co-Leader of EisnerAmper’s National Real Estate Group, shares insights from the latest round of Treasury and IRS guidance on Qualified Opportunity Funds, the impact these regulations could have on investors, and still-unresolved issues surrounding Qualified Opportunity Zones investing.
KL:Ken, what are you seeing in the Qualified Opportunity Fund space right now?
KW:It's evolved over the last two years. We're now seeing much larger deals and multi-asset funds being formed and taking advantage of this amazing tax benefit. We here at EisnerAmper have been on the forefront of opportunity zones from the beginning. We've been advising clients on the formation of funds, on structuring deals, on dealing with the development issues for property from day one. We've published two books already covering both sets of proposed regulations that have been issued previously and we're working on the final set of regs in our final volume of our guidance.
KL:Excellent. Which will be out soon.
KW:Which will be out soon.
KL:So we now appear to have what's the final word on qualified opporutnity zone investing. What are your overall thoughts on this guidance and was there anything that surprises you in it?
KW:Well, as with prior guidance, the guidance has been very taxpayer friendly. We're looking at a set of rules designed to encourage investment in the Qualified Opportunities Zones. The guidance is generous in terms of the ability to use cash raised to develop the properties as well as the timeline for investing.
KL:So when does the new guidance take effect?
KW:The new guidance takes effect 60 days after the publication of the regulations in the national register, which took place in January of 2020. So they're effective March, 2020 for tax years beginning in March, 2020, which means basically anything starting in 21 for calendar year taxpayers. In addition, you could adopt the regulations early. So if you're working on a project, you could adopt the new regulations from day one. Or you could use the second set of proposed regulations. Or you could use the first set of proposed regulations, or you can go by the straight language of the statute without regulation at your election for tax years beginning after 21, or after January 21, you're using the full set of guidance.
KL:So a lot of choices, just consistency is the key.
KL:So, do the new guidelines clarify the timeline for investing gains into QOFs? And if so, how?
KW:Well, the statute says you have 180 days from the date of sale to invest in a Qualified Opportunity Fund. But when is 180 days not 180 days? It's 180 days from the date of sale if you're selling it directly. If it's coming from a flow-through entity like a partnership or an S corporation or a trust, it's 180 days from the date of sale or 180 days from the year end, which is usually December 31st. Or it's 180 days from the due date of the tax return for that entity, which in the case of partnerships and S corporations is March 15th. In the case of trusts, it's April 1st. So you have a little bit of time to play with.
So technically, if I sell an asset on January 2nd, 2020, and I'm using these regs as opposed to the earlier version of the regs, I have until September 11th if the gain came through a partnership. And not September 11th of this year, September 11th of next year.
KL:Wow. How did the rules from gains from depreciable property change?
KW:Thank you for asking that. Depreciable property used in a trader business or real estate used in a trader business is subject to a special rule. Under the proposed regulations, those gains on a net basis had to be invested only after December 31st of that year because then you could determine if you had net gains or net losses for those investments for that year. Under the final regulations, after a lot of pushback from tax practitioners, the gains from depreciable property or real estate used in a trader business can be invested under the regular rules and it's on a gross basis.
So if the taxpayer had a gain from a sale of a building, they would have 180 days from the sale of that building if it was directly. If it was through a partnership, they would have the three choices, the date of the sale, 12/31, or the due date of the partnership return to start their 180 day period. And it's on a gross basis, which is important. Because if I have a 12/31 gain, let's say it's $500, and a 12/31 loss of $300, I can invest the full $500 gain in a Qualified Opportunity Fund and take the $300 loss as an ordinary loss. So it's very advantageous to taxpayers.
KL:I'd say. How long can businesses now use the working capital safe harbor for QOZ business funds? And what should they keep in mind as they do that?
KW:Well, Qualified Opportunity Funds don't have a working capital safe harbor. That is only available for Qualified Opportunity Zone businesses that Qualified Opportunity Funds invest in. Under this rule, the business can elect a 31 month period to use cash contributed or borrowed to invest in the Qualified Opportunities Fund business. They have to have a written plan and it has to be executed pursuant to that plan. The funds have to be held in cash, cash equivalents, or short term debt.
The new rules expanded the 31 months by saying, "Yes, you could have subsequent contributions of cash or drawdowns of cash from a lender and you have another 31 month period to use that." And the maximum amount of 31 month periods for startup funds is 62 months in total. For an existing business, let's say you buy a building that's operational and you have to substantially improve it, under these rules it has to be doubled. The basis of the building has to be doubled. You only have 30 months to double that basis. So even though you might have a longer 31 month period, it has to be done in inservice at the end of 30 months.
KL:Oh, okay. So we think we have the final word here on QOZ investing, but what's really final? Do you envision additional QOF guidance in the future?
KW:With the IRS and taxes, nothing is ever final. They didn't discuss involuntary terminations of QOFs. That is something that they're considering. It's something that really it's a tool the IRS should be able to have if they see that the QOF is not being used in the manner in which it should be used in light of what the statute is for. These basically are designed to stimulate investment in distressed areas throughout the country, including the possessions and commonwealths. So, if the fund is basically being used badly, right? So it's basically, there was one example in the regulations on anti-abuse rules, where they basically bought gold bullion and kept gold bullion in a vault in the Qualified Opportunity Zone and sold half of it every year and had one employee to watch the gold. That's not the kind of business they're looking for. They're really looking for an active conduct of a trader business.
So if they see a fund not conducting business like that, whether it's developing real estate, creating jobs through their activity, they should be able to pull the plug. I don't know if it'll come in regs or in revenue procedures or revenue rulings, but there will be additional guidance coming that way. In addition, there's always rumblings in Congress about amending the law. One of the things they're talking about doing is giving more reporting to the funds so that they know exactly what the funds are investing in and how many jobs are created or how many housing units, affordable housing units, are created. That is not required under existing groups.
So applying new metrics to measure the effectiveness of these funds, the investments.
KL:Interesting. Well, Ken, thanks so much for getting us up to speed on all things QOZ.
KL:And thank you for listening to Breaking Ground. Join us for our next podcast and visit eisneramper.com/RE for more real estate news you can use.