Relief Provided for Various Qualified Opportunity Fund Time-Sensitive Rules

June 10, 2020

By Richard Shapiro

One of the many consequences of the COVID-19 pandemic has been that a number of filing and other tax due dates have been extended to take into account the personal and business dislocations caused by the coronavirus.  The rules governing qualified opportunity funds (“QOFs”), a major product of the Tax Cuts and Jobs Act of 2017, are no exception.  In Notice 2020-39, the Treasury and IRS provide certain relief to QOFs and their investors.  The Notice addresses five time-sensitive rules contained in the QOF statute and regulations.

180-Day Investment Requirement for QOF Investors

In general, if a taxpayer has gain from the sale or exchange of property to an unrelated person, the taxpayer may elect to exclude from gross income for the taxable year so much of the gain as does not exceed the aggregate amount invested by the taxpayer in a QOF during the 180-day period beginning on the date of such sale or exchange (the “180-day investment requirement”).  This 180-day investment requirement is subject to a number of implementation rules.  Previously issued Notice 2020-23 postponed to July 15, 2020 any deadline for the 180-day investment requirement that would otherwise have occurred on or after April 1, 2020 and before July 15, 2020. 

Under Notice 2020-39, if the last day of the 180-day investment period falls on or after April 1, 2020 and before December 31, 2020, the last day of that 180-day investment period is postponed to December 31, 2020.  The relief is automatic.  However, a taxpayer will still need to make a valid deferral election in accordance with the instructions to Form 8949 (“Sales and Other Dispositions of Capital Assets”), complete Form 8997 (“Initial and Annual Statement of Qualified Opportunity Fund Investments”) and file completed Forms 8949 and 8997 with a timely filed federal income tax return (including extensions) or amended federal income tax return for the taxable year in which the gain would otherwise be recognized but for the deferral of the recognition of gain.

90% Investment Standard for QOFs

A QOF is an investment vehicle organized as a corporation or a partnership for the purpose of investing in qualified opportunity zone (“QOZ”) property (other than another QOF).  A QOF must hold at least 90% of its assets in QOZ property, determined by the average of the percentage of QOZ property held by that QOF as measured (i) on the last day of the first six-month period of the taxable year of the QOF and (ii) on the last day of the taxable year of the QOF (the “90% investment standard”).  If the average of the percentage of the QOZ property held by a QOF on the semi-annual testing dates fails to meet the 90% investment standard, generally the QOF must pay a penalty for each month that the QOF fails to meet the standard; however, no penalty is imposed “with respect to any failure if it is shown that such failure is due to reasonable cause.”

Notice 2020-39 provides that in the case of a QOF whose (i) last day of the first six-month period of the taxable year or (ii) last day of the taxable year falls within the period beginning on April 1, 2020 and ending on December 31, 2020, any failure by the QOF to satisfy the 90% investment standard for that taxable year of the QOF is deemed to be due to reasonable cause and is disregarded for purposes of determining whether the QOF or any otherwise qualifying investments in that QOF satisfy the QOF statute and regulations.  This relief is automatic.  A QOF must accurately complete all lines on Form 8996 (“Qualified Opportunity Fund”) except that the penalty (Part IV, Line 8) should be indicated as “$0.”  The Form 8996 must be filed with the QOF’s timely filed federal income tax return (including extensions) for the affected taxable year(s).

30-Month Substantial Improvement Period for QOFs and QOZ Businesses

Tangible property is treated as QOZ business property if the tangible property is used in a trade or business and satisfies certain general requirements.  One of those requirements is that that the original use of post-2017 acquired tangible property in the QOZ begins with the QOF (“original use requirement”) or the QOF must substantially improve the property (“substantial improvement requirement”).  In order to be a substantial improvement, during any 30-month period beginning after the date of acquisition of qualifying property, improvements with respect to the property must exceed an amount equal to the adjusted basis of such property at the beginning of the 30-month period.

Under the Notice, for purposes of the substantial improvement requirement with respect to property held by a QOF or QOZ business, the period beginning on April 1, 2020 and ending on December 31, 2020 is disregarded in determining any 30-month substantial improvement period (i.e., the 30-month substantial improvement period is tolled during the period beginning on April 1, 2020 and ending on December 31, 2020).

Working Capital Safe Harbor for QOZ Businesses

A “working capital safe harbor” allows a QOZ business to hold cash, cash equivalents or debt instruments with a term of 18 months or less for up to 31 months prior to investing in qualifying assets.  A QOZ business may extend the working capital safe harbor period to a maximum 62-month period if additional requirements are met for certain start-up businesses.  In addition, if the QOZ business is located in a QOZ within a “federally declared disaster” (which currently covers the entire U.S., Puerto Rico and other territories due to COVID-19), the QOZ business may receive up to an additional 24 months to utilize its working capital assets.

While not “new relief” under the Notice, the Notice points out that as a result of COVID-19 and the federally declared disaster, all QOZ businesses holding working capital assets intended to be covered by the working capital safe harbor before December 31, 2020 receive the up to 24-month disaster benefit (resulting in an up to maximum 86-months) as long as the QOZ business otherwise meets the various requirements of the working capital safe harbor.

Twelve-Month Reinvestment Period for QOFs

A QOF has 12 months from the time of the sale or disposition of QOZ property or the return of capital from investments in QOZ stock to reinvest the proceeds in other QOZ property before the proceeds would not be considered QOZ property for purposes of the 90% investment standard.  Prior to the investment in QOZ property, the proceeds must be held in cash, cash equivalents, or debt instruments with a term of 18 months or less in order to qualify. 

If the QOF’s plan to reinvest some or all of the proceeds in QOZ property is delayed due to a federally declared disaster (as noted above, such disaster exists throughout the U.S. currently), the QOF may receive not more than an additional 12 months to reinvest the proceeds, provided the QOF invests the proceeds in the manner originally intended before the disaster.

The Notice indicates that if any QOF’s 12-month reinvestment period includes January 20, 2020 (the beginning date of the COVID-19 disaster identified in the major disaster declarations), that QOF receives not more than an additional 12 months to reinvest in QOZ property some or all of the proceeds received by the QOF from the return of capital or sale or disposition of the QOF’s QOZ property, provided it invests the proceeds in the manner originally intended before January 20, 2020. 

Summary

The Notice should facilitate QOF activity that might otherwise have been materially impaired or eliminated by the effects of the COVID-19 situation.

About Richard J. Shapiro

Richard Shapiro, Tax Director and member of EisnerAmper Financial Services Group, has over 35 years' experience in federal income taxation, including the taxation of financial instruments and transactions, both domestic and international.