By Catherine Holmes, Brad Cohen and Guy Maisnik
On October 19, 2018, the IRS issued the first set of proposed regulations and a New Revenue Ruling on new Internal Revenue Code Section 1400Z-2 governing Opportunity Zone investments.
Under the new Opportunity Zone tax law, taxpayers who realize taxable capital gains from the sale of any asset (stock, property, etc.) and who reinvest those gains into “Qualified Opportunity Funds” (“QOFs”) or “Qualified Opportunity Zone Property” (“QOZP”) will be eligible to receive significant tax benefits, including deferral of their original gain, reduction of their original taxable gains after holding periods of five years or seven years, and no tax on capital gains realized from the new investment in a QOF or QOZP after a holding period of 10 years.
The first set of proposed regulations issued by the IRS under Code Section 1400Z-2 cover a number of issues that apply to individual taxpayers with respect to gains eligible for deferral, types of taxpayers eligible for deferral, the “180-day rule” defining when a qualified investment must be made in order to qualify for the deferral, and how to elect a deferral of the initial capital gain. In addition, the proposed regulations, along with new Revenue Ruling 2018-29, provide guidance to real estate developers seeking to form QOFs or determine whether their properties qualify as QOZP. This article focuses on the regulations and the Revenue Ruling that apply to QOFs and QOZP, and addresses how those regulations and the Revenue Ruling will help real estate developers seeking to raise Opportunity Zone investments to finance real estate development.
How to designate an entity as a QOF and how that Impacts the 90% Test for Eligibility as a QOF
The Regulations specify that any corporation or entity taxed as a partnership, including pre-existing entities, may self-certify as a QOF by using a form that has been proposed by the IRS. The Regulations further allow the QOF to choose the month in which the entity elects to be designated a QOF. If the QOF does not designate a month on the tax form, the Regulations provide that the designation will commence with the first month of the taxable year of the entity. This is important, because a QOF must hold at least 90% of its assets in QOZP as measured on the last day of the first 6-month period of the taxable year of the QOF and on the last day of the taxable year of the QOF. Therefore, if a QOF designates January as the first month of designation, the first six month test will apply in July. If a QOF designates any month after June of the taxable year, the Regulations state that the first test period will be the end of the first taxable year. Continue reading →