Qualified Opportunity Funds (“QOF”) were created in 2018 as a new investment vehicle to provide preferential income tax treatment for private investment in certain distressed communities designated as Qualified Opportunity Zones (“QOZ”). Provided the requirements are met, reinvesting proceeds from certain capital gains into QOFs and QOZ businesses offers taxpayers the following tax incentives:
- At a minimum, taxation of the capital gains is temporarily deferred until the earlier of when the investment in the QOF is later sold or December 31, 2026.
- Additionally, depending on how long the QOF investment is held, a portion of the deferred capital gain and all appreciation in the QOF investment could be permanently excluded from taxation.
Finally, in December 2019, after multiple rounds of proposed regulations, the IRS issued final regulations providing the details about investing in QOZ. For more information about the tax benefits and how the investments operate, please see our previous articles: Defer Income Tax on Capital Gains by Investing in Opportunity Zones and Update on Investing in Opportunity Zones.
Since all QOZs are located in areas subject to major disaster declarations, the IRS issued Notice 2020-23 to provide some relief during the pandemic. Now, the IRS has issued Notice 2020-39 (the “Notice”) further extending certain deadlines and providing additional relief and guidance for QOZs during the pandemic.
Relief for QOF
180-day Investment Period: Generally, there is a 180-day investment period to invest eligible gains in a QOF to qualify for QOZ tax incentives. If this window would have expired on or after April 1, 2020 and before December 31, 2020, the deadline is extended until December 31, 2020. Note that the start date of the 180-day period does have some nuances for certain taxpayers.
90% Investment Standard: QOFs are generally required to hold 90% of its assets in QOZ property as of two certain dates of the QOF’s tax year. If the investment standard is not met on the semi-annual testing dates and is not due to reasonable cause, the QOF is subject to penalties. The Notice provides reasonable cause such that the QOF will not be liable for the penalty if a failure to meet the 90% investment standard occurs on a test date during the period beginning on April 1, 2020, through December 31, 2020. Additionally, the failure will be disregarded for purposes of determining whether an entity qualifies as a QOF or an investment in a QOF is a qualifying investment.
Working Capital Safe Harbor: Generally, to be a QOZ business, certain requirements must be met, one of which is that less than 5% of the average of the aggregate unadjusted bases of the entity’s property can be attributable to nonqualified financial property. However, if certain requirements are met, there is an initial 31-month safe harbor and extension to 62 months available to allow for reasonable amounts of certain types of working capital. Additionally, if certain requirements are met, the Notice allows QOZ businesses located in a QOZ with a federally declared disaster that intend to be covered by the safe harbor before December 31, 2020, to extend the safe harbor period another 24 months (up to a maximum of 86 months) so long as the requirements are met.
30-Month Period for Substantial Improvement: One of the requirements for tangible property used in a trade or business of the QOF to be treated as QOZ business property is that the QOF must substantially improve the property within a 30-month period. The Notice provides relief by tolling the 30 months for the period beginning on April 1, 2020 through December 31, 2020.
12-Month Reinvestment Period: For purposes of the 90% investment standard, if certain requirements are met, QOFs generally have a 12-month reinvestment period for certain transactions relating to the sale of QOZ property or distribution of QOZ stock as a return of capital. If the 12-month reinvestment period originally included January 20, 2020, the Notice provides for an additional 12 months to make the reinvestment so long as additional requirements are met.
In addition to relief and guidance provided in the Notice, the IRS has also updated its FAQs website to respond to inquiries made to the IRS and to clarify the basic understanding of QOZs.
This article was written for general informational purposes and summarizes the tax laws. As such, it should not be relied upon for compliance with the Internal Revenue Code.
If you are interested in taking advantage of this new investment vehicle, please contact your BrownWinick attorney or one of our tax attorneys listed below.