IRS Provides COVID-19 Relief for QOZ Investors and QOFs
6.12.20 | Client Alert – COVID-19 Update
Last week, the IRS released long-awaited guidance on Covid-19 related relief for Qualified Opportunity Zone (QOZ) investors and Qualified Opportunity Funds (QOFs). For applicable taxpayers, this relief:
- Extends the 180-day period to invest in a QOF;
- Suspends 30-month substantial improvement period, effectively extending it;
- Waives testing dates for the 90% investment requirement occurring during the period from April 1, 2020 to December 31, 2020;
- Provides an additional 24-month extension of time to expend working capital for projects that meet the requirements of the working capital safe harbor; and
- Extends the QOF reinvestment period by up to an additional 12 months.
Below is a summary of each relief provision.
(1) 180-Day Investment Requirement for QOF Investors
The QOZ program, created by the 2017 Tax Cuts and Jobs Act (TCJA), provides an opportunity for QOF investors to receive the deferral, reduction, and in some cases elimination of capital gains tax. Investors normally have 180 days from the time they recognize an eligible gain to invest that gain in a QOF, unless an exception or an alternative timing rule applies.
Due to the economic slowdown caused by the COVID-19 pandemic, the IRS initially provided relief, allowing investors whose 180-day deadline was set to expire between April 1, 2020 and July 15, 2020 to invest by July 15. Last week, the IRS issued Notice 2020-391 (the “Notice”), which extends the last day of the investment period to December 31, 2020 if the last day of the 180-day investment period falls on or after April 1, 2020, and before December 31, 2020. This relief is automatic, but a taxpayer must make a valid deferral election in the manner prescribed by Notice 2020-39. Also, see updated IRS QOZ FAQs regarding Forms 8949 and 8997.
Berdon Observation: Taxpayers should be aware that 2019 tax returns are due before the last day of the investment period. Accordingly, even though they have until December 31, 2020 to invest their 2019 eligible gains in a QOF, their 2019 tax returns must reflect the proper forms and manner for electing to invest in the QOF and exclude such gains from taxable income. Currently there is no guidance on whether taxpayers who have not made a qualifying investment by the due date of their tax returns should report the gain and pay tax with their 2019 tax returns. Taxpayers who do not make the deferral election on the original return would need to amend their 2019 returns to exclude the gain when a qualifying investment is made. Alternatively, taxpayers can exclude the gain from their 2019 original return and then file an amended 2019 return to remove the deferral election and pay the applicable tax plus interest. Absent guidance, the prudent course would be the former as the applicability of penalties is uncertain. Affected taxpayers should discuss these options with their tax preparers currently to make the most informed decision.
(2) 30-Month Substantial Improvement Period for QOFs
To be considered QOZ business property, the QOZ rules require that tangible property whose original use in the QOZ did not begin with the QOF or qualified opportunity zone business (QOZB) be substantially improved within 30 months after the date of its purchase. The substantial improvement requirement is met only if, during any 30-month period beginning after the date of acquisition of the post-2017 acquired tangible property, there are “additions to basis with respect to such property” held by the QOF that, in the aggregate, exceed the QOF’s adjusted basis of that property as of the beginning of that 30-month period (30-month substantial improvement period). Under the Notice, the period between April 1, 2020, and December 31, 2020, is disregarded for purposes of the 30-month period during which property may be substantially improved.
(3) 90% Test Relief
In general, at least 90% of a QOF’s assets are required to consist of QOZ property, measured semi-annually on:
- the last day of the first six-month period of the taxable year of the QOF, and
- on the last day of the taxable year of the QOF (e.g., June 30 and December 31 would be the relevant testing dates for a calendar-year QOF).
If the QOF on these semi-annual testing dates fails to meet the 90% investment standard, the rules provide that the QOF must pay a penalty for each month that the QOF fails to meet that standard. However, no such penalty is imposed “with respect to any failure if it is shown that such failure is due to reasonable cause.”
The new IRS guidance provides that a QOF’s failure to hold 90% of its assets in QOZ property on any semi-annual testing dates from April 1, 2020, through Dec. 31, 2020, is deemed due to reasonable cause under Section 1400Z-2(f)(3) and such failure does not prevent qualification of an entity as a QOF or an investment in a QOF from being a qualifying investment. As such, the QOF will not be liable for the statutory penalty to such a failure during this period. This relief is automatic. However, the QOF must accurately complete Form 8996 in a manner prescribed by the Notice and updated IRS QOZ FAQs.
(4) 24-Month Extension of Working Capital Safe Harbor Spending Deadline
The QOZ statute provides that to qualify as a QOZB, less than 5% of the average of the aggregate unadjusted bases of the entity’s property can be attributable to nonqualified financial property, which excludes reasonable amounts of working capital held in cash or short-term instruments. To allow for flexibility, the rules provide a 31-month working capital (cash, cash equivalents and debt instruments with a term of 18 months or less) safe harbor under which an QOZB can hold cash as long as it has a written plan in place to spend these funds on qualified opportunity zone business property and the plan is substantially executed. A QOZB may extend the working capital safe harbor period to a maximum of 62-months if certain additional requirements are met. Furthermore, under the new Notice, a QOZB is eligible for an additional 24 months if it is located within a federally declared disaster area as defined in Section 165(i)(5)(A).
(5) Extension of 12-Month Reinvestment Period for QOFs
A QOF that sells or disposes of some or all of its QOZ property or that receives a distribution treated as a return of capital from QOZ property, may continue to treat those proceeds as QOZ property for purposes of the 90% test if the amounts are reinvested in QOZ property within 12 months. The Notice provides that, if any part of the 12-month reinvestment period includes January 20, 2020 (the disaster date identified in the Major Disaster Declaration), then the reinvestment period is automatically extended up to an additional 12 months due to the Federally declared disaster.
Berdon LLP New York Accountants