As part of its continuing response to the COVID-19 pandemic, the IRS, in Notice 2020-39, has loosened the rules for opportunity zone investments, extending deadlines and relaxing investment standards. The opportunity zone program offers generous tax benefits for investing in designated low-income areas as long as investment timetables are met and qualified opportunity funds (QOFs) hold at least 90% of their assets in qualified property.
180-Day Investment Window
Under statutory opportunity zone rules, an investor can defer capital gains from the sale of an asset by rolling gains over into a QOF within 180 days, from the date of sale. The Notice extends the last day of the 180-day period to December 31, 2020, if an investor’s 180-day window ends on or after April 1, 2020, and before December 31, 2020. The 180-day deadline was already extended to July 15, 2020, and Notice 2020-39 extends it another five and a half months, to the end of the year. This relief is automatic, but taxpayers still need to make the deferral election on forms filed with their 2020 Federal income tax return.
90 Percent Investment Standard
A QOF must hold at least 90% of its assets in qualified opportunity zone property, determined by the average of the percentage of qualified property held (i) on the last day of the first 6-month period of the taxable year of the QOF, and (ii) on the last day of the taxable year of the QOF. The Notice grants relief from this rule for QOFs that have semi-annual testing dates falling on or after April 1, 2020, through December 31, 2020. Failing to meet the 90% standard will be automatically be considered to be for reasonable cause, no penalties will apply, and the QOF investments will not be disqualified. Again, this relief is automatic.
Working Capital Safe Harbor
To be a qualified opportunity zone business, less than 5% of the average of the unadjusted bases of an entity’s property can be attributable to the nonqualified financial property. However, a reasonable amount of working capital is excluded from this definition and is allowed under a safe harbor based, in part, on the entity’s plan to expend those assets over a set period of time. The Notice clarifies that opportunity zone businesses have an additional 24 months in which to expend their working capital assets because of the federally declared disaster.
30-Month Substantial Improvement Period
Qualified opportunity funds have 30 months to substantially improve a property for it to be considered qualified property. This rule applies to property where the original use was not by the QOF. The Notice excludes the period from April 1, 2020, through December 31, 2020, in determining the 30-month substantial improvement period, giving investors more time to make improvements.
12-Month Reinvestment Period for QOFs
Under the regulations, a QOF has 12 months to reinvest any proceeds received from the sale of qualified opportunity zone property or from a distribution that is a return of capital. Proceeds that are reinvested are treated as qualified opportunity zone property for purposes of the 90% investment standard. The Notice gives QOFs an additional 12 months to reinvest the proceeds if the QOF’s reinvestment period includes January 20, 2020.
With the loan programs and tax benefits provided by the CARES Act and the volatile stock market, many taxpayers have been concentrating on protecting their current assets rather than proactively seeking out new investments. The IRS’s new rules for opportunity zone investments make it easier to get the most out of these popular investment vehicles, so it may be time to give them a second look. If you have questions about Opportunity Zones, please reach out to your Frazier & Deeter tax advisor.