The IRS has just given opportunity zone (OZ) investors and the funds they invest in some additional time to meet the program requirements for its first few tax years.
The Opportunity Zone Program was created as part of the 2017 Tax Cuts and Jobs Act and provides significant capital gains delays and forgiveness to investors in the more than 8,000 census tracts across the country deemed economically distressed.
The IRS issued its first final guidance on the program rules at the end of 2019. Since then, billions of funds have poured into qualified opportunity funds (QOFs), the investment vehicles created to put the money to work.
Deadline relief for funds that can demonstrate pandemic problems
Citing the impact of COVID-19 on individuals and businesses, the revenuer issued Notice 2021-10 on Jan. 19, pushing out deadlines that already had been extended to the end of 2020. That includes the 180-day deadline for new investments into QOFs until March 31, 2021, and relief from the 90% investment test to June 30, 2021.
A QOF must generally hold 90% qualified OZ property at each six-month testing date, says Blake Christian, a partner with HCVT, a Top 30 accounting firm in Los Angeles. Christian is based in his firm’s Park City, Utah, office and focuses on tax strategies for real estate investors.
He says Notice 2021-10 implies that for calendar 2021, the test will be turned off for most QOFs, provided the fund can show “reasonable cause” for the failure to meet the test.
Christian says: “A delay in acquiring qualified property or forming the QOZB (qualified OZ business) subsidiary due to COVID restrictions or other related issues should suffice. Documenting COVID’s impact is highly recommended to support the waiver.”
Allowing gains back to 2019 to be put into play
Christian says the latest extension opens up “late” OZ formation and funding for taxpayers that had 2019 K-1 capital gains (including IRS Section 1231 gains) or non-K-1 gains for “directly held” capital gains on or after Oct. 5, 2019. Amended 2019 tax returns can be filed to report the extended funding, Christian says.
The new notice also allows another three months through March 31, 2021, for taxpayers who generated “direct” or indirect (e.g., K-1) gains with an original 180-day reinvestment deadline on or after April 1, 2020.
Taxpayers with 2020 K-1-related capital gains generally have until Sept. 10, 2021, to form and fund a QOF under the general OZ regulations, and this notice has no impact on those gains, Christian says.
“Taxpayers with significant -- $200,000 or more -- in short-term or long-term capital gains in calendar 2019 or 2020 should take a hard look at possibly investing all or a portion of those gains into a QOF by March 31, 2021, to defer the gains until 2026 and achieve federal (and most states) exemption on all appreciation after holding the QOF for 10 years,” says Christian.
Pushing out the improvement period; working with no netting
The notice also delays the effective dates of the 30-month substantial improvement period for the period beginning on April 1, 2020, and ending on March 31, 2021. Like many of the extensions in the latest notice, this provision extends relief from IRS Notice 2020-39 issued last June.
Christian says taxpayers and their advisors must keep in mind that in determining the amount of gains eligible for reinvestment into a QOF, there is no netting of capital losses required, adding: “Therefore, a taxpayer with a $1 million capital gain and a $600,000 capital loss can choose to reinvest the full $1 million, or a lesser amount. Any remaining capital loss can carry over indefinitely for individuals until they have future gains."
The Millionacres bottom line
This may be the year those many billions of dollars in opportunity zone investments began to pay off in economic development in those 8,000 or so census-designated areas that need the activity. The IRS seems to be doing its bit by extending the ability for investors to get the money in place and the projects underway in such a challenging environment.