IRS Provides Additional Relief for Qualified Opportunity Funds and Investors Affected by Ongoing Pandemic
The COVID-19 pandemic has led to significant uncertainty and challenges for real estate owners and operators. By March 13, 2020, President Trump approved major disaster declarations for all 50 states, the District of Columbia, and U.S. territories regarding the COVID‐19 pandemic for the first time in history.[i]
On April 9, 2020, the Department of the Treasury (“Treasury”) and the Internal Revenue Service (“IRS”) issued Notice 2020-23 that provided relief for “time-sensitive actions” which were originally due between April 1st and July 15, 2020 but were automatically postponed to July 15, 2020. One of the most notable reliefs provided for Qualified Opportunity Zone (QOZ) investors was that the 180‐day rollover that was due between April 1, 2020 and before July 15, 2020, was automatically postponed to July 15, 2020.[ii]
On June 4, 2020, the IRS released Notice 2020-39 providing additional relief by extending certain deadlines for investing in Qualified Opportunity Funds (“QOFs”) and relaxed certain investment requirements for operators of QOFs. These changes are intended to make it easier for QOFs and investors to manage QOF deferrals in light of the ongoing COVID-19 pandemic.[iii]
Extension of the 180-Day Period for QOF Investors
The Tax Cuts and Jobs Act enacted a new investment opportunity in designating certain distressed communities as Qualified Opportunity Zones (“QOZ”). An investor with eligible 2019 or 2020 capital gains or business gains (i.e. Section 1231 gains which are taxed as capital gains) can defer the recognition of these gains by rolling them over in a Qualified Opportunity Fund (QOF). Generally, the rollover of the capital gains in a QOF must be done within 180 days after the gain is recognized (180-day investment period requirement). Notice 2020-39 provides additional relief that if the 180-day investment period falls between April 1, 2020 and December 31, 2020, the last day of the investment period is extended to December 31, 2020.
While this relief is automatic, an investor will still need to make a valid deferral election by filing IRS Form 8949, Sales and Other Dispositions of Capital Assets, and complete IRS Form 8997, Initial and Annual Statement of Qualified Opportunity Fund Investments with a timely filed Federal income tax return (including extensions) or amended Federal income tax return for the taxable year in which the gain would be recognized, if applicable.
90-Percent Investment Standard for QOFs
A QOF must perform an Asset Test every 6 months to determine that at least 90% of its assets are invested in a QOZ (90% investment standard). [i] If the QOF has less than 90% invested in the QOZ, the QOF must pay a nondeductible penalty every month it fails to meet the 90% investment standard.[ii] Notice 2020-39 provides that should a QOF fail either 90% Asset Test on any semiannual testing dates that fall between April 1, 2020, and December 31, 2020, it is deemed to be due to “reasonable cause” and the QOFs should still be actively evaluating and make efforts to deploy capital into QOZ Property (or QOZ Businesses) during the relief period. Therefore, despite the automatic relief between April 1, 2020 and December 31, 2020, the QOF is still required to maintain their qualifying purpose of being formed to invest in QOZ Property.
A QOF must accurately complete Form 8996 filed with respect to each affected taxable year EXCEPT that the QOF should place a “0” in Part IV, Line 8 (Penalty). Form 8996 must be filed with the QOF’s timely filed Federal income tax return (including extensions) for the affected taxable year(s).
24-Month Extension of Working Capital Safe Harbor
A QOF which is in the initial development stage of an underlying investment (i.e. QOZ Property or QOZ Businesses) will usually hold liquid assets during that time. A properly structured QOF can utilize a “working capital safe harbor” which allows the QOF to hold certain “Nonqualified financial property” (i.e. cash, cash equivalents, or debt instruments with a term of 18 months or less) if such property is deployed within 31 months after QOZ Property or Business is acquired. Further, the working capital safe harbor plan and deployment of the investments must be made pursuant to a written schedule.[iii] A QOF may extend the working capital safe harbor period to a maximum 62-months. Under Notice 2020-39, the working capital safe harbor period can be extended for an additional 24 months so QOF will have a total of 86 months to expend working capital assets if the QOZ property or business is located in a QOZ within a Federally declared disaster.
30-Month Substantial Improvement Period for QOFs
Under the QOF rules, tangible property is treated as QOZ business property if the tangible property is used in a trade or business of the QOF and, among other requirements, the QOF substantially improves that property.[iv]
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).[v]
Under Notice 2020-39 the period beginning on April 1, 2020, and ending on December 31, 2020, is disregarded in determining any 30-month substantial improvement period; the guidance suspends the running of the 30-month clock effective April 1, 2020 and will not restart the clock.
12-Month Extension of the Reinvestment Period
If a QOF sells or disposes of some or all of its QOZ property and if the QOF reinvests some or all of the proceeds in QOZ property or business within a year, then such proceeds will be deemed to be QOZ property or business for purposes of the 90-percent investment standard throughout that time.[vi] In the case of a federally declared disaster, the QOF rules further provide that a QOF may have an additional 12 months to reinvest such proceeds provided that the QOF reinvests the proceeds in the manner originally intended before the disaster.
Notice 2020-39 confirms that if a QOF’s 12-month reinvestment period includes January 20, 2020, such QOF will now have an additional 12 months to reinvest such proceeds in QOZ property without having any impact on the 90- percent investment standard provided that the QOF reinvests the proceeds in the original intended manner.
For example, if the QOF received proceeds from the sale of QOZ property on Jan. 1, 2020, the last day to reinvest such proceeds will be 24 months later, on Dec. 31, 2021.
The advisors at Sax will be sure to release updates and further information on Qualified Opportunity Funds as they emerge. For any questions or additional information needed at this time, please feel free to reach out to Sax’s Real Estate Practice.
Michael Benguigui, CPA is a Senior Manager at Sax LLP and a member of the firm’s Tax and Real Estate Practices. He specializes in tax and accounting services for property owners, developers and private equity investors. Michael can be reached at [email protected].
Jeffrey P. Roude, CPA is a Partner at Sax LLP and a member of the firm’s Real Estate Practice. With over 30 years of experience, Jeff provides industry specific services to family-owned and closely-held residential and commercial properties, in addition to common interest realty engagements for cooperative housing corporations and condominium associations. Jeff can be reached at [email protected].
[ii] See Notice 2020-23 which provided relief for certain time-sensitive actions due to be performed on or after April 1, 2020, and before July 15, 2020.
[iv] Notice 2020-39, I.R.B. 2020-26, June 4, 2020.
[ii] § 1400Z-2(f)(1).
[v] § 1400Z-2(f)(3).
[vi] See § 1.1400Z2(d)-1(d)(3)(v) which provides the scope of the working capital safe harbor and conditions for eligibility. § 1400Z-2(d)(3) incorporates § 1397C(b)(8), which limits the portion of the QOZ business’ assets that may be held in nonqualified financial property (NQFP) to less than 5 percent of the average of the aggregate unadjusted bases of the property of the QOF in a taxable year. “Nonqualified financial property” includes debt, stock, partnership interests, options, futures contracts, forward contracts, warrants, notional principal contracts, annuities, and other similar properties. However, reasonable amounts of working capital held in cash, cash equivalents, or debt instruments with a term of 18 months or less is excluded.
[vii] § 1400Z-2(d)(2)(D)(i)(II)-(III).
[viii] § 1400Z-2(d)(2)(D)(ii). Note that the QOF would only count the cost of building and improvements, not land for purpose of 30-month-substantial-improvement-requirement.
[ix] § 1.1400Z2(f)-1(b)(1).