On June 4, 2020, in response to the ongoing COVID-19 pandemic, the Treasury issued Notice 2020-39 to provide further relief for both investors and fund sponsors participating in the federal opportunity zone (“OZ”) program. This relief is in addition to the prior relief by the Treasury in Notice 2020-23 that generally delayed certain time sensitive tax-related actions to July 15, 2020 (see here for our prior alert concerning Notice 2020-23).
As a general matter, the OZ program allows taxpayers to (i) defer paying tax on capital gains if they timely invest in a qualified opportunity fund (“QOF”), typically within 180 days of recognizing the gain, (ii) reduce the amount of that gain when the tax becomes due by up to 15% if certain conditions are met, and (iii) exclude tax on gains resulting from the appreciation of the investment in a QOF that is held for 10 years.
The OZ program contains numerous timeframes, including timeframes in which investments must be made, invested funds must be deployed and property must be improved. In recognition that the pandemic has significantly impacted the economy, the banking system and government agencies, and that such wide-ranging impacts have affected the timing of various OZ investments and projects, the Treasury provided in Notice 2020-39 the following relief:
- Investment Period. If the end of the 180-day period in which a taxpayer must invest in a QOF falls between April 1, 2020, and December 31, 2020, the last day of the period is automatically extended to December 31, 2020.
- 90% Test for QOFs. As a general matter, if a QOF fails to have at least 90% of its assets be qualified OZ property on two testing dates during a tax year, generally June 30 and December 31, the OOF is subject to certain penalties at the then-current underpayment rate. The Notice provides that any failure to meet the 90% test on a testing date falling between April 1, 2020, and December 31, 2020, will be disregarded and treated under the reasonable cause exception. Note, however, reporting is still required.
- 30-Month Substantial Improvement Period. For rehabilitation projects, the qualified OZ property acquired by the QOF (or a qualified OZ business in which QOF invests) must be substantially improved within 30 months of acquisition. The Treasury provides in the Notice that the 30-month period is tolled from April 1, 2020, through December 31, 2020.
- 31-Month Working Capital Safe Harbor. For an entity to be a qualified OZ business it must meet various requirements. Such requirements include that nonqualified financial property (cash and cash equivalents) be no more than 5% of the total assets of the business, other than necessary working capital, and that 70% of the business’ tangible property constitutes qualified OZ business property. The Treasury Regulations provide a safe harbor as to what is necessary working capital, as well as treat the cash under safe harbor as qualified property for the term of the safe harbor. Along with other requirements, the safe harbor requires that the working capital be used for development of a trade or business in an OZ, including cash used for acquisition, construction, and development of real property, provided it is deployed in certain time frames, generally 31 months, and in compliance with a written plan. The Treasury Regulations provide further that such time period is extended for up to 24 months for a federally declared disaster. The Treasury has confirmed that the federal declarations pursuant to the current pandemic are sufficient for the 24-month extension.
- 12-Month QOF Reinvestment Period. A QOF generally has 12 months to reinvest capital it receives from the disposition of qualified opportunity zone property related to a sale prior to the 10-year holding period. The Treasury has confirmed that QOFs will have an additional 12 months if a QOF’s original 12-month reinvestment period includes January 20, 2020.
We are continuing to monitor both federal and state bills and administrative guidance that will impact your OZ investments and projects. Meanwhile, if you have any questions on the how the relief in Notice 2020-39 applies to you, or opportunity zones in general, please contact Bradley Wooldridge or your Manning Fulton relationship attorney.