Treasury Releases Proposed Regulations on Opportunity Zones Designed to Incentivize Investment in American Communities
October 22, 2018
The IRS has released proposed regulations on Opportunity Zones. The proposed regulations clarify that any person that recognizes capital gain for U.S. federal income tax purposes is eligible to defer all or a portion of such gain by investing in an Opportunity Fund. In the case of a capital gain experienced by a partnership, the rules allow either a partnership or its partners to elect deferral. Similar rules apply to other pass-through entities, such as S corporations and their shareholders, and estates and trusts and their beneficiaries. The comment period for these proposed regulations is 60 days from publishing in the Federal Register, which will be this week, making the deadline the third week of December. The regulations are 74 pages long, so I apologize for the lengthy email.
The IRS is soliciting comments on numerous aspects (specific questions italicized) – I have pulled the most relevant:
- Substantial Improvement Requirement with respect to a purchased building in a qualified OZ – All aspects of the definition of “original use” and “substantial improvement.” In particular, they are seeking comments on possible approaches to defining the “original use” requirement, for both real property and other tangible property. For example, what metrics would be appropriate for determining whether tangible property has “original use” in an opportunity zone?
- Should the use of tangible property be determined based on its physical presence within an opportunity zone, or based on some other measure?
- What if the tested tangible property is a vehicle or other movable tangible property that was previously used within the opportunity zone but acquired from a person outside the opportunity zone?
- Should some period of abandonment or under-utilization of tangible property erase the property’s history of prior use in the opportunity zone? If so, should such a fallow period enable subsequent productive utilization of the tangible property to qualify as “original use”?
- Should the rules appropriate for abandonment and underutilization of personal tangible property also apply to vacant real property that is productively utilized after some period? If so, what period of abandonment, underutilization, or vacancy would be consistent with the statute?
- In addition, comments are requested on whether any additional rules regarding the “substantial improvement” requirement for tangible property are warranted or would be useful.
- Deferring Tax on Capital Gains
- Types of Taxpayers Eligible to Elect Gain Deferral
i. Proposed regulations clarify that tax payers eligible to elect deferral are those that recognize capital gain for Federal income tax purposes (individuals, C Corps, partnerships, and other pass-through entities)
- Special rules for partnerships and pass-through entities – they can invest in a QOF and thus defer recognition of eligible gain. Comments are sought on whether the rules are sufficient and whether more detailed rules are required to provide additional certainty for investors in pass-through entities that are not partnerships.
- 180 Day Rule for Deferring Gain by Investing in a QOF
- To be able to defer gain, a taxpayer must generally invest in a QOF during the 180-day period beginning on the date of the sale or exchange that gave rise to the gain. Some gains, however, are the result of Federal tax rules deeming an amount to be a gain from the sale or exchange of a capital asset and in many cases the statutory language providing gain treatment does not provide a specific date for the deemed sale.
i. The proposed regulations provide that the first day of the 180-day period is the date on which the gain would be recognized for Federal income tax purposes (examples on page 9).
- Comments are requested as to whether the final regulations should contain exceptions to the general 180-day rule and whether it would be helpful for either the final regulations or other guidance to illustrate the application of the general 180-day rule to additional circumstances and what those circumstances are.
- Attributes of Included Income When Gain Deferral Ends
- Proposed rule provides that all of the deferred gain’s tax attributes are preserved through the deferral period and are taken into account when the gain is included.
- Comments are requested as to whether different methods should be used. Any methods must provide both certainty as to which fungible interest a taxpayer disposes of.
- Gains of Partnerships and Other Pass-Through Entities
- The proposed regulations provide rules that permit a partnership to elect deferral and allow a partner to do so. A partnership may elect to defer all or part of a capital gain to the extent that it makes an eligible investment in a QOF.
- Because the election provides for deferral, if the election is made, no part of the deferred gain is required to be included in the distributive shares of the partners. If all or any portion of a partner’s distributive share satisfies all of the rules for eligibility (including not arising from a sale or exchange with a person that is related either to the partnership or to the partner), then the partner generally may elect its own deferral with respect to the partner’s distributive share. The partner’s deferral is potentially available to the extent that the partner makes an eligible investment in a QOF.
- The proposed regulations state that rules analogous to the rules provided for partnerships and partners apply to other pass-through entities (including S corporations, decedents’ estates, and trusts) and to their shareholders and beneficiaries. Comments are requested regarding whether taxpayers need additional details regarding analogous treatment for pass-through entities that are not partnerships.
- Qualified Opportunity Zone Business
- See pages 24-27 – Definitions for Qualified Opportunity Zone Business that include the phrase “substantially all,” i.e., “If at least 70 percent of the tangible property owned or leased by a trade or business is qualified opportunity zone business property (as defined section 1400Z- 2(d)(3)(A)(i)), the trade or business is treated as satisfying the substantially all requirement in section 1400Z-2(d)(3)(A)(i).”
- Comments are requested regarding the proposed meaning of “substantially all.”
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