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IRS Extends Relief for Qualified Opportunity Zone Funds and Investors

By Michael GershonGary Zhang .

In response to the ongoing COVID-19 pandemic, on January 19, 2021the Department of the Treasury and the IRS issued Notice 2021-10 to provide additional relief under Section 7508A and the Section 1400Z-2 regulations for qualified opportunity funds (QOF) and their investors. The notice essentially extends the relief provisions granted in Notice 2020-39, pushing back the deadlines with respect to the 180-day investment requirement, the 30-month substantial improvement requirement and the 90% investment standard requirement. The notice also addresses the maximum safe harbor period for working capital deployment as well as the required time window to reinvest certain proceeds.  

180-Day Investment Requirement for QOF Investors 

In general, a taxpayer has 180 days to invest eligible capital gains in QOFs to qualify for the qualified opportunity zone (QOZ) tax incentives. In Notice 2020-39, the IRS had previously extended the investment deadline to December 31, 2020 for taxpayers with original investment due dates between April 1, 2020 and December 31, 2020.

Notice 2021-10 provides that if the last day of the 180-day investment period within which a taxpayer must make an investment in a QOF in order to satisfy the 180-day investment requirement falls on or after April 1, 2020, and before March 31, 2021, the last day of that 180-day investment period is postponed to March 31, 2021. As such, the notice gives a taxpayer an automatic extension to invest eligible capital gains recognized in 2019/2020 until March 31, 2021 to qualify for the QOZ tax incentives, if the taxpayer’s original investment period is set to expire between April 1, 2020 and March 31, 2021.

According to the notice, a taxpayer with eligible gains must file the completed Forms 8949 and 8997 with a timely filed or an amended federal income tax return for the taxable year in which the gain(s) would be recognized.  

30-Month Substantial Improvement Period for QOFs and QOZ Businesses

Under Section 1400Z-2(d)(2)(D)(ii), 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, the aggregate additions to the basis with respect to such property in the hands of the QOF exceed an amount equal to the adjusted basis of such property at the beginning of such 30-month period.

Notice 2021-10 provides that the months between April 1, 2020 and March 31, 2021 are disregarded for determining the 30-month substantial improvement timeline. 

90-Percent Investment Standards for QOFs

To qualify as a QOF, Section 1400Z-2(d)(1) requires that a QOF must hold at least 90 percent of its assets in QOZ property, determined by the average of the percentage of QOZ property held by such QOF. The 90-percent asset test is performed on the last day of the first 6-month period of the taxable year, and again on the last day of the taxable year of the QOF.

Notice 2021-10 grants automatic relief for a QOF that fails the 90-percent asset test if the test dates with respect to the QOF property held by the QOF fall within the period beginning on April 1, 2020 and ending on June 30, 2021.

In addition, the notice requires that a QOF must follow the reporting guidance to accurately complete Form 8996 and file the completed form with the QOF’s timely filed federal income tax return for the affected taxable year.  

Working Capital Safe Harbor for QOZ Businesses

The Section 1400Z-2 regulations provide QOZ businesses with a safe harbor to treat an amount of working capital as reasonable for purposes of the QOZ asset test for a period of up to 31 months, so long as certain requirements are met.

Notice 2021-10 provides that, as a result of the federally declared COVID-19 Emergency Declaration, all QOZ businesses holding working capital assets intended to be covered by the working capital safe harbor before June 30, 2021, receive not more than an additional 24 months to deploy the working capital assets, for a maximum safe harbor period of not more than 55 months (not more than 86 months total for start-up businesses), provided the QOZ business otherwise meets the other requirements under the regulations to qualify for the working capital safe harbor.  

12-Month Reinvestment Period for QOFs

The Section 1400Z-2 regulations provide that, the reinvested proceeds from a QOF are treated as QOZ property for purposes of the 90-percent asset test, if the QOF sells or disposes of some or all of its QOZ property, or if a distribution with respect to the QOF’s QOZ stock is treated as a return of capital in the hands of the QOF, and the QOF reinvests some or all of the proceeds in QOZ property by the last day of the 12-month period, and not more than 24 months if the reinvestment is delayed due to a federally declared disaster, beginning on the date of the sale, disposition or distribution. Per the regulations, this treatment is available to a QOF only to the extent that, prior to the reinvestment in QOZ property, the reinvested proceeds are continuously held in cash, cash equivalents, or debt instruments with a term of 18 months or less.

Notice 2021-10 applies the additional 12-month period to all QOFs if the QOF’s required reinvestment period includes June 30, 2020, provided that the QOF satisfies the requirements under the regulations and invests the proceeds in the manner originally intended before June 30, 2020.  

Actions Required

Notice 2021-10 provides taxpayers with a possible opportunity to defer additional eligible capital gains reported on their 2019 and 2020 federal income tax returns by making an investment in QOFs before March 31, 2021, and properly amending their federal income tax returns for the 2019 and 2020 tax years. Taxpayers should consult with their tax advisors and carefully review prior year tax return to determine eligibility and plan accordingly.   

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