16A — July 26 - August 8, 2019 — M id A tlantic
Real Estate Journal
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n April 17, 2019, the De- partment of Treasury released a second set By Brad A. Molotsky, Duane Morris LLP Opportunity Knocks – Treasury Releases Second Set of Opportunity Zone Regulations O property must be in a Quali- fied Opportunity Zone during substantially all of the period for which the business leases the property. application for which is com- pleted during the 31-month period. Measurement Periods
of the 50 percent test. 1. The first safe harbor re- quires that at least 50 percent of the services performed (based on hours) for such business by its employees and independent contractors (and employees of independent contractors) are performed within the Qualified Opportunity Zone. 2. The second safe harbor pro- vides that if at least 50 percent of the services performed for the business by its employees and independent contractors (and employees of independent contractors) are performed in the Qualified Opportunity Zone, based on amounts paid for the services performed, the business meets the 50 percent gross income test. 3. The third safe harbor pro- vides that a trade or business may satisfy the 50 percent gross income requirement if: (1) the tangible property of the business that is in a Qualified Opportunity Zone and (2) the management or operational functions performed for the business in the Qualified Op- portunity Zone are each neces- sary to generate 50 percent of the gross income of the trade or business. 4. Finally, taxpayers not meeting any of the other safe harbor tests may meet the 50 percent requirement based on a facts-and-circumstances test if, based on all pertinent informa- tion, at least 50 percent of the gross income of a trade or busi- ness is derived from the active conduct of a trade or business in the Qualified Opportunity Zone. Note that the 70 percent tan- gible property test requires 70 percent of the tangible property of the business located within the Opportunity Zone contin- ues to be operative for that business. Working Capital Plans — The 31-Month Test The following two changes were made to the safe harbor for working capital: 1. First, the written designa- tion for planned use of working capital now includes the devel- opment of a trade or business in the Qualified Opportunity Zone as well as acquisition, construction and/or substan- tial improvement of tangible property. 2. Second, exceeding the 31-month period does not violate the safe harbor if the delay is attributable to wait- ing for government action, the
of consideration other than the fair market value, this would violate the anti-abuse rule. Additional Leasing Regulations It is also worth noting that improvements made by a les- see to leased property satisfy the original use requirement and are considered purchased property. Thus, a tenant in a building can also satisfy the Qualified Opportunity Zone business tests noted under the Opportunity Zone program. Intangible Assets For purposes of determining whether a substantial portion of intangible property of a Qualified Opportunity Zone is used in the active conduct of a trade or business, the term “substantial portion” means at least 40 percent. Unimproved Land Unimproved land that is within a Qualified Opportunity Zone and acquired by purchase is not required to be substan- tially improved if it is used in a trade or business of the Qualified Opportunity Fund or the Qualified Opportunity Zone business. Investments Held by Funds Funds have been provided with additional flexibility to hold more than one investment within a fund if they are struc- tured appropriately. Inventory Inventory in transit to a Qualified Opportunity Zone business within its zone will be treated as tangible property that counts for purposes of the 70 percent test for Qualified Opportunity Zone businesses even if it is not within the Op- portunity Zone, so long as it is on the way. Debt Financed Distributions Guidance has been provided under the new regulations re- garding refinancing and distri- butions to partners/members which would permit appreci- ated portions of the property that have been refinanced to be distributed to the partners or members of the Qualified Opportunity Fund on a tax free basis, so long as the dis- tribution is not in excess of the investor’s basis. Brad A. Molotsky prac- tices in the area of real estate law. He serves as a team lead for the Duane Morris Project Develop- ment/P3 industry group and as co-head of the firm's Opportunity Zones practice group.
of proposed regulations for the Oppor- tunity Zone l e g i s l a t i o n (the first set of regulations was released i n Oc t ob e r 2018), which
To help startup businesses, the proposed regulations allow a Qualified Opportunity Fund to satisfy the 90 percent test without taking into account any investments received in the preceding six months―pro- vided those new assets be held in cash, cash equivalents or debt instruments with a term of 18 months or less. This flex- ibility is intended to alleviate concerns with a Qualified Op- portunity Fund receiving addi- tional capital gain funds right before a testing period and not being able to deploy the funds prior to then. Exclusion Elections A taxpayer that is the holder of a direct Qualified Opportuni- ty Fund partnership interest or qualifying stock of a Qualified Opportunity Fund S corpora- tion may make an election to exclude from gross income some or all of the capital gain from the disposition of Qualified Opportunity Zone property re- ported on Schedule K-1 of such entity, provided the disposition occurs after the taxpayer’s 10- year holding period. Continued Opportunity Zone Treatment after Death Neither a transfer of the Qualified Opportunity Fund investment to the deceased owner’s estate nor the distri- bution by the estate to the decedent’s legatee or heir would result in the loss of the Quali- fied Opportunity Fund invest- ment benefit. Vacant Property Where a building or other structure has been vacant for at least five years prior to pur- chase by a Qualified Opportu- nity Fund or Opportunity Zone business, the purchased build- ing or structure will satisfy the original use requirement. Leased Property — Qualified Opportunity Zone Businesses, Original Use, Related Party Leased property may be treated as Qualified Opportu- nity Zone business property if the following two general criteria are satisfied: 1. First, leased tangible prop- erty must be acquired under a lease entered into after Decem- ber 31, 2017. 2. Second, substantially all use of the leased tangible Permissions and Anti-Abuse Rules
The proposed regulations, however, do not impose an original use requirement with respect to leased tangible prop- erty and do not require leased tangible property to be acquired from a lessor that is unrelated. However, the proposed regula- tions provide one limitation as an alternative to imposing a related person rule or a sub- stantial improvement rule and two further limitations that ap- ply when the lessor and lessee are related. 1. First, the proposed regula- tions require in all cases that the lease under which a Quali- fied Opportunity Fund or Quali- fied Opportunity Zone business acquires rights with respect to any leased tangible property must be a “market rate lease.” 2. Second, if the lessor and lessee are related, a Qualified Opportunity Fund or Qualified Opportunity Zone business at any time may not make a prepayment to the lessor for a period of use of the leased tangible property that exceeds 12 months. 3. Third, the proposed regu- lations do not permit leased tangible personal property to be treated as Qualified Oppor- tunity Zone business property unless the lessee becomes the owner of tangible property that is Qualified Opportunity Zone business property and that has a value not less than the value of the leased personal property. This acquisition of property must occur during a period that begins on the date that the lessee receives posses- sion of the property under the lease and ends on the earlier of the last day of the lease or the end of the 30-month period beginning on the date that the lessee receives possession of the property under the lease. 4. Finally, the proposed regu- lations include an anti-abuse rule to prevent the use of leases to circumvent the substantial improvement requirement for purchases of real property (other than unimproved land). In the case of real property that is leased by a Qualified Op- portunity Fund, if, at the time the lease is entered into, there was a plan, intent or expecta- tion for the real property to be purchased by the Qualified Op- portunity Fund for an amount
Brad A. Molotsky
is intended to encourage eco- nomic growth and investment in designated distressed com- munities, known as Qualified Opportunity Zones, by provid- ing federal income tax benefits to taxpayers who invest new capital in businesses located within these areas through a Qualified Opportunity Fund. The 169 pages of proposed new regulations provide much needed guidance to encourage the future use of the Oppor- tunity Zone tax benefit and specifically provide guidance for Opportunity Zone businesses. The following are the highlights of the proposed regulations: Reinvestment of Proceeds from a Sale or Disposition A Qualified Opportunity Fund has 12 months from the time of the sale or disposition of Qualified Opportunity Zone property or the return of capital from investments in relative stock or partnership interests to reinvest the proceeds in other Qualified Opportunity Zone property before the proceeds would not be considered Quali- fied Opportunity Zone property with regards to the 90 percent asset test. Real Property Straddling an Opportunity Zone and a Non-Opportunity Zone A business that purchases real property straddling mul- tiple census tracts where not all of the tracts are designated as a Qualified Opportunity Zones may satisfy the relevant busi- ness requirements if the unad- justed cost of the real property inside a Qualified Opportunity Zone is greater than the un- adjusted cost of real property outside it. Safe Harbors for the 50 Percent Income Test for Qualified Opportunity Zone Businesses The proposed regulations provide three safe harbors and a facts-and-circumstances test for determining whether suffi- cient income is derived from a trade or business in a Qualified Opportunity Zone for purposes
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