Horizons Spring/Summer 2019

Eligible taxpayers that are investing capital into a QOF may continue to defer the initial gain until the earlier of the date of selling the interest in the QOF or December 31, 2026. If the investment in the QOF is held for at least five years, then permanent exclusion of a portion of the originally deferred gain is available. If held for at least seven years, the amount of the exclusion increases. Unfortunately, the December 31, 2026 date creates a deadline of investing capital gains into a QOF by the end of 2019 in order to achieve the seven-year holding period benefits. Lastly, if the interest in the QOF is held for more than ten years, any gains relating to appreciation on the investment in the QOF are not taxable. The investment in the QOF must be sold by December 31, 2047, in order to retain the ten-year benefit. The temporary nature of the program has created urgency among those wishing to utilize the program, but unanswered questions are making it challenging to navigate the rules. Discussion of Unanswered Questions There are many unresolved questions relating to these provisions, but we will delve only into a few of the overarching issues. The introduction calls out the real estate industry as leading the charge with the program. This is because the guidance to date provides more solid ground for real estate than any other industry. There is little guidance for how to invest in operating businesses and still meet the requirements of the program. To illustrate, a QOF may invest in a QOZB, as mentioned previously. There are a number of specific requirements laid out in the provisions that apply. One such provision is that 50% of the income of the QOZB must be derived from a QOZ, but there is no guidance on how to measure this yet. Issues could come up when customers reside both within and outside of a QOZ. Is the proper measurement the location of

the customer the business is serving or is a physical location of the business inside a QOZ enough to pass the test? It is currently unknown and creates risk for investing in an operating business. A QOF may instead acquire the qualified tangible property directly and avoid the 50% income test and other requirements needed to be a QOZB, but it still must meet its asset test at six-month testing periods for the entire life of the QOF. This test requires that any capital in the QOF must be deployed in qualified tangible business property by the end of each testing challenges for operating a business and avoiding consequences relating to not passing the asset test, as a large portion of operating business assets may need to comprise working capital, receivables or intangible assets. Another issue relates to inconsistencies between how a QOF owning a QOZB versus acquiring the qualified tangible property directly is treated. A QOF must hold 90% of its assets as either an investment in a QOZB or in qualified tangible business property. A QOZB is only required to hold 70% of its assets in qualified tangible property. When holding the qualified tangible property directly, other assets of the QOF may only comprise up to 10% of total assets, but other assets of the QOZB in which a QOF invests may comprise up to 30% of total assets. The proposed regulations clearly outline these differences, but there are other inconsistencies that may be unintentional that current guidance does not address. One such inconsistency is that a QOZB may utilize a 31-month working capital safe harbor, by which it has 31 months to deploy capital invested in it by a QOF into qualified tangible business property, but it seems this safe harbor is not available to a QOF directly owning the qualified tangible property without investing through a subsidiary QOZB. window and account for 90% of the QOF’s assets. This creates extreme

38 Opportunity Zones have Potential to Bring Growth, but Post Lingering Questions