Page 20 - Venture - State of the Market 2019

The updated regulations provide crucial information to guide investors as they navigate the space. We’ve
OPPORTUNITY ZONES
CAPITAL AND TAXPAYER GAINS
OZs are for capital gains only, meaning that other gains, such as dividends or royalties, cannot be
directed into a fund. Partnerships can defer and invest gain in an opportunity fund. The updated regulations
clarify that deferred gains will not be included in the distributive shares of the partners, and if the
partnership does not elect to defer gain and invest in an QOF, a partner generally may elect his or her own
deferral with respect to the distributive share and separately invest in a QOF. The updated
regulations explain that the 180-day window to invest the gain begins on the date the gain otherwise would
be recognized for federal income tax purposes. For publicly traded stock, this is the trade date. For a REIT
undistributed capital gain, the period begins on the last day of the REIT’s taxable year. For REIT capital gain
dividends, the period begins when the dividend is paid. For investors in a partnership the 180 day-period
can start on the last day of the partnership’s taxable year.
RULE CHANGES
When opportunity zones (OZ) were first enacted last winter, investors knew it would be a game changer in
the commercial real estate space, with the potential to improve communities across the country. Our early
conversations indicated tremendous investor interest, however, due to ambiguities in the initial regulations,
many remained on the sideline.
In the fall, the Treasury released updated guidelines to address key unknowns, and while there are still
some lingering questions, this guidance is enough to get investors and fund managers off the sidelines and
onto the field.
18 VENTURE | 2019 STATE OF THE MARKET
grouped the new rules into four categories - those concerning gains, businesses, Qualified Opportunity
Funds (QOF), or building and land.
OPPORTUNITY ZONE BUSINESS
To qualify as an OZ business, the Treasury originally stated that “substantially all” of a partnership or corpo-
ration’s tangible property owned or leased must be qualified
opportunity zone business property. There was uncertainty about what “substantially all” meant. The
Treasury has concluded 70 percent represents “substantially all.” Further at least 50 percent of the gross
income of a qualified OZ business must be derived from the active conduct of a trade or business in the
qualified OZ.
QUALIFIED OPPORTUNITY FUNDS
QOFs must be classified as a corporation or partnership for income tax purposes,
therefore a limited liability company (LLC) qualifies as an ownership structure. Investors
favor LLCs for the flexibility they allow, this clarification is particularly welcome.
Opportunity funds must also be created or organized in one of the 50 U.S. states, DC, or a U.S. territory.
The updated regulations also provide clarity surrounding the valuation method for applying the 90-percent
asset test, removing ambiguity about how to prove that assets are being invested and reinvested properly.
The QOF uses the asset values that are reported on the QOF’s applicable audited financial statement for
the taxable year, or if there is no statement available then the cost of its assets will be used.
The last day of the fund’s taxable year will now be considered a test date for the
90-percent asset test. This point is particularly important, as it allows QOFs to hold cash without violating
the rule that opportunity funds must reinvest 90 percent of all
investments into OZ assets by 6-31 or 12-31 of the year the money was invested in the QOF. The regulations
confirm that the QOF can borrow funds to invest in OZ assets and the funds will not be deemed contribu-
tions of cash and create a separate, taxable
interest in the fund.
Another question that was addressed concerned the effect of the expiring OZ legislation in 2028. Per the
latest guidance, investors can now take advantage of basis step-up
election at sale of the QOF investment, under the proposed regulations until Dec. 31, 2047.
BUILDING AND LAND IMPROVEMENTS
Property must either be put to its original use by the fund, or the fund must substantially improve the prop-
erty. The OZ law defines substantial improvement as the doubling of the adjusted tax basis of the proper-
ty. The updated regulations provide that the original use and substantial improvement requirements only
relate to the structure and not the
underlying land. Revenue Ruling 2018-29 was released along with the proposed r
egulations and clears up concerns surrounding the improvement of the building.
Essentially, it states that:
•The original use of the building in the qualified opportunity zone (QOZ) is not considered to have com-
menced with the QOF.
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