The IRS has issued additional guidance on opportunity zone investments that clarifies many open items for investors and developers.
Many of the outstanding questions tempering investment in the zones were answered favorably. The new regulations can be found on the IRS website.
With this new guidance, investors that were on the sidelines are now moving forward with opportunity zone investments.
Previously, advisers were concerned with an opportunity zone fund owning more than one investment. The new rules indicate that investors can own multiple investments through a fund and still receive tax-free appreciation after holding the fund for 10 years.
This is a welcome clarification, as it simplifies opportunity zone fund structuring and reduces uncertainty for investors. The new rules also clarify that the holding period for a fund starts when the first investment is made.
The rules require taxpayers to reinvest capital gains to enjoy the opportunity zone benefits. Capital gains from the sale of stocks or bonds were clearly eligible, but there was some uncertainty around the sale of certain business property. The new rules state that sales of Section 1231 assets also qualify for investment in opportunity zone funds if the net of all 1231 asset sales for the year results in an overall gain. Such sales include a hotel, multifamily rental property and land or other buildings used in a trade or business.
The fund must invest in qualified opportunity zone business through a partnership or corporation, or the fund can operate a trade or business with qualified property. Substantially all of the property must be held and used within an opportunity zone to qualify. The new regulation provides that “substantially all” means the property must be held by the opportunity zone fund within a zone at least 90% of the time.
The new rules also state that qualified property must be used by the fund within a zone at least 70% of the time. The IRS believes taxpayers can control how and when property is held by the fund.
The use standard needs to have more flexibility because of equipment downtime for such events as maintenance and seasonal business trends. The IRS also clarified that leased property qualifies but is subject to these same rules that apply to property owned by the opportunity zone fund.
The new rules also provide clarity regarding when the fund sells an investment or business. The regulations state a fund has one year from the date of sale to reinvest the proceeds in another opportunity zone business or property. The proceeds must be continuously held by the fund in cash, cash equivalents or debt instruments with a term of 18 months or less.
It’s important to note the holding period restarts for the 10-year holding requirement to receive tax-free appreciation. If there are multiple investments with different holding periods, the restarted holding periods can lead to some administrative headaches for the fund.
Investors also receive clarification on the 50% of gross receipts test for an opportunity zone fund by providing safe harbors. For example, the test is met if 50% of the employee time worked is within an opportunity zone or 50% of the employee compensation is within a zone.
Overall, the new regulations provide welcome clarifications for investors and developers. Additional investments are already moving forward as a result of these new rules.
Derek Smith is a partner at BKD CPAs & Advisors. He can be reached at
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