Taking Advantage of Opportunity Zones
Investing in qualified opportunity zones (QOZ) can provide taxpayers a deferral of capital gain taxes until 2026, a 10-percent reduction if the Qualified Opportunity Fund (QOF) investment is held for five years, and a permanent exclusion from taxes on any incremental gains if the QOF investment is held for 10 years. As a result of the coronavirus pandemic, the IRS has extended several deadlines and granted numerous measures of relief for QOF investors, QOFs and Qualified Opportunity Zone Businesses (QOZB) under Notice 2020-39.
Additional Time to Invest
To qualify for the benefits mentioned above, taxpayers need a realized capital gain and need to reinvest into a QOF within 180 days of the date of the realized capital gain. The 180-day period for Section 1231 gains (no longer netted with 1231 losses) starts on the date of the sale/exchange that gives rise to the Section 1231 gains. When a partnership recognizes a gain, partners have three options for when the 180-day period can start:
- The day the gain is realized by the partnership
- The last day of the partnership’s tax year in which the gain is recognized
- The due date (without extensions) of the partnership’s tax return (generally March 15) for the year in which the gain is recognized
Notice 2020-39 extends the 180-day period for QOF investors to reinvest their qualified gains. If the last day of the 180-day period falls between April 1, 2020, and Dec. 31, 2020, then the last day of the 180-day period is postponed to Dec. 31, 2020. For example, if a taxpayer realized a capital gain on Nov. 3, 2019, the 180-day period ended May 1, 2020 (within the relief period). The taxpayer now has until Dec. 31, 2020, to reinvest their capital gain into a QOF. The relief is automatic. However, taxpayers still need to make the deferral election per the instructions for Form 8949 and file Form 8997 timely with their annual tax return.
Relief for QOFs/QOZBs
There are several measures of relief for QOFs and QOZBs:
- 90-percent test. QOFs must invest at least 90 percent of their assets into a QOZ property. The 90-percent test must be met biannually and reported on Form 8996 on the QOF’s yearly tax return. If the QOF fails the test, they are subject to a penalty for each month they fail to meet the requirements. The testing periods are the last day of the first six-month period of the taxpayer’s tax year (for initial years, the last day of the six-month period after a taxpayer chooses to be a QOF) and the last day of the taxpayer’s tax year. Notice 2020-39 provides penalty relief for failure to meet the 90-percent test if the last day of the first six-month period or the last day of the tax year falls between April 1, 2020, and Dec. 31, 2020. The QOF should still file Form 8996 timely with their annual tax return, but can put “0” in Part IV, Line 9, Penalty.
- Substantial improvements. QOZBs must substantially improve QOZ property within any 30-month period. Under Notice 2020-39, the nine months between April 1, 2020, and Dec. 31, 2020, are essentially ignored in counting toward the overall 30-month period.
- Working capital safe harbor. A QOZB cannot hold more than 5 percent of its assets in nonqualified financial property (cash or cash equivalents). However, QOZBs are afforded a working capital safe harbor for 31 months if certain requirements are met. Notice 2020-39 states that all QOZBs holding working capital assets who intended to use the working capital safe harbor before Dec. 31, 2020, receive an additional 24 months to spend the cash as long as the QOZB would otherwise meet the requirements of the safe harbor.
- 12-month reinvestment period for QOFs. The final regulations allow a QOF that sells or disposes its QOZ property to reinvest the proceeds into other QOZ property within 12 months after the disposition and treat the reinvested proceeds as QOZ property for purposes of the 90-percent test. If the 12-month reinvestment period includes Jan. 20, 2020, the reinvestment period may be extended up to an additional 12 months.
CPAs should inform their clients about the welcome extensions under Notice 2020-39, whether they are a taxpayer with capital gains who now has extra time to reinvest or a QOF or QOZB who has extra time to meet the various requirements.
Ashley M. Kettler
Ashley M. Kettler, CPA, is a tax senior manager specializing in real estate at Withum. She is a member of the NJCPA.
This article appeared in the November/December 2020 issue of New Jersey CPA magazine. Read the full issue.