Guidance from the IRS Needed to Spur Investment in Opportunity Zones
While potential investors and Opportunity Fund managers have been diligently modeling different fund structures and investment options in recent months, it has become clear that many are awaiting further clarification and guidance from the Internal Revenue Service (IRS) before finalizing their strategies and deploying capital into Opportunity Zones.
The IRS has released two rounds of Frequently Asked Questions (FAQs) – one in April, another in June –to provide information beyond what is outlined in the Tax Cuts and Jobs Act that explains different facets of Opportunity Zones; the tax benefit, fund certification, etc. More information from the IRS is anticipated, although the timeline is unclear. This month, Treasury Secretary Mnuchin testified before Congress that we may see more robust regulatory guidance on Opportunity Zones by year’s end.
While we await additional information from the IRS, a level of uncertainty remains. The following examples have been identified as common barriers that first movers are wrestling with, especially as they attempt to innovate and invest in activities that wouldn’t otherwise occur.
Examples of Where Requests for Guidance Have Been Made
What is a Qualified Opportunity Zone Business?
A Qualified Opportunity Zone Business is defined as one “in which substantially all of the tangible property owned or leased by the taxpayer is [QOZ Business Property]” and that meets certain additional requirements. The term “substantially all” is not defined in the statute, therefore clarity is needed regarding when the “substantially all” threshold has been met.
There are a number of similar examples where key terms are in need of further clarity.
How long can eligible capital sit in an Opportunity Fund before it must be invested, and the Fund tested?
It’s clear that investors have 180 days to move unrealized capital gains into an Opportunity Fund. However, once that capital is received by the fund, it is unclear how long the fund can hold the capital before its tested for compliance with the 90% deployment threshold.
The statute directed Treasury to identify an adequate timeframe for the deployment and reinvestment of capital, as well as the length of time between when an Opportunity Fund is formed and when it must participate in its first semi-annual testing date. Some have recommended an 18-month start-up period prior to the fund’s first deployment test, allowing a runway for aggregating investor capital, developing a pipeline of investable deals, and deploying capital into Opportunity Zones.
Can capital be recycled/revolved in one Opportunity Fund through multiple investments?
Some potential Opportunity Fund structures have been modeled as partnerships where capital is deployed and paid back multiple times over the term of a single investment However, without clarifying guidance, it seems that the Opportunity Fund partner (investor) would be immediately taxed when the fund exits an investment before exiting the Fund, meaning they would not be eligible to receive the tax benefits associated with full-term of their investment in the fund.
For example: An investor makes a seven-year investment into an Opportunity Fund. The fund then makes an initial investment of three years, and at exit uses that same capital to make a four-year investment. It is unclear whether the IRS will view this investment as eligible to receive tax benefits associated with a seven-year investment, or a three-year and four-year investment.
This is sometimes referred to as the “interim gains” issue and taking the latter approach is viewed as contrary to the original intent of the statute.
These are just three issues highlighted by a cohort of investors, community development practitioners, policy shops, and tax/accounting firms in a recent letter submitted to the IRS requesting guidance. Similar letters - including the letter Enterprise submitted in March - have been sent to Treasury on a range of issues including transparency, reporting requirements, fraud and abuse. Enterprise urges the IRS to act swiftly in providing a transparent process for delivering regulations that allows for robust public input.