In response to the economic disruptions caused by the COVID-19 pandemic, the United States Treasury Department (“Treasury”), on June 4, 2020, issued Notice 2020-39 (the “Notice”) providing relief for Qualified Opportunity Funds (“QOFs”) and taxpayers invested in QOFs. The Notice relaxes several important deadlines imposed by the QOF rules that would otherwise be applicable during 2020.

Background

Sections 1400Z-1 and -2 of the Internal Revenue Code (the “Code”) were enacted as a part of The Tax Cuts and Jobs Act of 2017[i] to spur investment into certain economically distressed communities. The program provides taxpayers who have recently realized gains with a means of deferring, and to some extent avoiding, taxation of those gains as well as the taxation of the gain on the prospective appreciation of their investment.

Pursuant to Code Section 1400Z-2, taxpayers with recently realized gains from the sale of stock, securities, real estate, and other capital assets may defer and even escape some taxation on that gain to the extent the gains are invested in a QOF within 180 days of the sale giving rise to the gain (the “180-day period”). Once invested in a QOF, the taxpayer’s deferred gain must be recognized on the earlier of the date of sale of the taxpayer’s interest in the QOF (or any event treated as an “inclusion event” by the Final Regulations) or December 31, 2026. However, if the taxpayer’s interest in the QOF is held for at least 5 years, the taxpayer’s basis in their QOF interest will be increased by 10 percent. Further, if such interest is held for at least 7 years, the taxpayer’s basis will be increased by an additional 5 percent. If such interest is held for at least 10 years, the taxpayer may elect to have the basis increased to fair market value (the “10-Year Basis Step-Up”) for purposes of a sale of the taxpayer’s QOF interest or the sale of assets by the QOF.

A QOF is defined as a corporation or partnership that is organized for the purpose of investing its assets in qualified opportunity zone property (“QOZP” and the equity interests in such corporation or partnership “QOZ Stock” and “QOZ Partnership Interest” respectively). A QOF is subject to a semi-annual requirement that at least 90% of its assets are invested in QOZP (the “90% Test”). The assets of a QOF are generally tested twice a year with the results being averaged. Noncompliance with the 90% Test will result in certain penalties applicable against a QOF and, in the case of a QOF structured as a partnership or S corporation, a QOF’s investors.

QOZP consists of (i) stock or partnership interests in an entity that qualifies as a “qualified opportunity zone business” (“QOZB”) or (ii) tangible property that qualifies as qualified opportunity zone business property (“QOZBP”).

For a summary of the prior guidance provided by Treasury including proposed Treasury Regulations and the Final Regulations, see our previous Tax Reports here:

• Treasury Releases Corrections to Final Qualified Opportunity Zone Regulations
• Qualified Opportunity Zones: Final Regulations Released
• Qualified Opportunity Zones Guidance: Second Set of Proposed Regulations Released
• New Qualified Opportunity Zones Guidance: Proposed Regulations and Revenue Ruling 2018-29

The Notice

The Notice provides the following relief measures for QOF’s and QOF investors affected by the COVID-19 pandemic.

• 180-Day Period Extension. The Notice provides that if the last day of an investor’s 180-day period falls on or after April 1, 2020, and before December 31, 2020, the last day of that 180-day period is postponed to December 31, 2020. In effect, investors who have realized a capital gain on October 4, 2019 or after will now have until December 31, 2020 to roll that gain into a QOF.
• 90% Test Relief. The Notice provides that for QOFs with a testing date for the 90% Test that falls within the period beginning April 1, 2020, and ending on December 31, 2020, any failure to satisfy the 90% Test on such date will be deemed to be due to reasonable cause under Code Section 1400Z-2(f)(3) and will be disregarded.
• Substantial Improvement Period Relief. The Notice provides that for QOFs or QOZBs with assets that required to be “substantially improved” under Code Section 1400Z-2(d)(2)(D)(i), the 30-month period during which such “substantial improvement” is to be completed will be tolled during the period beginning on April 1, 2020, and ending on December 31, 2020.
• Working Capital Safe Harbor Period Relief. The Notice provides that QOZBs with assets intended to be covered by the “working capital safe harbor” provided for under Treasury Regulations Section 1.1400Z2(d)-1(d)(3)(v) (the “Working Capital Safe Harbor”) before December 31, 2020, will receive not more than an additional 24 months to expend such assets covered by the Working Capital Safe Harbor (provided that such assets meet the other requirements of the safe harbor).
• QOF 12-Month Reinvestment Period Extension. The Notice provides that QOFs making use of the 12-month reinvestment period provided for under Treasury Regulations Section 1.14002(f)-1(b)(1) (the “12-Month Reinvestment Period”) will receive an additional 12 months to reinvest cash covered by such 12-Month Reinvestment Period provided that the original 12-Month Reinvestment Period includes January 20, 2020.

If you have any questions or comments about the foregoing summary of the Notice, please contact Drew Hermiller or Wells Hall who have contributed to the preparation of this Report, or any other member of the Nelson Mullins Opportunity Zone Practice Group.

[i] P.L. 115-97. References to “Section” in this Report refer to Sections of the Code.