On August 4th, the Treasury Department modified regulations around qualified opportunity zone funds (QOFs) which are, essentially, an incentive for private and public investments into underserved communities across America.
Opportunity Zones (OZ) were created to help economically distressed areas by giving investors preferential tax treatment with new investments in these “specified” areas. Similar to QSBS, if the investment meets eligibility criteria and is held for at least 5 years, the investor can defer or be exempted from capital gains taxes (i.e. if held for at least 5 years, the taxpayer can exclude 10% of the gain and the percentage increases (or “steps up”) to 15% after 7 years).
One of the requirements of QOFs is that the funds must be invested in a qualified opportunity zone business (QOZB). To be a QOZB:
- 70% (sometimes 90%) of assets must be qualified opportunity zone business, otherwise known as the Good Asset Test.
- Less than 5% of assets are in passive investments, otherwise known as the Bad Asset Test.
These tests are applied semi-annually. There is an exception to the Bad Asset test where more than 5% of assets may be in passive investments if it is for reasonable working capital amounts—this is called the working capital safe harbor (WCSH). Regulations conclude that when there is a WCSH and it is met, then the Good Asset Test also meets requirements while WCSH is still in effect. However, because of an error in drafting, there were many questions as to when this exception would apply.
On August 4th, the IRS and Treasury Department corrected the error and explained that if the WCSH was satisfied, the Good Asset Test would also satisfy. However, this correction only applies to start-up businesses. The issue now is that there is no definition for what is considered a start-up.
As a result, the IRS and Treasury Department cleared up one aspect of the opportunity zone fund regulations, while creating confusion around another. Clarification will be needed as to what constitutes a start-up business, especially in regards to real estate development and acquisition.
This article does not constitute legal or tax advice. Please consult with your legal or tax advisor with respect to your particular circumstance.