IRS Extends Qualified Opportunity Zone Deadlines in Response to COVID-19 Pandemic
Gibbons Special Alert
June 12, 2020
The Qualified Opportunity Zone (QOZ) provisions of the 2017 Tax Act include a good number of time-sensitive deadlines that must be met by an investor, a Qualified Opportunity Fund (QOF), or a Qualified Opportunity Zone Business (QOZB) within specific timeframes. The COVID-19 pandemic has made many of these deadlines difficult to meet, just as the QOZ program was becoming used on a more widespread basis. On June 4, the IRS released Notice 2020-39, which provides much needed additional time to meet numerous requirements under IRC Section 1400Z-2 and the implementing regulations, and offers extensions with respect to certain QOZ requirements affected by the COVID-19 pandemic. The Notice also reaffirms the previous guidance offered in IRS Notice 2020-23.
180-Day Investment Period
Investors who recognize taxable gain generally have 180 days from the initial date of the sale or exchange to reinvest the gain into a QOF to qualify for the tax benefits of the QOZ provisions. For allocated partnership gains, a partner has the option of starting the 180-day period on (i) the initial date of sale; (ii) the last day of the partnership’s taxable year, generally December 31 of that taxable year; or (iii) the unextended due date of the partnership’s tax return (generally March 15 of the next calendar year).
For any gains recognized on or after October 4, 2019 (for which the earliest 180-day period would have expired on April 1, 2020), Notice 2020-23 previously extended the deadline until July 15, 2020. Notice 2020-39 further extends this deadline until the end of this year, December 31, 2020. Therefore, investors who were faced with a 180-day period that would have expired any time on or after April 1, 2020 and before December 31, 2020 will now have until December 31, 2020 to reinvest their gains into a QOF.
A taxpayer that takes advantage of this extension must file IRS Forms 8949 (Sales and Dispositions of Capital Assets) and 8997 (Initial and Annual Statement of Qualified Opportunity Fund (QOF) Investments) together with their timely filed (including extensions) or amended federal income tax return for the year in which the gain would have been recognized if not for the taxpayer’s investment in a QOF.
90% Asset Test
Under IRC Section 1400Z-2(d)(1), 90% of a QOF’s assets must consist of qualifying QOZ property on specific semiannual testing dates. Notice 2020-39 provides that any failure by a QOF to meet the 90% asset test on any testing dates that fall within the period beginning April 1 and ending December 31, 2020 will automatically be considered to have satisfied the reasonable cause standard for avoiding penalties under Section 1400Z-2(f)(3). Consequently, such a failure will not result in the statutory penalty under Section 1400Z-2(f) and will not prevent a QOF from otherwise satisfying the requirements of Section 1400Z-2. While this and all other extensions provided by the Notice are available automatically, QOFs must still comply with the applicable tax filing requirements, in this case by completing and filing Form 8996 (showing a “0” as the penalty amount) with a timely filed federal income tax return.
30-Month Substantial Improvement Requirement
A core requirement for tangible QOZ property is that it must be either (i) substantially improved if a pre-existing asset, or (ii) originally used by a QOZB if the asset has not yet been placed in service. Substantial improvement means that the QOZB makes expenditures that double the property’s cost basis over a 30-month period. Notice 2020-39 tolls the 30-month substantial improvement period for the period beginning on April 1, 2020 and ending on December 31, 2020. For example, if a QOZB bought property early in January 2020, such that only three months had elapsed by April 2020, the QOZB would have 27 more months to substantially improve the property when the counter resumes on January 1, 2021.
Working Capital Safe Harbor
A QOZB is normally restricted to holding no more than 5% of its total assets in the form of cash or various other “nonqualified financial assets.” A working capital safe harbor allows a QOZB to hold cash pursuant to a written plan for up to 31 months, provided the working capital is disbursed to acquire or build QOZB property within that time period in accordance with the plan.
Notice 2020-39 extends the working capital safe harbor period for “not more than” an additional 24 months (i.e., 31 months plus 24 months, up to 55 months in total) by effectively treating all QOZ property as being in a federally declared disaster area and therefore eligible for the 24-month relief period provided for in the existing Treasury Regulations. This extension applies to all working capital plans in place before December 31, 2020, whether by a QOZB or by a QOF.
An issue with potentially severe consequences was not addressed, however – how much the written plan is permitted to deviate from the original written plan as a result of the substantial market disruptions caused by the COVID-19 pandemic. Currently, the plan is required to be effectuated in a manner “substantially consistent with the original written plan.”
12-Month Reinvestment Period
A QOF or QOZB that sells QOZ property (or receives a return of capital from a QOZ property) is permitted to roll over the proceeds into other QOZ Property within a 12-month period, so long as the proceeds are continuously held in cash or short-term debt instruments prior to the reinvestment. The proceeds (which are otherwise not qualifying QOZ property) are treated as QOZ property for purposes of the 90% asset test during that 12-month period. If a QOF’s 12-month reinvestment period includes January 20, 2020, Notice 2020-39 extends this rollover period for an additional 12 months so long as the other requirements applicable to QOF or QOZB reinvestments are satisfied.