Opportunity Zone Tax Incentives May Expand Dramatically

The Opportunity Zone tax incentives have generated a tremendous amount of press and a more than a few multimillion-dollar Opportunity Funds designed to take advantage of the regulations. Despite the chatter, many investors, fund promoters, real estate developers and independent sponsors have not embraced the incentives as a core investment strategy. Rather, the incentives are often seen as a way to opportunistically increase returns on a good investment that happens to meet the fairly restrictive terms of the Opportunity Zone framework. The current proposed regulations are limiting, especially when it comes to Qualified Opportunity Zone Businesses. It may be premature, however, to simply assume the Opportunity Zone tax incentives will be icing on the cake of an otherwise good deal. Rather, if the proposed regulations are modified, then the types of investments that qualify, and therefore the tax savings, could expand dramatically. This is especially true with investments, directly or indirectly, in Qualified Opportunity Zone Businesses.

Despite the Opportunity Zone regulations being concrete enough to produce the IRS forms for certifying eligibility for the incentives, a panoply of the regulations are simply proposed regulations. As a result, it is possible that they can be expanded dramatically, especially under the force of the current substantial lobbying efforts. The finalization of the regulations is behind schedule. For example, a public hearing on proposed Opportunity Zone regulations relating to guidance related to deferring gains resulting from investments in qualified opportunity funds was scheduled for January 10, 2019 in the IRS Auditorium in Washington, D.C. Because of the shutdown, however, the hearing was postponed for over a month. Even more problematic, some of the regulations that the Treasury Department has been given the authority to promulgate have not even been drafted. On January 24, 2019, a group of Congressmen and Senators, including the cosponsors of the Investing in Opportunity Act, asked the Department of Treasury to clarify several issues. The legislators, who were the authors of the “original legislative vehicle for Opportunity Zones,” have advocated for the expansion of the incentives.

One fundamental unresolved issue is what businesses qualify as a Qualified Opportunity Zone Business. The proposed regulations state that the threshold of the amount of Opportunity Zone Business Property required for a business to considered a of Qualified Opportunity Zone Business is 70%. That percentage, however, could be modified depending on the final regulations.

Another principal element of a Qualified Opportunity Zone Business is the threshold of gross income of the trade or business generated from the opportunity zone. The proposed regulations require at least 50% of the gross income of a business to be derived from activity within the opportunity zone. Meeting that threshold severely restricts whether a company can qualify as a Qualified Opportunity Zone Business. If a group of lawmakers have their way, however, the criteria will be altered dramatically. Currently, the proposed regulations require that 50% of the business comes from within the opportunity zone. The Opportunity Zone advocates, however, are pushing to eliminate that requirement and instead replace it with a requirement that a minimum of 50% of the gross income will have to be derived from the active conduct of the entity’s trade or business. Such a change, if adopted, could dramatically reduce the threshold for qualifying as a Qualified Opportunity Zone Business.

Regulations governing Opportunity Fund reinvestment flexibility are not just in flux – some of them have yet to be written. Current proposed regulations provide a working capital safe harbor period for businesses that receive Opportunity Fund investments. The proposed regulations, however, do not provide comparable flexibility for Opportunity Funds seeking investments in Qualified Opportunity Zone Businesses. The Tax Cuts and Jobs Act of 2017 provides the Treasury Department with the authority to draft regulations that provide timing flexibility to Opportunity Funds. It is unclear whether, or when, those regulations will be drafted.

Opportunity Fund and Qualified Opportunity Zone Business regulations provide, and will continue to provide, substantial benefits to investors, both to those investing in funds and directly in businesses. The scope of the businesses and the nature of the investments that qualify for the tax incentives, however, are in flux as the regulations are issued, refined and finalized. If the regulations are loosened, then the Opportunity Zone tax incentives can provide an even greater opportunity for investors, developers and independent sponsors.