The IRS recently issued Notice 2020‑39 (the “Notice”), which grants relief for qualified opportunity funds (QOFs) and their investors in response to the ongoing COVID‑19 pandemic.
The Internal Revenue Code (the “Code”) authorizes the IRS to allow taxpayers to postpone the timeline for performing certain acts determined to be affected by a federally-declared disaster. On April 9, 2020, the IRS issued Notice 2020‑23 to provide COVID‑19 relief for certain time-sensitive actions due to be performed on or after April 1, 2020, and before July 15, 2020. Notice 2020‑39 modifies the relief granted in Notice 2020‑23.
Postponement of 180-Day Investment Period for QOF Investors
The qualified opportunity zone rules provide, in general, that if a taxpayer has a “gain from the sale to, or exchange with, an unrelated person of any property held by the taxpayer,” the taxpayer may elect to exclude from gross income for the taxable year “so much of such gain as does not exceed the aggregate amount invested by the taxpayer in a QOF during the 180-day period beginning on the date of such sale or exchange.” Notice 2020-23 postponed to July 15, 2020, any deadline for the 180-day investment requirement that otherwise would have occurred on or after April 1, 2020, and before July 15, 2020. Notice 2020-39 provides that if the last day of the 180-day investment period falls on or after April 1, 2020, and before December 31, 2020, then the last day of the 180-day period is postponed to December 31, 2020. This relief is automatic and taxpayers do not need to call or write the IRS to receive the relief. However, taxpayers will still need to make a valid election to defer gain in accordance with the instructions to Form 8949, complete Form 8997 and file these forms with a timely-filed federal income tax return for the taxable year in which the gain would be recognized, if the qualified opportunity zone rules did not apply to defer the recognition of gain.
Postponement of 90-Percent Investment Standard for QOFs
The qualified opportunity zone rules define a QOF as any investment vehicle organized as a corporation or partnership for the purpose of investing in qualified opportunity zone property (other than another QOF). The definition also requires a QOF to hold at least 90 percent of its assets in qualified opportunity zone property, determined by the average of the percentage of qualified opportunity zone property held by the QOF as measured: (i) on the last day of the first six-month period of the taxable year of the QOF; and (ii) on the last day of the taxable year of the QOF (the “90-percent investment standard”). If the average of the percentages of the qualified opportunity zone property held by a QOF on these semi-annual testing dates fails to meet the 90-percent investment standard, then the Code generally imposes a penalty for each month that the QOF fails to meet the standard unless the failure is due to “reasonable cause.” Notice 2020-39 provides that in the case of a QOF whose last day of the first six-month period of the taxable year or the last day of the taxable year falls within the period beginning April 1, 2020, and ending on December 31, 2020, then any failure by that QOF to satisfy the 90-percent investment standard for that taxable year of the QOF is:
This relief is automatic and there is no need to contact the IRS. However, a QOF must accurately complete Form 8996 - except that the “Penalty” in Part IV, Line 8 should be shown as “0.”
Working Capital Safe Harbor
An entity must meet certain requirements to be a qualified opportunity zone business, including the requirement that less than five percent of the average of the aggregate unadjusted bases of the entity’s property be attributable to nonqualified financial property. The rules exclude from the definition of nonqualified financial property reasonable amounts of working capital that are held in cash, cash equivalents or debt instruments with a term of 18 months or less.
The Treasury Regulations provide qualified opportunity zone businesses with a safe harbor for treating an amount of working capital as reasonable if certain requirements are met. One of the requirements is that there is a written schedule consistent with ordinary start-up of a trade or business for the expenditure of the working capital assets within 31 months of the receipt of the assets by the business. This 31-month safe harbor period may be extended to a maximum 62-month period if certain additional requirements are met. The Treasury Regulations indicate that if the qualified opportunity zone is located in a federally-declared disaster area, then the business may receive up to an additional 24 months to expend its working capital.
Notice 2020‑39 indicates that as a result of the federal COVID‑19 Emergency Declaration, all qualified opportunity zone businesses holding working capital assets intended to be covered by the working capital safe harbor before December 31, 2020, receive up to an additional 24 months to expend the working capital assets of the qualified opportunity zone business as long as the business otherwise meets the requirements of the working capital safe harbor.
30-Month Substantial Improvement Period for QOFs
The QOF rules provide that tangible property is treated as qualified opportunity zone business property if it is used as trade or business property and satisfies certain other requirements. One of these requirements is that the original use of the post-2017 acquired property must begin with the QOF, or the QOF must substantially improve the property. The substantial improvement requirement is met only if during any 30-month period beginning after the date of acquisition of the post-2017 acquired tangible property, there are “additions to basis with respect to such property” held by the QOF that, in the aggregate, exceed the QOF’s adjusted basis of that property as of the beginning of that 30-month period (the “30‑month substantial improvement period”). Notice 2020‑39 provides that the period beginning on April 1, 2020, and ending on December 31, 2020, is disregarded in determining any 30‑month substantial improvement period (i.e., the 30-month substantial improvement period is tolled during this period).
12-Month Reinvestment Period for QOFs
The QOF rules provide, in general, that if: (i) a QOF sells or disposes of some or all of its qualified opportunity zone property, or a distribution with respect to the QOF’s qualified opportunity zone stock is treated as a return of capital in the QOF’s hands, and (ii) the QOF reinvests some or all of the proceeds in qualified opportunity zone property by the last day of the 12‑month period beginning on the date of the distribution, sale or disposition, then the proceeds, to the extent that they are reinvested, are treated as qualified opportunity zone property for purposes of the 90-percent investment standard. This treatment is available only to the extent that, prior to the reinvestment in qualified opportunity zone property, the reinvested proceeds are continuously held in cash, cash equivalents or debt instruments with a term of 18 months or less. If the QOF’s plan to reinvest some or all of the proceeds is delayed due to a federally-declared disaster, the QOF may receive not more than an additional 12 months to reinvest the proceeds, provided that the QOF invests the proceeds in the manner originally intended before the disaster. Notice 2020‑39 indicates that if any QOF’s 12-month reinvestment period includes January 20, 2020, that QOF receives up to an additional 12 months to reinvest in qualified opportunity zone property provided that the QOF satisfies the requirements of the Treasury Regulations and invests the proceeds in the manner originally intended before January 20, 2020.
Please contact Jay Kennedy, William Lentine, Sean Cook, Cameron DeLong or a member of Warner’s Tax Law Practice Group if you have any questions.
