Qualified Opportunity Fund Partnership Investments Under...
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Qualified Opportunity Fund Partnership Investments
Under 1400Z: Special Timing and Deferral OpportunitiesTHURSDAY, AUGUST 29, 2019, 1:00-2:50 pm Eastern
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August 29, 2019
Qualified Opportunity Fund Partnership Investments Under 1400Z: Special Timing and Deferral Opportunities
William C. Lentine, Partner
Warner Norcross + Judd
Daren R. Shaver, Attorney
Hanson Bridgett
Dave Sobochan, CPA, Partner
Cohen & Company
Notice
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The information contained herein is of a general nature and based on authorities that are
subject to change. Applicability of the information to specific situations should be
determined through consultation with your tax adviser.
Qualified Opportunity Fund Partnership Investments
August 29, 2019
Terminology
Abbreviation Term
QOZ Qualified Opportunity Zone
QOZB Qualified Opportunity Zone Business
QOZBP Qualified Opportunity Zone Business Property
NQFP Non-Qualified Financial Property
QOF Qualified Opportunity Fund
QOZP Qualified Opportunity Zone Property
PTE Pass-through Entity
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Overview
Qualified Property
Investor
Qualified Opportunity
Fund
Qualified Business
• Tangible property• Acquired by purchase• New or substantially improved• Used in QOZ
• Only capital gains• Timing –180 days• Rollover gain deferral and
reduction• Post-acquisition gain exclusion
• Geography• Corp or P/S invests in QOZ
property• 90% of assets are QOZ property• Mixed funds
• 70% qualified property• 50% or > of total income in QOZ• 40% of intangibles used in
business• Not too much cash/securities• No sin businesses
Cash or property
Stock or partnership interest
*Source: Staff of the Joint Committee on Taxation, June 2019 - Doc 2019-238147
Background
• Created as part of the Tax Cuts and Jobs Act that was signed into law December 22,
2017
― Established 2 new code sections 1400Z-1 and 1400Z-2
• This provision is designed to incentivize long-term investment in low-income and
economically distressed communities
• Is available to a wide range of taxpayers - individuals, C Corps (including RICs and
REITs), S Corps, partnerships, trusts and estates
• Taxpayers have the ability to defer paying tax on capital gains by investing those
capital gains into QOFs which in turn invest in QOZP
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Structural Scenarios
Scenario 1: Partner(s) initially contributed non-eligible gains to QOZB; now wish to
replace those funds with eligible gains and take advantage of OZ benefits.
Scenario 2: OZ Land acquired by an LLC/Partnership after Dec. 31, 2017
Scenario 3: Existing OZ land held by an LLC/Partnership acquired before Dec. 31,
2017
Scenario 4: Working Capital Reserve (i.e., examples of WCR in action)
Scenario 5: How/when to cash-out using proceeds of a non-recourse financing
Tax Incentives
• The 1st main tax incentive for taxpayers is the temporary deferral of inclusion of capital gain
into taxable income
• The gain must be derived from a sale/exchange with an unrelated party (20% test)
• Includes all types of gain treated as capital gain for Federal income tax purposes:
― Short-term capital gain and long-term capital gain would qualify
― Unrecaptured 1250 gain would qualify
― Gain subject to section 1245 and 1250 recapture would NOT qualify
― Only net Section 1231 gain (subject to end of year netting process and the 5-
year lookback rules for section 1231 losses)
― The 180 day period for reinvesting net Sec. 1231 gains does not begin until
the last day of the tax year
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Tax Incentives (cont’d)
Zero
Bas
is
BASIS
10% Basis
15% Basis
At time of sale or exchange or taxable year that includes December 31, 2026, remaining rollover gain is recognized and tax is paid. If investment has lost value, gain is computed using fair market value
After 5 years, basis is increased by 10% of the rollover gain
After 7 years, basis is increased by and additional 5% of the rollover gain
Basis starts at zero
Ro
llove
r G
ain
A
mo
un
t
*Source: Staff of the Joint Committee on Taxation, June 2019 - Doc 2019-2381411
Tax Incentives (cont’d)
The 3rd main tax incentive is the permanent exclusion of post-acquisition appreciation
on the original investment in the QOF
• This incentive is only available to those taxpayers who have held their
investment in the QOF for at least 10 years
• Can hold investment through December 31, 2047 and still qualify for
permanent step up
• The taxpayer’s exit strategy from the QOF will determine the ability for the
taxpayer to exclude some or all gain on sale of the investment.
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180-Day Rule
The proposed regs permit a partnership to elect to defer the gain at the pass-through
entity (PTE) level (these rules also apply to other PTEs and their shareholders or
beneficiaries - S corps/trusts/estates).
• To the extent the partnership (or PTE) does not elect deferral, the partner or
shareholder etc., will be permitted to do so
• The partner’s 180-day period generally begins on the last day of the
partnership’s tax year
• Alternatively the partner may choose to begin his or her own 180-day period
on the same date as the start of the partnership’s 180-day period
The deferral election will be made using IRS Form 8949
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Qualified Opportunity Fund
A QOF is an investment vehicle organized as a corporation or partnership whose purpose is
to deploy funds into qualified opportunity zone property
• Funds will undergo a self-certification process by filing Form 8996
• Form 8996 will need to be attached to the timely filed federal income tax return for
the fund, including extensions
• Must hold 90% of its assets in qualified opportunity zone property
― Failure to meet the 90% asset test will result in penalties
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Qualified Opportunity Fund
*Source: Staff of the Joint Committee on Taxation, June 2019 - Doc 2019-2381416
Census Tracts Designated as Opportunity Zones
There were criteria around which census tracts that could be nominated by the Governors of
each state and subsequently approved by the IRS
• Leveraged definitions under Sec. 45D(e) for what was considered a low-income
community
The designation and approval process is now complete
• 31,848 Eligible Low-Income Community census tracts
• 10,312 Eligible Non-Low-Income Community Contiguous tracts
• 8,764 Designated QOZs
• A complete list of the designated Qualified Opportunity Zones can be found in IRS
Notice 2018-48
The Community Development Financial Institutions Fund has created a mapping tool that will
identify the opportunity zones in each state:
https://www.cims.cdfifund.gov/preparation/?config=config_nmtc.xml
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Qualified Opportunity Zone Property
There are 2 different ways a QOF can invest in eligible property
The 1st way is a direct investment in “Qualified Opportunity Zone business property (QOZBP)”
• This includes tangible property such as machinery and equipment, furniture and fixtures, buildings, tenant improvements and land acquired by the QOF by purchase after 12/31/17
• Substantially all of the use (70%) of the property must be in the QOZ for substantially all (90%) of the QOF’s holding period
• The original use of the property in the QOZ must commence with the taxpayer
• Alternatively the fund can substantially improve the property
― Substantial improvement requirement is met if during a 30-month window following acquisition, the basis of the property increases by an amount that exceeds the amount of the adjusted basis at the beginning of the period
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Qualified Opportunity Zone Property (cont’d)
The 2nd way of investing in eligible property is an indirect investment through a qualified
opportunity zone stock or a qualified opportunity zone partnership interest
• The stock or partnership interest must be acquired in exchange for cash after
December 31, 2017
• The corporation or partnership must qualify as a qualified opportunity zone
business (QOZB)
• Must be original issue if acquiring qualified opportunity zone stock (redemption
rule under Section 1202(c)(3) applies)
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Qualified Opportunity Zone Business
• Substantially all (70%) of the tangible property owned or leased by the taxpayer is
qualified opportunity zone business property
• At least 50% of the business’s total gross receipts are derived from the active conduct
of a trade or business
• A substantial (40%) portion of the business’s intangible property is used in the active
conduct of a trade or business
• Less than 5% of the average of the aggregate unadjusted bases of the business
property is attributed to nonqualified financial property (NQFP)
• Business cannot be a “sin” business
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Qualified Business: Sufficient QOZ Activity Safe Harbor
First safe harbor: At least 50% of services performed (based on hours) in the QOZ by
employees and contractors
Opportunity Zone
= service provider
*Source: Staff of the Joint Committee on Taxation, June 2019 - Doc 2019-2381421
Qualified Business: Sufficient QOZ Activity Safe Harbor
Second safe harbor: At least 50% of amounts paid are for services performed in the QOZ
Opportunity Zone
= service provider
= income from services performed in the QOZ
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Qualified Business: Sufficient QOZ Activity Safe Harbor
Third safe harbor: Tangible property and operational functions combine to generate 50%
of gross income
Opportunity Zone
= service provider
= manager
= tangible property
*Source: Staff of the Joint Committee on Taxation, June 2019 - Doc 2019-2381423
Qualified Opportunity Fund: Structure
Qualified Opportunity Fund(partnership or corporation)
One Tier Two Tier
Taxpayer 1 Taxpayer 2 Taxpayer 1 Taxpayer 2
Qualified Opportunity Fund(partnership or corporation)
Qualified Business(partnership or corporation)
Qualified Property
Qualified Property
• 50% or greater of total income in QOZ
• 40% of intangibles used in business
• Not too much cash/securities• No sin businesses
90% requirement90% requirement
*Source: Staff of the Joint Committee on Taxation, June 2019 - Doc 2019-2381425
Qualified Business
90% Requirement• Applies in “one tier”
and “two tier” structures
• Looks to all assets of QOF.
• May be a 63% test (90% * 70%) in a “two tier” structure
Substantially All (70%) Requirement• Applies only in “two tier”
structure• Looks to tangible property of
qualified business. Other assets are excluded from test
• Qualified business must also satisfy additional requirements which do not apply in “one tier” structure
*Source: Staff of the Joint Committee on Taxation, June 2019 - Doc 2019-2381426
Qualified Opportunity Zone Business (cont’d)
Working Capital Safe Harbor (For NQFP Rule)
• Available for qualified opportunity zone businesses that acquire, construct or
rehabilitate tangible business property, which includes both real property and
other tangible property, used in a business operating in an opportunity zone
• Also available for the development of a trade or business within an opportunity
zone.
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Qualified Opportunity Zone Business (cont’d)
Working Capital Safe Harbor Cont.
• Will provide for a period of up to 31 months before the cash being held by the
qualified opportunity zone business will be considered NQFP if the following
are true:
― There is a written plan designating the amounts for the acquisition,
construction and/or substantial improvement of property within the
zone
― The written plan is reasonable
― The working capital assets are actually used in a manner consistent
with the schedule
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Preferred Structuring and Exit Strategy
• The largest tax benefit for a taxpayer participating in QOZ program is the ability to
permanently exclude gain attributable on the appreciation of his or her QOF interest
if held for at least 10 years
• The proposed regulations provide for differing treatment of the gain on sale
depending upon if the taxpayer sells his or her QOF interest vs. the QOF selling
qualified opportunity zone property
• Debt financed distributions after 24 months is allowable but care should be taken in
analyzing complex partnership debt allocations rules and interest tracing rules.
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Preferred Structuring and Exit Strategy (cont.)
Sale of a QOF partnership interest
• The basis of all assets of the QOF are deemed to be stepped up to FMV similar
to a Sec. 743(b) adjustment under a valid Sec. 754 election
• A consequence of the deemed step-up is that no amounts of the gain on sale
will be re-characterized as ordinary income under the Sec. 751 rules related
to “hot assets”
― Hot assets include unrealized receivables, inventory items and
depreciation recapture
• Ultimately this results in all gain (both ordinary and capital) escaping taxation
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Preferred Structuring and Exit Strategy (cont.)
Sale of assets
• The taxpayer can make an election to exclude from gross income some or all
of the capital gain arising from the disposition of QOZP reported on the
Schedule K-1 he or she receives from the QOF
• The taxpayer must have held a qualifying investment in a QOF partnership or
QOF S corporation for at least 10 years
• The QOF partnership or QOF S Corporation must dispose of the QOZP after
such 10 year holding period
• The election only applies to capital gain from QOZP
― Therefore a taxpayer will be required to recognize into income any
ordinary income that results under the Sec. 751 rules
• Taxpayers cannot rely on this rule at this time
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Comparisons
New Market Tax Credit
• Section 45D provides tax credits for
taxpayers who invest in low-income
communities
• Similar to the QOZ rules, taxpayers
must invest through entities
• Credit is limited to amounts
allocated to investment through
application process
• Investors without allocations get no
benefits
• No new allocations after 2019
Like-Kind Exchanges• Section 1031 provides taxpayers
who sell property and reinvest in
like-kind property with deferral of
tax on gain
• In contrast to the QOZ rules,
taxpayers must directly acquire
replacement property
• The 2017 Tax Act limited the
applicability of Section 1031
*Source: Staff of the Joint Committee on Taxation, June 2019 - Doc 2019-2381432
QOZ Investment vs. 1031 Exchange
QOZ Investment 1031 Exchange
How much needs to be invested? Only capital gains from sale in any
amount
All proceeds (to receive full tax deferral)
Identification requirements replacement
property
No separate identification requirement Replacement property must be identified
in 45 days (limit on # of properties to be
identified)
Acquisition of replacement property Must invest in QOF within 180 days. The
QOF has additional time to reinvest the
proceeds into QOZP
Within 180 days
Eligible asset classes Very flexible, including real property and
tangible personal property substantially
all of which is used in the conduct of an
active trade/business in a QOZ
Beginning in 2018, will only be allowed
for real property held for investment in
use in a trade/business.
Additional requirements on property? Property must meet original use or
substantial improvement tests
No improvement requirements
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QOZ Investment vs. 1031 Exchange cont.
QOZ Investment 1031 Exchange
Is an intermediary required? No Yes
Tracing of proceeds required? No direct tracing rules Yes – taxpayer cannot have access to
the funds
Related parties Can’t defer capital gain from a sale or
exchange with a related party
Permitted, however a 2 year holding
period is required post-exchange
Where can you Invest? Only through a QOF that invests in
eligible census tracts designated as
opportunity zones
Anywhere in the U.S.
Taxpayer considerations Either the partnership (or other PTE) or
its partners may elect deferral
Taxpayer selling property must also
acquire the replacement property
State considerations Will depend upon a state’s conformity to
the IRC – not all states recognize the
provision
A vast majority of the states conform to
federal treatment.
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QOZ Investment vs. 1031 Exchange cont.
QOZ Investment 1031 Exchange
Tax Benefits 1) Capital gains will be
deferred until the earlier of
either the QOF interest is
sold or December 31,
2016, whichever comes
earlier.
2) QOF investments held for
5 years see 10% of
originally deferred gain
excluded; held for 7 years
will have 15% excluded.
3) QOF investments held for
10 years are eligible for all
post appreciation gain on
investment permanently
exclude tax.
A QOF investment is
considered an IRD asset and
ineligible for a basis step-up at
death.
1) Tax will continue to be
deferred indefinitely
through perpetual
exchanges, but capital
gains will be fully taxable
upon the sale of the final
replacement property.
2) The property is eligible for
a step-up to the property’s
FMV upon death of the
exchanger.
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Filing Requirements
Investor
• Elect deferral of the capital gain using Form 8949
QOF
• Self-certify using Form 8996 for the initial tax year the entity will be
considered a QOF
• File Form 8996 annually to report compliance with the 90% asset test
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Documentation Checklist
QOF
• Articles of organization
• Application for EIN
• Multi-member operating agreement
• Form 8996 to certify the fund and report annual 90% asset test compliance
QOZB
• Articles of organization
• Application for EIN
• Multi-member operating agreement (if taxed as a partnership)
• Construction plan for working capital safe harbor (as applicable)
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Structural Scenarios
Scenario 1: Partner(s) initially contributed non-eligible gains to QOZB; now wish to
replace those funds with eligible gains and take advantage of OZ benefits.
Issues: Disguised Sale of underlying property, disguised sale of membership interest,
QOZ requirement that membership interest be acquired at “original issue”/anti-
churning rule
Scenario 2: OZ Land acquired by an LLC/Partnership after Dec. 31, 2017
Issues: Best structure for OZ benefits; whether existing LLC/Partnership can/should
become the QOF or QOZB?
Scenario 3: Existing OZ land held by an LLC/Partnership acquired before Dec. 31,
2017
Issue: If land sold, must pass related party tests; lease structure can avoid that
result
Structural Scenarios
Scenario 4: Working Capital Reserve (i.e., examples of WCR in action)
Issue: Where to park cash in Scenario 1 circumstance
Issue: Whether cash in WCR is treated as “spent” for good/bad asset computational
purposes, or excluded altogether
Scenario 5: How/when to cash-out using proceeds of a non-recourse financing
Issues: OZ program limitations (disguised sale reference in April regs); basis allocations
Questions?
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