Opportunity Zones: Frequently Asked Questions Part 2
posted May 8, 2019 by Joe Tamburo, CPA in the Global Tax Blog
Real estate investors, are you looking to save tax? The Opportunity Zone tax incentives under Internal Revenue Code (IRC) 1400Z-2 are designed to encourage investment in designated underdeveloped areas throughout the country. Check out Part 1 of our Opportunity Zone FAQs to learn more about the basics of these investment vehicles.
Here are some more FAQs to clarify other aspects of opportunity zones.
Q: How is the 90% requirement determined and are there any penalties for non-compliance?
A: In general, the 90% requirement is tested two times per year: the last day of the first six month period of the entity’s tax year and the last day of the tax year. If the opportunity zone fund has an applicable financial statement (i.e., SEC filing or auditing financial statement) they must use the asset values on the financial statement to perform the tests. If the fund does not have an applicable financial statement, they must use the cost of the assets. There is a monthly penalty for having less than 90% of the total assets as qualified opportunity zone property. The penalty is the percentage of short fall multiplied by the underpayment rate which is currently 5%per year. There is no penalty if reasonable cause is shown.
Q: What paperwork/certifications are needed to establish a “Qualified Opportunity Zone Fund”
A: A QOF must self-certify with the IRS by filing Form 8996 with its tax return for each year the fund will operate as QOF. This form will also be where the QOF certifies it meets the 90% requirement.
Q: What is the qualified opportunity zone property a QOF must invest in?
A: Qualified opportunity zone property includes the following three categories:
- Qualified opportunity zone stock
- Qualified opportunity zone partnership interests
- Qualified opportunity zone business property
Q: What is a qualified opportunity zone business?
A: A qualified opportunity zone business is defined as trade or business in which substantially all of property owned or leased is opportunity zone property. Also, at least 50% of the income needs to be derived by active conduct of a trade of business in the zone. Finally the substantial portion of the intangible assets must be used in the active conduct of trade or business in the zone.
Q: Are there any businesses that are strictly prohibited from being qualified opportunity zone businesses?
A: Yes, the business cannot be a “sin business” which includes the following:
- Golf Course
- Country Club
- Massage Parlor
- Hot Tub Facility
- Suntan Facility
- Racetrack or Gambling
- Any store where the principal business is the sale of alcoholic beverages for consumption off the premises.
Q: What is qualified opportunity zone property?
A: It is tangible property used in the active conduct of a trade or business that was acquired by purchase from a non-related party after 12/31/17. The use of that property must commence within the opportunity zone business or opportunity zone fund and during substantially all of the property’s holding period that is used in the opportunity zone.
Q: What if the property’s original use is not started in the opportunity zone business or opportunity zone fund?
A: This will be a common occurrence in many transactions where the business equipment or the real property (i.e., buildings & land) was not used in the initial opportunity zone business/fund. If that is the case, the opportunity zone business/fund must substantially improve the property. This means that within 30 months after the date of acquisition, the investment in that property must be doubled.
For example: If you buy a piece of equipment that was not used for $5,000, then you must invest at least another $5,000 to substantially improve that piece of equipment. This fact pattern may be difficult to meet for certain acquisitions of equipment and other property.
Q: Are there any special rules for real estate transactions that involve purchasing a building on an existing parcel of land?
A: Yes, when an acquired a piece of real estate includes both land and building the cost basis of the land is not considered in the substantial improvement calculation. For example let’s say a taxpayer were to purchase a piece of property for $10 million with $4 million being allocated to the cost basis of land and $6 million being allocated to the cost basis of the building. Given the fact that the land and building were previously located in an opportunity zone, they do not meet the original use requirement. They must substantially improve the property for it to be considered Qualified Opportunity Zone Property. If the taxpayer adds improvements to the building of $6 million, then both the building and land will be qualified as opportunity zone property.
Don’t forget to check out part 1 of our Opportunity Zone FAQs where we cover the basics of these tax-saving investments.
Questions on opportunity zones? Contact us.