Opportunity Zone Magazine Opportunity Zone Magazine Volume 1, Issue 1 | Page 50

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OPPORTUNITY ZONE MAGAZINE | VOLUME 1
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ISSUE 1
a working capital safe harbor for a QOZB. When utilizing an
indirect investment method, a business can treat otherwise
non-qualified property as qualified if they meet a number of
requirements. To use the working capital safe harbor, the QOZB
must have a written plan identifying that these funds are held
for acquisition, construction or substantial improvement, as
well as a written schedule of planned deployment of such funds
within 31 months of receipt. Additionally, the QOZB must have
reasonably complied with both the plan and schedule.
Introduction of this working capital safe harbor allows a
QOZB a larger timeframe to deploy cash into construction
or rehabilitation expenditures. With the possible exception
of being able to prove reasonable cause, current opportunity
zone guidance does not provide a QOF or a direct investment
a similar safe harbor for holding cash without penalty.
Are there any stipulations on production of business
income?
As written, the guidance does not reference the income of a direct
investment QOF. When utilizing an indirect investment strategy,
a QOZB is required to derive 50 percent of its gross income from
the active conduct of a trade or business. The proposed regulations
further expanded this requirement to say that the income must be
derived in the zone. The guidance did provide leniency, however,
in regards to income generated by reasonable working capital
under the safe harbor.
When utilizing an indirect
investment strategy, a QOZB
is required to derive 50
percent of its gross income
from the active conduct
of a trade or business.
These requirements for gross income in an indirect investment
have created uncertainty about what sort of business operations
will meet the active conduct test and how gross income will be
sourced in applying the “in the QOZ” test. Such uncertainty
has caused a chilling effect on QOF investments into operating
businesses. As a result, most of the QOF investments that
have closed to date have been in real estate developments. As
a word of caution, QOFs investing in real estate developments
utilizing an indirect structure can’t just ignore the gross income
test. Such test could be problematic for landlords that lease
property under a triple net lease, since the tax law is generally
well established that a triple net lease does not constitute the
active conduct of a trade or business. Consequently, QOZBs
that derive more than 50 percent of their gross income from
tenants under triple net leases may not be able to satisfy the
gross income test.
Are there any other requirements placed on an indirect
investment into a QOZB?
The statute places limits on an investment into a QOZB that do
not appear to apply to a QOF’s direct investment into a QOZBP.
These limitations include a requirement that a substantial portion
of intangible property is used in the active conduct of business
(though there is no limit as long as the business requirement is
met), less than 5 percent of property is nonqualified financial
property (unless covered by the working capital safe harbor), and
restrictions on operations of “sin businesses.” While intangible
property and nonqualified financial property would be subject
to the 90 percent test for a direct investment, these specific rules
only apply to the assets of a QOZB.
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The statute also includes a safe harbor for QOZB’s that own
tangible property that ceases to be QOZBP. In particular, such
tangible property is treated as QOZBP for up to 5 years after it
ceases to be QOZBP as long as the property is still held by the
QOZB. There is no comparable safe harbor for QOZBP owned
directly by a QOF.
What investment strategy is best for my fund?
There is little clarity around the reason for the discrepancies
between the treatment of the underlying tangible property
a nd bu siness operation s for a direct versu s indirect
investment. It is possible that future guidance will attempt
to treat these two more similarly. In the interim, the business
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