Opportunity Zone Magazine Volume 1, Issue 3 | Page 86

86 OPPORTUNITY ZONE MAGAZINE | VOLUME 1 • ISSUE 3
POTENTIAL ISSUES WITH OZ COMPLIANCE FOR REAL ESTATE FOCUSED OPPORTUNITY FUNDS
CASH BALANCES AT QOZB
One of the requirements to qualify as a QOZB is that
cash and other nonqualified financial property makes up
less than 5% of the average aggregate unadjusted basis of
property owned by the QOZB. 2 This is sometimes referred
to as the “5% test.” Initially, there was a concern that this
5% test would prevent ground-up development projects
from qualifying as a QOZB, since in the early stages of a
development project the entity would be carrying large
cash balances to fund the construction of the property.
However, the OZ regulations address this concern through
the creation of the working capital safe harbor. 3
Cash, cash equivalents, or
debt instruments with a term
of 18 months or less are
not considered nonqualified
financial property for purposes
of the 5% test if they qualify
as a reasonable amount of
working capital.
Cash, cash equivalents, or debt instruments with a term
of 18 months or less are not considered nonqualified
financial property for purposes of the 5% test if they
qualify as a reasonable amount of working capital.
Amongst other requirements, the cash, cash equivalents,
and debt instruments with a term of 18 months or less
must be identified in writing as working capital and
must be spent within 31 months of the receipt by the
business of the assets to qualify as a reasonable amount
of working capital. 4 The regulations also allow a QOZB
to utilize multiple working capital plans for subsequent
cash infusions for a period up to 62 months from the
date of the first working capital plan. In response to the
COVID-19 pandemic, the IRS recently issued guidance
in Notice 2020-39 aimed at relief for OZs. Among other
items, the notice provides relief for all QOZBs holding
working capital assets before Dec. 31, 2020. This relief will
allow these QOZBs to receive an additional 24 months
to expend the working capital assets of the QOZB. The
relief was previously provided for in the OZ regulations
but this notice gave clear guidance on how the rule applies
to QOZBs affected by the COVID-19 pandemic. It is
important to note that in order to receive this additional
24 months, a QOZB has to fall under the working capital
safe harbor outlined in the regulations.
While this safe harbor seems to address cash balances
being used for the development of real property, it does
not address other instances when a QOZB may need to
carry large cash balances. For example, consider an office
building that will have tenants whose leases are nearing
the end of their term. As the entity’s leases with the
building tenants near the end of the lease term, it is not
uncommon that the entity will start holding back cash
from operating distributions to reserve cash for upcoming
tenant improvements needed to secure a lease renewal
or a new tenant. Since this cash is from operations, it
would be received on numerous dates throughout the year
and it will be a laborious task to have a working capital
plan in writing for each date of the receipt of said cash.
Therefore, this cash reserve balance held at the QOZB will
potentially not qualify for the safe harbor provided in the
proposed regulations.
It is important to note that falling outside of this safe
harbor definition of working capital doesn’t automatically
mean that the cash, cash equivalents, or debt instruments
with a term of 18 months of less at your QOZB is not
reasonable working capital. It merely means that the entity
would need to defend its classification of these amounts as
reasonable working capital if the IRS ever challenged it.
DISTRIBUTIONS TO INVESTORS FROM QOF
The OZ regulations outline a number of “inclusion events”
that would cause an investor to recognize some/all of the
gain they deferred by investing into the opportunity fund.
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