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

[email protected]

Daren R. Shaver, Attorney

Hanson Bridgett

[email protected]

Dave Sobochan, CPA, Partner

Cohen & Company

[email protected]

Notice

ANY TAX ADVICE IN THIS COMMUNICATION IS NOT INTENDED OR WRITTEN BY

THE SPEAKERS’ FIRMS TO BE USED, AND CANNOT BE USED, BY A CLIENT OR ANY

OTHER PERSON OR ENTITY FOR THE PURPOSE OF (i) AVOIDING PENALTIES THAT

MAY BE IMPOSED ON ANY TAXPAYER OR (ii) PROMOTING, MARKETING OR

RECOMMENDING TO ANOTHER PARTY ANY MATTERS ADDRESSED HEREIN.

You (and your employees, representatives, or agents) may disclose to any and all persons,

without limitation, the tax treatment or tax structure, or both, of any transaction

described in the associated materials we provide to you, including, but not limited to,

any tax opinions, memoranda, or other tax analyses contained in those materials.

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

6

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

8

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

10

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


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.

12

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

14

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

15

Qualified Opportunity Fund


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

17

https://www.cims.cdfifund.gov/preparation/?config=config_nmtc.xml

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

18

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)

19

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

20

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



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

22


Third safe harbor: Tangible property and operational functions combine to generate 50%

of gross income

Opportunity Zone

= service provider

= manager

= tangible property


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


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


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.

29

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

30

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

31

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


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

33

QOZ Investment vs. 1031 Exchange cont.


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.

34

QOZ Investment vs. 1031 Exchange cont.


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.

35

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

36

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)

37


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


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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