Late last week, the IRS released Notice 2020-39 providing relief for Qualified Opportunity Funds (QOFs) and their investors in response to COVID-19, and updated the Qualified Opportunity Zones frequently asked questions on its website to reflect the recent changes. With the June 30th investment standard testing date fast approaching for many QOFs, this presents welcome relief and flexibility to QOFs and their investors.
It is worth noting that none of the relief provisions under Notice 2020-39 require QOFs or their investors to certify they have been adversely impacted by the virus. In addition, the relief provisions do not require any filing or formal extension request and will automatically apply to those affected.
Now, without further ado, below is a summary of the relief provisions included in Notice 2020-39, followed by our commentary.
Relief for QOF Investors
Taxpayers with capital gains generally have 180 days to invest those gains into a QOF to capture the OZ tax benefits. Notice 2020-39 extends the time to invest eligible capital gains into a QOF until December 31, 2020. However, gains qualifying for this extension must have a deferral window that otherwise would have expired between 4/1/2020 and 12/31/2020. So, despite the virus beginning to impact the country in February and March, capital gains that expired before 3/31/2020 do NOT qualify for this relief. Overall, this relief provides those with eligible capital gains additional time to find and invest in QOF projects, including some that may have thought they missed their window just a few weeks ago. But don't wait just for the sake of waiting, as the 10-year holding period required to qualify for tax-free appreciation does not start until your QOF investment is made.
Relief for QOFs & QOZBs
Notice 2020-39 provides four (4) relief provisions specific to QOFs and Qualified Opportunity Zone Businesses (QOZBs), which we have listed below. The relief eliminates nearly all of the critical OZ-testing provisions for 2020 and extends the time for many time-sensitive actions. Here's what's included in the relief:
1) A QOF will be deemed to qualify for the reasonable cause penalty exception for failure to satisfy its 90% investment standard if either of its semi-annual testing dates fall within the period from 4/1/2020 to 12/31/2020. Additionally, the failure does not prevent qualification as a QOF or an investment in a QOF from being a qualifying investment.
The 90% investment standard test is the primary means by which the IRS measures whether a QOF is in compliance with the OZ rules. By eliminating the penalty associated with failing this test, for 2020, many QOFs can disregarded many of the OZ-specific rules that usually require attention and planning. Most notably, QOFs generally have 6 months to invest cash from equity contributions into opportunity zone property or they risk failing the 90% test. This relief allows most QOFs to hold equity contributions in cash until June 2021 without adverse effects.
2) The period between 4/1/2020 and 12/31/2020 is suspended ("tolled") for purposes of the 30-month substantial improvement test.
For previously used property to qualify as qualified opportunity zone property, a QOF or QOZB generally must double its basis in the property within 30 months after acquiring it. This relief provides up to an additional 9 months (39 months in total) to meet that requirement for assets acquired prior to 4/1/2020. Accordingly, QOFs and QOZBs working on multi-year building rehabilitations may have additional time to expend assets and complete their construction.
3) QOZBs with working capital safe harbor (WCSH) plans in effect before 12/31/2020 will receive an additional 24 months to expend that working capital.
A WCSH plan is critically important for most QOZBs and allows them to maintain cash and other liquid assets as long as they plan to expend those assets within 31 months of receipt. This relief now allows QOZBs to maintain working capital for up to 55 months.
The relief also clarifies that this additional 24 months can be tacked on to the maximum 62-month WCSH period allowed to certain QOZBs that stack WCSH plans. Accordingly, a QOZB may have up to 86 months to expend all of its working capital on a project.
4) QOFs are granted an additional 12 months to reinvest proceeds from the sale of qualified opportunity zone property into new qualified opportunity zone property, as long as the original reinvestment date included 1/20/2020.
Since a QOF cannot avail itself of a WCSH, the regulations generally allow a QOF to retain cash proceeds from the exit of an opportunity zone investment without penalty if it reinvests those proceeds into another opportunity zone investment within 12 months. Accordingly, QOFs that sold assets between 1/20/2019 and 1/20/2020 have 24 months to reinvest. Most QOFs will not need to avail themselves of this relief as the OZ program encourages long-term investments and few QOFs will find themselves with asset sales within this time period.