Treasury Provides Additional Guidance On Opportunity Zone Provisions
Thursday, May 2, 2019

The Tax Cuts and Jobs Act of 2017 introduced Opportunity Zone Provisions, IRC Sections 1400Z-1 and 1400Z-2, as an incentive to encourage investment in low-income communities. The provisions allow taxpayers to defer tax on reinvested capital gains, potentially reduce the tax on their initial capital gain up to 15% and eliminate gain on appreciation of their “qualified opportunity fund” (QOF) investments after holding them for 10 years.

On October 19, 2018, the US Treasury (Treasury) released Proposed Regulations (the October Regulations), providing initial guidance under the Opportunity Zone Provisions. While the October Regulations clarified many questions regarding the Opportunity Zone Provisions, they left uncertainty in some areas. On April 18, 2019, Treasury released the second highly anticipated set of Proposed Regulations (the Proposed Regulations) in an effort to provide a higher degree of taxpayer certainty.

In Depth

A “qualified opportunity zone” (QOZ) is an eligible low-income census tract that is designated as a QOZ and certified by Treasury. The governors of all 50 states and Puerto Rico have identified a total of 8,764 QOZs. Under the Opportunity Zone Provisions, taxpayers may qualify for certain tax benefits by investing capital gains from sales or exchanges within the previous 180 days in a structure known as a QOF. The benefits of investing in a QOF are tax deferral on the initial investment, exclusion of up to 15% of the initial capital gain from US federal income tax and the elimination of gain on appreciation of any QOF investment held for 10 years or longer.

A QOF is an entity organized as a corporation or partnership for the purpose of investing in QOZ property that holds at least 90% of its assets in QOZ property. QOZ property includes QOZ stock, QOZ partnership interests and QOZ business property. Whether a fund meets the 90% asset test is determined by calculating the average percentage of QOZ property held by the fund as measured at six-month intervals.

This basic framework was greatly expanded on by the October Regulations. However, certain issues remained unresolved. The open questions ranged from definitional considerations, such as the meaning of the term “substantially all” throughout the statute, to more mechanical clarifications, such as what would happen if a taxpayer wanted to dispose of one QOZ investment and use the money to enter a new QOZ investment. The Proposed Regulations clarify many of these ambiguities, but leave certain considerations for future guidance and interpretation.


Substantially All: 

The definition of “substantially all” has been a topic of speculation since the publication of the Opportunity Zone Provisions. Section 1400Z-2 lays out the mechanics of the opportunity zone incentive and uses the term substantially all in three separate contexts: (1) the definition of QOZ business (2) the requisite holding period for all three forms of QOZ property and (3) the definition of QOZ business property.

A QOZ business is one in which substantially all of the tangible property owned or leased by the taxpayer is QOZ business property. The October Regulations clarified that substantially all for this purpose meant 70% or greater, but declined to opine on the other two uses of the term.

For an entity to be considered a QOF, it must (1) invest at least 90% of its assets in QOZ property and (2) have been a QOZ business during substantially all of the holding period for all such property. Neither the statute nor the October Regulations defined substantially all for this purpose. The preamble to the Proposed Regulations states this 90% threshold was chosen to comport with Congressional intent and because taxpayers can control the period for which they hold property. This high threshold nonetheless may limit the investment strategies QOFs will be able to consider, because it constrains flexibility.

QOZ business property must meet four criteria: (1) it must be used in the trade or business of a QOF (2) it must be acquired by purchase after December 31, 2017, (3) it must either be originally used by the QOF in the QOZ or substantially improved by the QOF, and (4) during substantially all of the holding period of the property, substantially all of its use must be in a QOF. The Proposed Regulations define substantially all for the use requirement as 70%. The Proposed Regulations rely on this 70% requirement regardless of whether tangible property is owned or leased.

Original Use: 

As outlined above, QOZ business property must originally be used by the QOF in a QOZ or substantially improved by the QOF. Treasury and the IRS solicited comments on the definition of “original use” in the October Regulations. The Proposed Regulations generally utilize the date property is first placed in service in the QOZ for purposes of depreciation or amortization as the “original use” date. Alternatively, if the person using the property is not its owner, the Proposed Regulations use the date in which the property is first used in a manner that would allow depreciation or amortization if that person were the property’s owner. These rules allow a buyer who purchases property that has yet to be placed in service to count the property toward their QOZ business property percentage without making substantial improvements.

The Proposed Regulations further provide that where a QOF or QOZ business purchases a vacant building in a QOZ, the original use requirement is satisfied if the building has been vacant for five years or more. This provision is on the longer end of periods recommended to Treasury by various commenters that ranged from one to five years. The disadvantage of a longer requirement is that taxpayers will not be incentivized to invest in certain vacant or abandoned buildings under the provisions. However, Treasury suggests a longer requirement may be needed to discourage taxpayers from intentionally leaving buildings vacant for a period of time to increase their marketability prior to sale. Finally, the Proposed Regulations mirror Rev. Rul. 2018-29 in excepting land from the original use requirement.

Substantial Portion: 

In addition to the above requirements, a QOZ trade or business must use a “substantial portion” of its intangible property in the active conduct of a trade or business in a QOZ. The Proposed Regulations clarify “substantial portion” means 40% for these purposes.

Trade or Business: 

The Proposed Regulations adopt the definition of “trade or business” under Section 162. This definition is combined with an expansion for the ownership and operation of real property for purposes of the QOZ provisions. Entering into a triple-net-lease by itself is not considered the active conduct of a trade or business; however, there is a possibility taxpayers who enter into triple-net-lease arrangements will qualify if their activities otherwise meet the Section 162 definition. The use of the Section 162 definition of trade or business mirrors its use in proposed regulations under Sections 163(j) and 199A of the Code. Treasury sees this definition as advantageous because it is accompanied by a long history of interpretation and case law. The additional clarification as to the status of certain real property operations will be welcome by many, because the status of some of these operations under Section 162 has led to considerable debate in the past.

Mechanical Clarifications

The Gross Income Test: 

A trade or business must derive at least 50% of its total gross income from the active conduct of a trade or business in a QOZ to qualify as a QOZ business. The Proposed Regulations provide three safe harbors and a facts and circumstances test to guide taxpayers in determining whether 50% of a QOZ business’ gross income derives from a QOZ.

The first safe harbor allows a business where 50% or more of the services performed by its employees, independent contractors or independent contractors’ employees are performed in the QOZ based on hours to qualify. This safe harbor will be useful to businesses that perform substantial services within the QOZ.

The second safe harbor is similar to the first in that it looks to services performed by employees, independent contractors and independent contractors’ employees. However, the second safe harbor looks to amounts paid for these services in gauging the 50% threshold. This safe harbor appears to be an effort to account for the benefit of attracting higher-value services to the QOZ. For example a business involved in the development of IP may locate its development functions within a QOZ, but its support functions outside the zone. If more than 50% of its payroll stems from the development functions, this business would qualify under the safe harbor.

The third safe harbor allows a trade or business to satisfy the 50% gross income threshold where the business’ tangible property located in the QOZ coupled with its management or operational functions performed in the QOZ are necessary to generate 50% of its gross income. This safe harbor appears to account for businesses that may have operations across a wide area but clearly locate their nerve center or headquarters within a QOZ, thereby providing opportunities for development within the QOZ.

A trade or business that fails to meet the above three safe harbors may still qualify under the gross income test based on its facts and circumstances. Treasury is open to suggestions for additional safe harbors as well as anti-abuse provisions. Those who believe certain business models may be beneficial to a QOZ but fear their circumstances make substantiating the 50% requirement difficult should consider providing comments.

The 90% Asset Test: 

The QOZ provisions require QOZ entities hold 90% of their assets in qualified property or face a penalty. The 90% test is applied on a six-month basis. The Proposed Regulations provide two major clarifications to the requirements to meet the 90% asset test.

First, the Proposed Regulations expand the working capital safe harbor provided in the October Regulations. This safe harbor allows for specified property to qualify as working capital for up to 31 months. The Proposed Regulations allow a written plan for the development of a trade or business in the QOZ to qualify. This regulation will likely benefit start-up companies in particular, because they can raise funds pursuant to a business plan without feeling pressured into early investments in tangible property that may not best suit their needs. The Proposed Regulations also provide that exceeding the 31-month period does not apply where delay is attributable to waiting on government action. This portion of the regulations will be a comfort to highly regulated businesses that require approvals from various levels of government. Between the significant guidance provided in the October Regulations and these additional details, the treatment of working capital under the QOZ provisions is greatly clarified.

Second, the Proposed Regulations offer guidance on reinvesting proceeds from the disposition of qualified property. After the release of the Opportunity Zone Provisions and October Regulations, many taxpayers were concerned about the ability to reinvest proceeds from the sale of QOZ stock, partnership interests or business assets. The concern was whether sale of these items could cause an entity to fail the 90% test prior to the opportunity to reinvest. The Proposed Regulations clear up this concern by allowing for reinvestment of the proceeds within 12 months, but taxpayers still must recognize gain on the sale. Mechanically, the Proposed Regulations simply treat the proceeds of these sales as QOZ property over the 12-month period, thus counting toward the 90% threshold where the proceeds are held as cash, cash equivalents or debt instruments with a term of 18 months or less. Finally and critically, Treasury clarified that proceeds from the sale of one form of QOZ investment may be reinvested into a different form (e.g., the proceeds from sale of stock may be used to purchase a partnership interest). These rules afford taxpayers flexibility in entering and exiting specific investments while maintaining a commitment within QOZs generally.

Leased Tangible Property: 

A trade or businesses’ leased property is relevant in calculating both the amount of assets it holds in a QOZ under the 90% asset test to qualify as a QOF and in determining that substantially all of its property is QOZ business property to qualify as a QOZ business. The Proposed Regulations allow a taxpayer to select between one of two methods when valuing its leased tangible property, but require a taxpayer to use the same method to value all leased property during that tax year.

The first method allows a taxpayer to rely on a financial statement valuation method used for their financial reporting if prepared according to US Generally Accepted Accounting Principles (GAAP). In the alternative, taxpayers may value tangible leased property based on the present value of such property equal to the sum of the present values of all payments to be made under the lease.

Debt-Financed Distributions: 

The Proposed Regulations provide helpful examples demonstrating how debt financed distributions are likely to be treated. Generally, these examples appear to permit debt-financed distributions causing income recognition only where the distribution exceeds a partner’s basis. The following summarizes an example provided in the Proposed Regulations: A and B form Q a QOF. A and B each contribute $200 initial cash that is deferred under Section 1400Z-2. Q obtains a nonrecourse loan for $300 allocated equally to A and B, resulting in a basis of $150 each. Q then distributes $50 to A. A is not required to recognize gain, but their basis is reduced to $100. The Proposed Regulations further contemplate this treatment may be overridden by the disguised sale rules of Section 707. If A and B originally contributed property instead of cash to Q, the contributions and distributions may invoke the disguised sale rules depending on the timing of the distribution and allocation of debt. If a transaction is re-characterized as a sale, the investment is reduced by the amount of the contribution that is re-characterized. Finally, the income inclusion rules, discussed below, provide that distributions exceeding a partner’s basis may result in recognition of deferred gain.

Inclusion of Deferred Gain: 

Deferral of gain is one of the primary incentives to investment in a QOZ. However, consistent with Congress’ goal of encouraging long-term investment in distressed economic areas, deferral is generally only permitted for as long as a taxpayer maintains their investment. The QOZ provisions provide that deferral ends and income must be recognized either when an investment is sold or exchanged, or by December 31, 2026. The Proposed Regulations expand upon these scenarios by listing several events that will lead to income inclusion. These include both taxable and nontaxable events. Of particular interest to many may be the treatment of gifts and bequests. Typically, gifts of QOF interests are treated as inclusion events unless made to a grantor trust. Conversely, neither the termination of a grantor trust’s status by reason of death nor bequests to a decedent’s estate or heirs are considered inclusion events.

Treasury specifically states the list of inclusion events is not exclusive. In addition, the preamble to the Proposed Regulations provides the general guidepost that an income inclusion event occurs when a transfer reduces the taxpayer’s equity interest in the qualifying investment for federal income tax purposes. Finally, Treasury and the IRS request comments on the inclusion events that would result in an investor recognizing deferred gain, including pledging of qualifying investments as collateral for nonrecourse loans.

Treatment of Section 1231 Gain: 

Only capital gains are eligible for deferral under the Opportunity Zone provisions. Neither the statute nor the October Regulations addressed whether gains from Section 1231 property were eligible for deferral. The Proposed Regulations clarify that the only eligible gain from Section 1231 property is the net amount of capital gain for the taxable year. Additionally, the Proposed Regulations provide that the 180-day period for investing such capital gain income from section 1231 property in a QOF begins on the last day of the taxable year. This differs from the normal rule.


The Proposed Regulations provide a general and broad anti-abuse provision. The rule allows the Commissioner to recast a transaction if a significant purpose of the transaction is to achieve a tax result inconsistent with the Opportunity Zone Provisions. The preamble to the Proposed Regulations provides the example of a taxpayer purchasing agricultural land within a QOZ. If the taxpayer’s intent is to continue using this land for growing crops or raising livestock, rather than investing in the area’s development, the transaction may be challenged under the broad anti-abuse powers contemplated in the Proposed Regulations. Note it appears the disqualifying purpose need only be a significant purpose to invoke this rule, leaving the exact scope of the power unclear, but certainly implying it is quite broad. It may also be difficult to determine whether certain purposes are inconsistent with the Opportunity Zone Provisions. The only specific guidance in this area is that a QOZ business cannot be a business described in Section 144(c)(6)(B), which includes golf courses, country clubs, massage parlors, hot tub and suntan facilities, gambling facilities and liquor stores.

Additional Guidance: 

The Proposed Regulations reserve on some areas and request comments in several others. Two areas that are not addressed by the Proposed Regulations are the consequences of a QOF failing to maintain the 90% investment standard and the information reporting requirements for eligible taxpayers. These open areas are expected to be addressed in future regulations, forms or publications. The Proposed Regulations also do not address the mechanics of nonrecognition in the case of tiered partnerships. Gain from the sale of a qualifying investment escapes taxation if the investment is held for 10 years, but the Proposed Regulations do not make clear whether the QOF itself has to sell the asset after this time period or if a lower tier entity is permitted to sell it. Finally the Proposed Regulations adopt an asset-by-asset approach to whether tangible property is substantially improved for purposes of 1400Z-2(d)(2)(D)(ii). Treasury recognizes this approach may be burdensome for some taxpayers and requests comments on the advantages and disadvantages of adopting an aggregate approach.

The above outlines some of the major features of the Proposed Regulations and attempts to highlight areas we believe will be of particular importance to taxpayers. The Proposed Regulations provide additional detailed guidance that may be relevant to many transactions and taxpayers, including guidance on the investment of mixed funds, filing consolidated returns, and the interaction between the rules and laws of Indian tribal governments. In addition to the Proposed Regulations, Treasury released a request for information seeking detailed comments on metrics and methodologies for assessing investments held by QOFs to gauge their effectiveness. Final Regulations concerning QOZs are expected to be issued sometime after a notice and comment period; however, the preamble to the Proposed Regulations states most of the provisions may be relied upon prior to adoption of final regulations as long as taxpayers apply the proposals consistently and in their entirety.


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