Final OZ Regulations - Quick Take

Published by John Sciarretti and Michael J. Novogradac on Thursday, December 19, 2019 - 12:00AM

Treasury released today final (and proposed) opportunity zones (OZ) regulations. The final rule merges the first two tranches of regulations into one and provides greater clarity on many issues, as well as some outright changes.

The Novogradac Opportunity Zones Working Group (OZ Working Group) previously submitted a detailed letter commenting on the second tranche of proposed regulations that were released April 17, a letter that weighed in on many areas that needed additional clarity or changes, and submitted separate letters on corporate consolidated return rules and challenges facing affordable housing. We are pleased to see that many of the comments were incorporated into the final (and proposed) regulations.

The OZ Working Group’s letters to Treasury included 26 issues that needed greater clarity or changes in the updated regulations. This post quickly addresses those 26 issues, which are segregated into five categories:

  1. Investors
  2. Qualified Opportunity Funds (QOFs)
  3. Affordable housing investments in OZs
  4. OZ business property and
  5. OZ businesses.

For a more detailed description of the issues, analysis, and recommendations previously provided to Treasury, please review the letters linked above.
As you review these issues, we encourage you to weigh in with your thoughts and ideas as to how Treasury addressed them. Share them by emailing [email protected], by becoming a member of the OZ Working Group and/or joining us in Long Beach. How OZ funds, investors and businesses are dealing with these 26 issues will be discussed–along with many other real-world topics of interest to a broad range of OZ stakeholders–at the Novogradac 2019 Opportunity Zones Conference, April 23-24 in Long Beach, California.

A subsequent blog post will address some of the new terrain covered in the regulations, such as expanded anti-abuse rules.

Investor Issues

1. Corporate consolidated return rules

Corporations with one or more subsidiaries are generally treated as a consolidated group and generally file a consolidated return. The final regulations allow a member of a consolidated group to make investments in a QOF of the capital gains of another member of the consolidated group. The regulations also allow a QOF to be a member of a consolidated group, subject to certain conditions.

2. Section 1231 Gains

The final regulations provide that taxpayers can invest gross Internal Revenue Code (IRC) Section 1231 gains, even if they have net Section 1231 losses for a given year. The general 180-day time frame for investing applies.

3. 10-year Sale of Interest in a QOF Partnership

Treasury clarified in the regulations that a QOF partnership adjusts partnership assets to fair market value (FMV) with respect to a disposed-of interest, when a partner sells an interest after 10 years and elects to adjust the basis of their partnership interest to FMV.

4. 10-year Gain Exclusion Provision for Partnerships and S Corporations

When a QOF partnership or S corporation sells property, if its owners have held their interest for 10 years, such owners can elect to exclude the gain. This rule extends to pass-through gains from the sale of property by QOZBs owned by a QOF.  This exclusion rule does not apply to gains from the sale of inventory in the ordinary course of business.

5. 10-year Gain Exclusion for Real Estate Investment Trust (REIT)

Treasury states that REIT capital gains dividends are “excluded” from income, so long as the investor has held their interest for 10 years.

6. Effect of Inclusion Event on 10-year FMV Basis Election

The final regulations provide that an inclusion event generally results in a reduction or termination of a qualifying investment’s status as a qualifying investment to the extent of the reduction or termination. However, certain types of inclusion events (namely, certain distributions) do not terminate a taxpayer’s qualifying investment.

7. Transfer of Qualifying Interest by Reason of Death

When the interest in a QOF is transferred to heirs because of death, the final regulations clarify that section 1014 does not apply to adjust the basis of an inherited qualifying investment to its fair market value as of the deceased owner’s death.

Qualified Opportunity Fund Issues

8. Debt Financed Distributions

The final regulations confirm that a debt-financed distribution of cash to a QOF partnership investor is generally not an inclusion event if made after two years. Treasury also provides an explicit example of a debt-financed distribution that is not a disguised sale.

9. Option to Disregard Recently Contributed Property to a QOF

For recently contributed property to a QOF, the final regulations properly provide a grace period to invest contributions in qualified OZ property. However, final regulations provide property is excluded from the numerator and the denominator, and does not provide, as requested, that any property received by a QOF is treated as invested in qualified OZ property so long as such property is invested in qualified OZ property by the next testing date that is more than six months after the property is received.

10. Carried Interest

The final regulations remove the requirement to use the “highest share of residual profits” in determining the portion of sales proceeds allocated to the non-qualifying carried interest, and more properly require the use of the “share of residual profits.”

Affordable Housing Issues

11. Affordable housing

Treasury did create a modified aggregate approach for QOFs and qualified OZ businesses to use in measuring the substantial improvement test, as opposed to the strict asset-by-asset requirement.

Treasury did not change the special gain inclusion rule that can result in investors in QOF partnerships having to recapture some or all of prior losses, as capital gain income, on Dec. 31, 2026. This is a major disappointment for many.

Treasury did not allow certain exclusions from the definition of non-qualified financial property for low-income housing tax credit (LIHTC) developments; and Treasury did provide leases for the use of state or local government property, or Indian tribal government property is not subject to the arm’s-length market rate standard.

Qualified Opportunity Zone Business Property Issues

12. Substantial Improvement Test–Asset-by-Asset vs. Aggregate Application of Test

The final regulations provide for a modified aggregate basis rule, wherein original use assets must improve the functionality of non-original use assets to be included.

13. Improvements to Non-Qualifying Property

The regulations provide that improvements made to nonqualified OZ property (either because it was purchased on or before Dec. 31, 2017; purchased from a related party; or lacks substantial improvements) do not satisfy original-use requirements as purchased property unlike lessee improvements which are treated as separate property.

14. Substantially All of the Usage of QOF Tangible Property

The final regulations remove a test contained in the proposed regulations that created a QOF level trade or business tangible property use test.

15. Vacant Property

Treasury shortened the five-year period to one year for property in an OZ that was vacant one year before the designation of the tract as an OZ and three years for other property. Regarding the definition of vacant, real property, including land and buildings, is considered vacant if the property is “significantly unused.” A building or land is considered “significantly unused” if more than 80 percent of the building or land, as measured by the square footage of useable space, is not being used.

16. Unimproved Land

The proposed regulations provided that original use and substantial improvement requirements don’t apply to unimproved land and that land is generally eligible to be qualified OZ business property if it’s used in a trade or business and meets other requirements. However, such guidance isn’t applicable if the land is unimproved or “minimally improved” and the land was purchased with an expectation, intention or view to not be improved by, “more than an insubstantial amount” within the 30-month period. Final regulations generally retain these rules, but note that in determining whether an entity had an expectation or an intention to improve the land by more than an insubstantial amount, improvements to the land by the eligible entity (including grading, clearing of the land, remediation of the contaminated land, or acquisition of related qualified opportunity zone business property that facilitates the use of the land in a trade or business of the eligible entity) is taken into account.

17. Original Use–Demolition of Existing Property

Treasury did not affirmatively clarify that structures in an OZ that will be demolished pursuant to the development of a trade or business should be treated as qualified OZ business property during the period before demolition.

18. Self-Constructed Property

The regulations clearly provide that self-constructed property (property manufactured, built or produced by a taxpayer for its trade or business) is generally eligible to be considered “acquired by purchase.”

19. Related-Party Fees

Final regulations did not clarify that reasonable capitalized fees paid to a related party with respect to the development or redevelopment of tangible property are considered an addition to adjusted basis for purposes of measuring the substantial improvement of property and don’t cause the property to fail to qualify as qualified OZ business property.

20. Real Property Straddling an OZ

Concerning property that straddles an OZ, Treasury regulations allow taxpayers to choose one of two methods in determining whether the real property located in the qualified opportunity zone is substantial. One method was in the preamble to the May 2019 proposed regulations, the other in the text of the May 2019 proposed regulations.

21. Inventory In-Transit

Treasury regulations now allow taxpayers the option to exclude inventory (including raw materials) from the numerator and denominator of the 70 percent use of tangible property test and the 90 percent investment standard test for QOF direct investments in qualified OZ business property.

Qualified Opportunity Zone Business Issues

22. A Qualified OZ Business in the Zone

Treasury regulations describe a qualified OZ business by describing provisions that must be met in the qualified opportunity zone, which could be interpreted as meaning a business with interests in multiple OZs must satisfy various OZ requirements in a single OZ. Treasury did not specifically clarify or state that “the” opportunity zone means one or more OZs.

23. Grace Period for Businesses to Become Qualified

Treasury in the final regulations expanded the working capital safe harbor to qualified OZ businesses, and created a safe harbor for QOF’s substantially improving property, but no additional guidance on QOFs constructing new property or QOZBs not qualifying under the working capital safe harbor.
Treasury did provide a six-month cure period for qualified OZ businesses.

24. Property that a QOF Leases

The updated regulations provide that the requirement for property leases to be arms-length does not apply to leases with a state or local government, or an Indian tribal government. The final regulations create a rebuttable presumption that the terms of a lease are market rate for leases between unrelated persons.

25. Intangible Property

The final regulations provide that intangible property is used in the active conduct of a trade or business in a qualified opportunity zone if—
(1) The use of the intangible property is normal, usual, or customary in the conduct of the trade or business; and
(2) The intangible property is used in the qualified opportunity zone in the performance of an activity of the trade or business that contributes to the generation of gross income for the trade or business.

26. Working Capital and Tangible Property Safe Harbor

Final regulations provide that a governmental permitting delay that has caused the delay of a project covered by the 31-month working capital safe harbor, and no other action could be taken to improve the tangible property or complete the project during the permitting process, then the 31-month working capital safe harbor will be tolled for a duration equal to the permitting delay. The final regulations also provide an additional 24 months to the 31-month working capital safe harbor if a project is located within a QOZ designated as a part of a federally declared disaster area and the project is delayed due to that disaster.


The final regulations represent a tremendous effort by Treasury to expeditiously provide regulatory guidance on the OZ incentive. With the release of the final regulations, we expect significantly more equity investment to be made in distressed communities across the nation. Treasury should be commended for its efforts. While questions and issues remain, the regulatory foundation provided provides sufficient clarity and certainty for many more taxpayers to confidently invest in QOFs.

Look for our next blog post, which will review some of the new terrain covered in the regulations, such as expanded anti-abuse rules.

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