Qualifying Land as Opportunity Zone Business Property

Published by John Sciarretti on Wednesday, September 5, 2018
Journal cover thumb September 2018

Question: Can land qualify as opportunity zone business property?

Answer: Land will not likely qualify under the “original use” standard under the opportunity zones statute. Therefore, land will likely need to be substantially improved to qualify. Land may qualify as substantially improved property through a sufficient amount of new construction or through the substantial improvement of an existing building located on the land. However, it is likely that only the portion of the land that is integral to the business using such improvements will qualify. 

Example: A qualified opportunity fund (QOF) purchases 100 acres of vacant land in an opportunity zone for $5 million and builds a hotel for $10 million. Only 10 acres of the land is integral to the hotel business. QOF made $400,000 of improvements to the remaining 90 acres and used it in a farming business. QOF will likely have $10.5 million of qualified opportunity zone business property and $4.9 million of nonqualified property assuming that land can be substantially improved.

General Rule

The term “qualified opportunity zone business property” means tangible property used in a trade or business of the qualified opportunity fund if:

  • such property was acquired by the qualified opportunity fund by purchase after Dec. 31, 2017,
  • the original use of such property in the qualified opportunity zone commences with the qualified opportunity fund or the qualified opportunity fund substantially improves the property, and
  • during substantially all of the qualified opportunity fund’s holding period for such property, substantially all of the use of such property was in a qualified opportunity zone.

Original Use

Original use is not defined in the opportunity zones statute.

Under a similar “original use” standard found in the Gulf Opportunity Zone (GO Zone) bonus depreciation incentive, original use means the first use to which the property was put, whether or not that use corresponds to the use of the property by the taxpayer.

The GO Zone definition of original use also incorporates rules similar to the following rules for “original use” found under general bonus depreciation guidance:

  • If a taxpayer initially acquires new property for personal use and subsequently uses the property in the taxpayer’s trade or business or for the taxpayer’s production of income, the taxpayer is considered the original user of the property.
  • If a person initially acquires new property for personal use and a taxpayer subsequently acquires the property from the person for use in the taxpayer’s trade or business or for the taxpayer’s production of income, the taxpayer is not considered the original user of the property.
  • If a taxpayer initially acquires new property and holds the property primarily for sale to customers in the ordinary course of the taxpayer’s business and subsequently withdraws the property from inventory and uses the property primarily in the taxpayer’s trade or business or primarily for the taxpayer’s production of income, the taxpayer is considered the original user of the property.
  • If a person initially acquires new property and holds the property primarily for sale to customers in the ordinary course of the person’s business and a taxpayer subsequently acquires the property from the person for use primarily in the taxpayer’s trade or business or primarily for the taxpayer’s production of income, the taxpayer is considered the original user of the property.

Under this “original use” guidance, land could not meet the definition of qualified opportunity zones business property because, by its very nature, it would have been used before (personally or for business use) in the opportunity zone. Accordingly, it appears that land would have to be substantially improved to qualify.

Substantial Improvement 

Under the qualified opportunity zone business property rules, property is treated as substantially improved only if, during any 30-month period beginning after the date of acquisition of such property, additions to basis with respect to such property in the hands of the qualified opportunity fund exceed an amount equal to the adjusted basis of such property at the beginning of such 30-month period in the hands of the qualified opportunity fund.

The opportunity zones statute does not specifically address whether land can be substantially improved through the new construction, or substantial improvement of a building located on the land. Nor does it address whether the reference to “such property” under the substantial improvement provision includes the integrated pair of building and land. 

An analogous standard under Internal Revenue Code Section 1400B–allowing for the exclusion of gain on District of Columbia (DC) Zone business property–provides that original use of property commencing with the taxpayer is treated as met with respect to property that is substantially improved including any land that that property is located. The legislative history of this DC Zone statute provides that land that is not an integral part of a DC Zone business be excluded from the definition of DC Zone business property. Therefore, under the DC Zone incentive, land does not appear to have to be substantially improved to qualify as long as the land is integral to the business using the building that has been substantially improved. The opportunity zones statute does not have a similar path to qualify land. 

Based upon the similar DC Zone substantial improvement standard, it is reasonable to suppose that taxpayers might be able qualify land through new construction or substantial improvements that exceed the beginning basis of the land (or land and existing building in the case of a substantially improved building) as long as the land is integral to the business using such improvements. Although, until we receive further guidance from Treasury, we cannot know for sure.