Opportunity Zone Magazine Volume 1, Issue 3 - Page 14

14 OPPORTUNITY ZONE MAGAZINE | VOLUME 1 • ISSUE 3
into two general categories: specific risks of deploying capital
into QOZs, which are most often economically depressed
areas of the United States; and unique risks posed by the tax
rules and regulations of the OZ program itself, which requires
careful compliance discussed in more detail below.
The aim of lining up all of the proper legal documents is
to protect the QOF sponsor (for a Syndicated QOF) or the
equity investors (for a Personal QOF) from lawsuits, adverse
tax consequences, and unnecessary legal costs to correct prior
mistakes. The old saw “an ounce of prevention is worth a
pound of cure” rings as true for QOFs as it would in almost
any other imaginable context. Once the attorneys have
finished the paperwork required for initial setup, the spotlight
shifts to the accountants and other tax personnel tasked with
keeping the QOF in compliance with the program’s various
requirements.
ONGOING COMPLIANCE FOR QOZBS AND QOFs
The first compliance hurdle is usually the deployment of
invested QOF capital. The Treasury Regulations are quite
generous with this topic, in keeping with the general theme
of the Trump Administration’s desire for as much capital
as possible to flow into OZs. The Regulations allow QOFs
an extension of time to place contributed capital into
QOZP. Even so, taxpayers should form and capitalize QOFs
with their minds on a specific investment so as to avoid
two adverse outcomes. The first and most obvious is the
inability to find a suitable investment, which may not result
in significant adverse consequences, depending on when
and how the investment is unwound. The second is making
a decision based not on the quality of a given project but
the time constraints a QOF may face under the compliance
requirements; cognitive biases can delude taxpayers into
believing a certain proposition may be a better idea than it
actually is, which would be a dangerous path in a tax program
requiring profitability for taxpayers to be successful.
The easiest way to avoid any mishaps with compliance testing
at the QOF level would be to form a QOZB in advance of
a cash contribution (recall that QOZBs cannot be initially
capitalized with property). If timed correctly, a QOF can
extend the schedule for required deployment of capital by
waiting out the duration of the
new cash safe harbor and investing
into a QOZB with the required
business plan in place to toll the
working capital safe harbor. For
example, suppose a QOF is fully
capitalized with cash investments
on Jan. 1, 2021. The safe harbor
allows a QOF until Dec. 31, 2021
to achieve 90% investment in
QOZP. If the QOF forms a QOZB
and invests all of its cash on hand
into the QOZB on Dec. 30, 2021,
the QOZB can claim the working
The easiest way to avoid any
mishaps with compliance
testing at the QOF level would
be to form a QOZB in advance
of a cash contribution .
capital safe harbor if the QOZB has a qualifying business plan
on the date of receipt. The working capital safe harbor lasts
31 months, so the QOZB would have until as late as July 31,
2024 (and perhaps another 31 months if certain conditions
apply) to fully spend down the capital contributions the
parent QOF accepted more than 3 years earlier. This example
illustrates why using a QOZB as the vehicle to hold any QOZ
investment allows taxpayers to take advantage of a more
favorable compliance regime for QOZBs than QOFs.
The only essential element that must be in place before
funding a QOZB is the business plan detailing how and
when the incoming cash will be spent. Once the QOF has
formed and capitalized at least one QOZB, the remainder
of the compliance will be sorted out at the QOZB level.
Accountants and other tax professionals must assist with the
following mathematical testing to preserve eligibility for OZ
tax benefits:
• The 70% test for QOZBP,
which could be more
complex than meets the eye
when QOZBP is in the midst
of substantial improvement.
• The requirement that
QOZBP be held in a QOZ for
90% of the QOZB’s holding
period.
• The requirement that 50%
of the QOZB’s income be
derived from the QOZ,
OPPORTUNITYZONE.COM