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