What We Can Learn From the Opportunity Zone Comment Letters

In October 2018, the Treasury Department and the IRS released highly anticipated regulatory guidance related to the Opportunity Zone program. The guidance answered a lot of questions and its generally favorable approach for real estate jump-started interest in the program.

But as Treasury admitted in the release there were still issues to be resolved and it promised another guidance. In the meantime, comment letters have been pouring in that, the writers hope, will have some influence on the final shape of the regulations.

If nothing else, the comment letters provide a guide as to what developers and other participants are thinking about the Opportunity Zones and how they might be used.

CREModels did an analysis on some of the letters and concluded that, “We are starting to see development-friendly trends emerge in the comment letters.”

“There are repeated requests for clarifications surrounding substantial improvement and original use. We also see a lot of requests for extensions beyond the 30/31 month timelines and flexibility around the asset and gross income tests,” it wrote.

Here are some excerpts from comment letters that may shed light on the future shape of the Opportunity Zone program.

National Multifamily Housing Council National Apartment Association

NMHC/NAA request that the Treasury Department and the Internal Revenue Service clarify in a specific example in the final regulations that land itself need not be improved to meet the original use requirement so long as development occurs on the land . We also request that the Treasury Department and Internal Revenue specifically state that the land may have been acquired prior to 2018 and still qualify as Opportunity Zone property so long as development on that land occurs after 2018 consistent with Opportunity Zone rules.

To incentivize additional multifamily rehabilitation projects and address our nation’s workforce housing shortage, we once again respectfully request that the Treasury Department and Internal Revenue Service allow a waiver to the “double the basis” rule if property has been vacant for a period exceeding one year.

While beyond the scope of final regulations, the multifamily industry also urges the Trump Administration to support statutory modifications to reduce the basis increase necessary to qualify a multifamily rehabilitation project for Opportunity Zone purposes.

NMHC/NAA request that the Treasury Department and Internal Revenue Service use final regulations to clarify that debt-financed returns of capital that do not exceed a partner’s basis in an Opportunity Fund are not treated as a sale or exchange.

Individuals may wish to exit one Opportunity Fund to invest in another. We recommend that the Treasury Department and Internal Revenue Service allow such reinvestments without negative consequence to the five-, seven-, and 10-year basis adjustment thresholds so long as proceeds from exiting a Qualified Opportunity Fund are reinvested in another Qualifying Opportunity Fund within 180 days.

NMHC/NAA are concerned that the proposed regulations do not address the ability of an Opportunity Fund to: (1) dispose of a qualifying multifamily asset and acquire or construct another qualifying asset; and (2) own multiple multifamily assets within a single Opportunity Fund. We recommend that the Treasury Department and Internal Revenue Service address the first issue by providing Opportunity Funds the ability to reinvest capital from a sale without adverse Opportunity Fund tax consequence to either the Fund or its investors. This could be done by treating proceeds from a sale as working capital eligible for the 30-month working capital rule. We also request that the Treasury Department and Internal Revenue Service allow for multiple properties to be held within a single Opportunity Fund and that Opportunity Funds be allowed to divide into two funds in the case that a property is sold and the Fund does not reinvest the resulting capital in a qualifying Opportunity Fund asset. In such case, investors would still be able to realize Opportunity Fund tax benefits with regard to assets remaining in the original Opportunity Fund.

Stroock & Stroock & Lavan LLP

It would be very helpful for the IRS to provide guidance that addresses the following questions:

When will a QOZ business be treated as engaged in the active conduct of the QOZ business? For example, if a startup is just spending money on R&D, is that active enough for these purposes?

What constitutes a “substantial portion” of the intangible property of the business? We would suggest that 40% is a substantial portion, based on the use of that percentage for the new markets tax credit. See Treas. Reg. §1.45D-1(d).

Is cash used for advertising, research and development or other purposes eligible for the working capital exception? We would suggest that cash used for expenses to create or buy intangible property be eligible for the same 31-month safe harbor that is provided for cash that is used by a QOZ business to acquire or construct tangible property pursuant to a written schedule.

Under what circumstances should a business be treated as being conducted (and intangible assets be considered to be used) in the zone? For example, should this determination be made solely based on the location of employees and/or tangible assets of the business? We believe those factors should be determinative. Should the location in which property is sold or services are provided be relevant? We believe they should not be, at least if the employee or tangible asset tests are met. Based on the use of 40% for purposes of the new markets tax credit, we would suggest that a business would be considered conducted in qualified opportunity zones if at least 40% of the tangible assets of the business are in one or more QOZs or at least 40% of the employees of the business are employed in QOZs.

Center for American Progress

The zone selection process has resulted in the creation of Opportunity Zones in many tracts that are relatively well off or already gentrifying….In these tracts, the forfeited tax revenue will simply provide windfalls to those who already invested there before the program began rather than to community residents. In fact, certain developers have already cashed in due to their property being in a tract that was designated as a zone.

The Small Business Investor Alliance

SBIA recommends a broader definition of “qualified opportunity zone business property” to include intangible property because the active conduct of certain QOZ businesses will, no doubt, involve intangible product.

Please consider expanding the “substantially all” test (70 percent/total tangible property) to include investments in both tangible and intangible property provided the intangible property relates back to the tangible property of a QOZB.

Treasury regulations should expressly permit QOF investments in entities defined as small businesses under the Small Business Investment Act of 1958 as amended….