Developers Get More Time with Opportunity Fund Safe Harbor

NEW YORK CITY—The Internal Revenue Service Opportunity Zone Guidelines responded to taxpayers’ concerns. As a result, the proposed regulations made two changes to the safe harbor for working capital.

Richard LaFalce, a former assistant branch chief in the IRS Office of Chief Counsel, financial institutions and products, is now a partner at the law firm Morgan Lewis. He counsels clients on the creation and taxation of investment vehicles including Opportunity Zone funds. LaFalce sat down with GlobeSt.com to explain the safe harbor changes and other ways the proposed regs could affect real estate professionals.

He notes planned use of working capital now includes the development of a trade or business in the qualified Opportunity Zone as well as acquisition, construction and/or substantial improvement of tangible property.

Under the working capital safe harbor, you have 31 months to implement your working capital plan. LaFalce explains how this works. Just say, you get assets in your qualified Opportunity Fund and those assets are not eligible assets but are just cash and other cash items. But if you have a working capital plan and you deploy your cash according to that plan, which is a development of a building, that cash is treated as an eligible asset.

“But sometimes you might not be able to finish a project in 31 months. So, the new rules said if the delay is due to basically getting government permits, that won’t cause you to run afoul of these rules,” says LaFalce.

The proposed rules state, “[E]xceeding the 31-month period does not violate the safe harbor if the delay is attributable to waiting for government action the application for which is completed during the 31-month period.”

Prior to the new regulations, LaFalce says this was one of the biggest concerns in the real estate industry. “Because frankly, 31 months is not long enough in all cases. Sometimes the process of working with local and state government to get all the necessary permits can take a year or two, sometimes just to get through that process,” he states. “Developing a large office building could take another 24 or 36 months on top of the permitting process.”

LaFalce says what could use more clarification is that the law currently states the working capital safe harbor applies to a qualified Opportunity Zone business. But he notes what often happens is a qualified Opportunity Fund gets capital from its investors and then the qualified Opportunity Fund usually forms an entity which is going to be a qualified Opportunity Zone business. That business is usually the one that is going to develop the real estate and the entity that uses the working capital safe harbor. “There was a hope that they would extend the working capital safe harbor rule to a qualified Opportunity Fund, so the fund itself does not necessarily have to drop the assets into a subsidiary entity,” says the tax expert.

He notes the new regs did not extend the rule to the qualified Opportunity Fund. But LaFalce notices although the IRS was silent on the issue, they changed the forms. These now give an impression based on the instructions that the rule about the working capital safe harbor applies to a qualified Opportunity Fund. He says many in the legal community had assumed the new proposed regulations would have confirmed that.

However, he states the new regs are generally favorable to the real estate world.

LaFalce emphasizes the most important change was allowing a qualified Opportunity Fund to sell assets after 10 years and to allow investors to get the step-up basis, as previously reported on GlobeSt.com. He describes the previous rule as making the program inoperable. With the new regs, the tax lawyer comments, “The IRS effectively found a way for the transactions to line up with marketplace practices which is to have the entity sell the assets rather than having the investors have to sell their interests in the entity.”

➤➤ Join the GlobeSt.com ADAPT: Opportunity Zones conference September 16-17 in Baltimore, MD The new national conference series is aimed at identifying Opportunity Zones across all property types and geographic regions. This first-of-its-kind event will educate, connect and celebrate the investors, developers and owners with the people behind the planning and decision-making, such as architects, consultants, academics and, most importantly, municipal officials.

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