By   On April 7, 2020
POSTED IN CategoryOpportunity Zone

Part 2 – What Do We Know, And What Is Yet To Come?

In December 2019, the U.S. Treasury Department and Internal Revenue Service issued its final regulations governing the Opportunity Zone program. These 544 pages of regulations, including commentary and examples, sought to address both the initial lack of guidance in the prior proposed regulations, as well as address specific concerns raised by potential investors and their professional advisors. Despite being voluminous, the final regulations are still a relatively high-level framework governing the opportunity zone program, and details applicable to the almost unlimited variety of transaction structures in the marketplace will have to trickle out over time through further IRS guidance and revenue rulings, state and federal case law, and the like.

While a detailed discussion of the more complex aspects of the regulations is beyond the scope of this article, it is important to note how the regulations address certain threshold matters, and how these final regulations vary from the related proposed regulations. Below we will discuss three of those threshold matters, including the “substantial improvement” rule, the working capital safe harbor, and compliant transaction structure for exiting the investment.

The substantial improvement rule requires that a qualified opportunity fund spend as much capital to improve the applicable property over the first 30 months following acquisition of that property as is equal to the fund’s original basis in said property. In other words, a property acquired for $1 million will require at least $1 million of improvements over the 30 month post-acquisition period in order to qualify as being “substantially improved.” This facet of the program has been consistent through its inception, but what has changed in the final regulations is that an investor can now aggregate all property of the business for purposes of calculating the substantial improvement thresholds, where previously each asset had to be individually analyzed. For example, this would allow a developer to include the cost of original use equipment and furniture purchased for the property to count towards such property’s improvement. There are (of course) certain limitations on the ability to use the aggregated calculation, but this change will ultimately provide greater flexibility and ease to investors seeking to satisfy the substantial improvement test.

For qualified opportunity zone businesses, the proposed regulations included a requirement that no more than five percent of the business’s assets be held in cash or other financial instruments, excluding reasonable amounts of working capital. There was limited guidance in the proposed regulations regarding what was deemed “reasonable”, but it did specify that having a written plan for the deployment of working capital over a 31 month term – and actually using the working capital in accordance with that plan – would qualify for the safe harbor. In addition to leaving this guidance intact, the final regulations also now permit infusing new working capital into the original 31 month plan, provided that: (a) the total period does not exceed 62 months; (b) the new working capital otherwise meets the safe harbor requirements; and (c) the original and new working capital expenditures are an integral part and further the goals of the original plan. As such, the final regulations allow for substantially more flexibility in making additional, post-acquisition working capital infusions and ensuring that any such infusions do not run afoul of the safe harbor protections.

Lastly, even at the initial stages of the investment, best practices necessitate an analysis of potential transaction structures for an eventual exit. The proposed regulations contained a fairly limited set of acceptable structures to effectuate an investment exit, including by the sale of equity in the qualified opportunity fund or, in more limited cases, the sale by the qualified opportunity fund of its equity interest in a qualified opportunity zone business. Notably, however, the proposed regulations did not include the sale of an asset by the qualified opportunity zone business and attendant distribution of the proceeds to its owners. The final regulations have significantly expanded the means by which a compliant exit transaction can be effectuated, including through the aforementioned asset sale and distribution structure, as well with respect to a partial sale of interests. In other words, the interests can now be sold in tranches, each of which can qualify for opportunity zone tax benefits, thereby providing additional flexibility to the investor for exit transactions.

For a more detailed discussion of the final regulations, including the regulations concerning the treatment of property (as opposed to cash) contributed to a qualified opportunity fund, the “used in trade or business” requirements of qualified opportunity zone businesses, and scope of “eligible gains” for opportunity zone investment purposes, you can read our Opportunity Zone Client Alerts at the following link:


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While this Series will serve as an effective primer on the opportunity zone regulations and compliance framework, the devil is always in the details. If you are considering making an opportunity zone investment in the near future, or just want to learn more than this primer can offer, the attorneys at Martin LLP are always available to consult with you.

In the meantime, stay tuned for Part 3!


Part 1 / Part 3 / Part 4 / Part 5


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