United States: IRS Provides Pandemic-Related Relief For Certain Opportunity Zone Deadlines

Highlights

• IRS Notice 2020-39 provides relief from certain deadlines under Section 1400Z-2 of the Internal Revenue Code of 1986 and the U.S. Department of the Treasury regulations thereunder (the Opportunity Zone Rules).
• Delay caused by the impact of the COVID-19 pandemic have made achieving these deadlines within the time expected difficult or impossible. Accordingly, the IRS has acted to assist taxpayers adversely impacted by the COVID-19 crisis by tolling or extending certain important Opportunity Zone deadlines.
• Notice 2020-39 provides that if a taxpayer's 180-day investment period ends between April 1, 2020, and Dec. 31, 2020, the end of such taxpayer's 180-day investment period is automatically extended to Dec. 31, 2020.

The IRS issued Notice 2020-39 on June 5, 2020, to provide relief from certain deadlines under Section 1400Z-2 of the Internal Revenue Code of 1986 and the U.S. Department of the Treasury regulations thereunder (the Opportunity Zone Rules). Consistent with the policy behind the Opportunity Zone incentive to push investment money into low-income communities speedily, the Opportunity Zone Rules contain a number of deadlines for investing in qualified opportunity funds (QOFs) and qualified opportunity zone businesses (QOZBs) and for completing the projects funded by Opportunity Zone investments. Delay caused by the impact of the COVID-19 pandemic have made achieving these deadlines within the time expected difficult or impossible. Accordingly, the IRS has acted to assist taxpayers adversely impacted by the COVID-19 crisis by tolling or extending certain important Opportunity Zone deadlines.

The authority for the IRS to extend deadlines is based on President Donald Trump's declarations under the Robert T. Stafford Disaster Relief and Emergency Assistance Act that major disasters existed as of Jan. 20, 2020, with respect to all 50 states, the District of Columbia and five territories (the Major Disaster Declarations). Every census tract that has been designated as an Opportunity Zone is within the areas designated by the Major Disaster Declarations.

Relief for Investors in QOFs

Under the Opportunity Zone Rules, a taxpayer may elect to defer the recognition of capital gain on the sale of an asset for a period generally equal to 180 days from the date of the sale or exchange that generated the gain. Special rules apply to certain types of taxpayers, such as partnerships and other pass-through entities, and to certain types of gain, that may affect the starting date of the 180-day period. Notice 2020-39 provides that if a taxpayer's 180-day investment period ends between April 1, 2020, and Dec. 31, 2020 (the Pandemic Impact Period), the end of such taxpayer's 180-day investment period is automatically postponed until Dec. 31, 2020. Notice 2020-39 supersedes Notice 2020-23 on this point. Notice 2020-23 included an extension of the 180-day period to July 15, 2020, with a laundry list of other non-Opportunity Zone "time-sensitive" relief provisions.

Relief for QOF "Investment Standard" Deadlines

QOFs must maintain at least 90 percent of the funds they raise in qualified opportunity zone projects or businesses (the Investment Standard). Compliance with this requirement generally must be tested at the end of the first six months of the QOF's tax year and on the last day of the QOF's tax year. Compliance is measured by averaging the percentages on these dates, provided that funds contributed by a QOF within the six months preceding a testing date can be effectively disregarded pursuant to a formula.

In the early days of the Opportunity Zone incentive, QOFs found it difficult to place funds raised into qualifying investments within the short time frames permitted. The rule permitting "early contributions" to be effectively disregarded, as well as the rule permitting funds invested to be held in a working capital reserve (discussed below) at the project level, were intended to provide QOFs with some relief from the strict requirements for pushing investment money into low-income communities. Mitigation of the risks of the COVID-19 pandemic adversely affected many industries and, in turn, has seriously exacerbated timing issues as potential projects are delayed or fail to underwrite in the current economy.

In response, Notice 2020-39 provides that if a QOF whose 1) last day of the first six-month period of the taxable year or 2) last day of the taxable year falls within the Pandemic Impact Period, any failure by the QOF to meet the Investment Standard for that tax year is automatically 1) deemed to be due to "reasonable cause" under the Opportunity Zone Rules and 2) disregarded for purposes of determining whether the QOF or any otherwise qualifying investments in the QOF satisfy the Opportunity Zone Rules for any taxable year of the QOF. It appears that for a QOF whose six-month and year-end testing dates fall within the Pandemic Impact Period, the next meaningful testing date would be June 30, 2021 (if such QOF has a calendar year tax year).

Relief for QOZBs Relying on the Working Capital Safe Harbor

Many QOZBs have relied on the working capital safe harbor outlined in the Opportunity Zone Rules (the Working Capital Safe Harbor) to ensure that working capital reserves are not treated as non-qualified financial property, which could cause the business to fail to qualify as a QOZB. Perhaps more important are the other benefits offered by the Working Capital Safe Harbor, including facilitating the ability of a QOF to fund its investment in time to meet QOF investment deadlines as well as facilitating a framework for qualifying the business as a QOZB early in the development process and prior to the ultimate completion of the project. In order to qualify for the Working Capital Safe Harbor, among other things, the business must develop the project in accordance with a working capital plan that is projected to be completed within 31 months, subject to an extension to a maximum of 62 months under certain circumstances.

The Opportunity Zone Rules already provide that the working capital period may be extended for an additional 24 months if the project is located in a federally declared disaster area. Notice 2020-39 acknowledges that as a result of the Major Disaster Declarations, all Opportunity Zone census tracts are federally declared disaster areas, and thus all QOZBs are entitled to an additional 24 months to expend working capital assets subject to the Working Capital Safe Harbor, resulting in a working capital period of up to 86 months. This will be very helpful to QOZBs in areas that have been subject to work stoppages or other construction delays as a result of COVID-19.

Relief for QOZBs Subject to the Substantial Improvement Requirement

Businesses that seek to qualify as a QOZB must meet a variety of tests, including that at least 70 percent of their tangible assets must be QOZB property. If the hopeful QOZB is not the original user of a tangible asset, the business must improve the asset by adding to the basis of the asset an amount equal to at least 100 percent of the basis of the asset within a 30-month period (the Substantial Improvement Test). For example, a business that purchases an existing building must improve the building with expenditures at least equal to the purchase price of the building (excluding the land on which it is located) within 30 months from the acquisition of the building. Notice 2020-39 provides that the substantial improvement period is tolled during the Pandemic Impact Period. Accordingly, in calculating compliance with the Substantial Improvement Test, the Pandemic Impact Period is disregarded. This additional cushion will be helpful to rehabilitation projects whose construction period has been disrupted by the economic impact of COVID 19 and the practical impact of mitigation efforts.

Extension of 12-Month Reinvestment Period for QOFs

If a QOF sells or disposes of its interest in a QOZB, or receives a return of capital with respect to such interest, and reinvests the proceeds in another QOZB within 12 months from the receipt of the proceeds, the proceeds are treated as qualified opportunity zone property for purposes of the QOF's Investment Standard test, provided that, until reinvested, the proceeds are held continuously in cash, cash equivalents or debt instruments with a term of 18 months or less. Under the Opportunity Zone Rules, if the QOF's plan to reinvest the proceeds is delayed due to a federally declared disaster, the QOF has an additional 12 months within which to reinvest the proceeds in the manner originally intended. Notice 2020-39 provides that if a QOF's 12-month reinvestment period includes Jan. 20, 2020 (the effective date of the disasters as stated by the Major Disaster Declarations), the QOF has an additional 12 months to reinvest, provided it satisfies the other conditions to reinvestment and invests the proceeds in the manner originally intended before Jan. 20, 2020. Because the Major Disaster Declarations cover all states, the District of Columbia and five territories, all QOFs with a reinvestment period that includes Jan. 20, 2020, will have up to 24 months to reinvest.