Qualified Opportunity Funds (QOF) were created as a part of the 2017 Tax Cuts and Jobs Act (TCJA) as a vehicle to defer tax on gains. Qualified opportunity zones were designated by each individual state in areas that were deemed to be economically distressed.  To defer gains, a taxpayer must invest their gains into a QOF, which is defined as a partnership or corporation that invests directly in QOZ business or property.    

The Qualified Opportunity Zone program differs from other gain deferral incentives in that only the gain portion of a sale or transaction need be reinvested, not the total proceeds.  Typically, gains need to be reinvested within 180-days of the transaction which generated the gains, with some exceptions. 

The basis of investments for gains deferred into QOFs are initially zero.  After a holding period of five years, the basis in the investment is increased by 10% of the original gain deferred.  If the investment is held in QOF for seven years, an additional 5% of the original gain deferred is added to the basis of the investment as well.  On the earlier of December 31, 2026 or the date of sale of the taxpayer’s interest in the QOF, taxes will be required to be paid on the original gain amount less any holding period step up(s) in basis.  If the investment is held for ten years or more, any additional appreciation in the investment may be recognized by the taxpayer tax-free.

The IRS recently issued Notice 2021-10 which provided additional relief for opportunity zone investors and funds in meeting certain deadlines and standards described in the regulations.  Areas in which relief was provided for include the 180-day reinvestment period, the 90-percent investment standard, 30-month substantial improvement period, working capital safe harbor, and the return of capital reinvestment period. 

The following is a brief summary of each of these requirements and the relief provided for in Notice 2021-10.

180-Day Reinvestment Period

Taxpayers are required to invest gains into a QOF within 180 days of the transaction giving rise to the gain.  Some exceptions apply for gains generated inside a flow through entity in which the date to begin the 180-day window may either be the date the gain is generated, the last day of the entity’s tax year, or the due date of the entity’s tax return, without extensions.  Prior to notice 2021-10, the IRS had extended the close of the 180-day window for any gain deferrals where the 180-day window would have ended between April 1, 2020 and December 31, 2020 to automatically be extended through December 31, 2020.  Notice 2021-10 expanded the window through March 31, 2021.

90-Percent Investment Standard

Qualified Opportunity Funds are required to hold 90 percent of their assets in qualified opportunity zone property in order to qualify as a QOF.  The fund’s assets are to be tested twice annually.  Notice 2021-10 provides that if an entity fails to meet the 90 percent standard for any testing dates that fall between April 1, 2020 and June 30, 2021, the fund’s QOF status will not be affected due to reasonable cause on account of the COVID-19 pandemic. 

30-Month Substantial Improvement Period

Certain real property holdings inside a fund are required to be substantially improved within 30 months of the entity’s purchase of the property.  There are some exceptions that apply where substantial improvement is not required (example: raw land), but where improvement is required within 30 months, any 30-month period set to expire between April 1, 2020 and March 31, 2021 are automatically extended by Notice 2021-10 through March 31, 2021.

Working Capital Safe Harbor Spending Deadline

A working capital safe harbor was established in the QOZ regulations that allowed a fund 31 months to expend capital in an opportunity zone, granted they had a written plan for the deployment of capital and documented how the plan was being followed.  Notice 2021-10 provides that for any working capital safe harbor that was in place prior to June 20, 2021, an additional 24 months were added to the period in which the capital must be expended.

Return of Capital Reinvestment Period

The final opportunity zone regulations provided funds with a 12-month window in which capital generated from the sale of qualified property held by the fund could be reinvested in other qualified property.  Notice 2021-10 allows an additional 12 months for any reinvestments where the 12 month window for reinvestment includes June 30, 2020. This treatment is available to a QOF only to the extent that, prior to the reinvestment in qualified opportunity zone property, the reinvested proceeds are continuously held in cash, cash equivalents, or debt instruments with a term of 18 months or less. 

Please don’t hesitate to reach out to John Mayer at john.mayer@sobelcollc.com or Mariana Moghadam at mariana.moghadam@sobelcollc.com if you have any questions regarding Qualified Opportunity Funds.

John Mayer is a Supervisor in the SobelCo Tax Department.  Mariana Moghadam is a Member of the Firm with a distinctive role in the SobelCo's Tax and Real Estate Practices.