Source: http://www.daiassociates.com/qualified-opportunity-zones-and-select-partnership-issues/
Timestamp: 2019-04-24 12:37:38+00:00

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﻿ Qualified Opportunity Zones and Select Partnership Issues - DAI & ASSOCIATES, P.C. | DAI & ASSOCIATES, P.C.
The 2017 tax act (Pub. L. No. 115-97) created the new concept of qualified opportunity zones (QOZ), which are low-income census tracts in which certain investments are provided tax benefits. On October 19, 2018, the Treasury Department and the Internal Revenue Service released the initial proposed regulations, which address some QOZ issues but have created some new uncertainties, particularly in the partnership area.
QO Fund interest is held for 10 years or more.
over a 30-month period (or its original use in the QOZ commences with the QO Fund).
The lower-tier corporation or partnership must meet various requirements to be a QOZ business. For example, substantially all (at least 70%) of a QOZ business’s owned or leased tangible property must consist of QOZ business property. Furthermore, less than 5% of the QOZ business’s tangible and intangible property (by unadjusted basis)10 can be stocks, debt, partnership interests, and similar ‘‘nonqualified financial property,’’ but nonqualified financial property does not include cash and other working capital generally held for up to 31 months of acquisition, construction,and/or substantial improvement of QOZ business property. A lower-tier corporation or partnership can therefore own any amount of such working capital, provided that the entity meets the 70% test for tangible property and the other QOZ business requirements.
Example: A QO Fund contributes $700 of cash to a lower-tier partnership, which already owns $100 of contributed land. The lower-tier partnership plans to spend the $700 to construct a building on the land within a year, which permits the $700 cash to be held as working capital. The partnership’s tangible property includes the land, which was not acquired by purchase and may cause the partnership to fail to be a QOZ business. Depending on the proper interpretation of the working capital safety harbor, the partnership may or may not have to spend at least $234 on construction in the QOZ quickly, in order to have at least 70% of its tangible property consist of QOZ business property, as periodically measured under the various methodologies in Prop. Reg. §1.1400Z-2(d)-1(d)(3).
QO Fund may be able to own an interest in the lowertier partnership as long as the partnership eventually becomes a QOZ business and remains so during ‘‘substantially all’’ of the QO Fund’s holding period. There is no safe harbor for working capital owned directly by a QO Fund. In order to meet the 90% test, a QO Fund should apparently not directly own more than 10% cash, goodwill, or other intangible property, which may be an issue for certain businesses that can be owned directly by a QO Fund but are prohibited for a lower-tier corporation or partnership, such as a golf course, country club, massage parlor, hot tub facility, suntan facility, gambling facility, or liquor store.
The proposed regulations provide that a partnership may defer its partnership-level gain with a QO Fund investment, within the 180-day reinvestment period beginning on the partnership’s sale or exchange date. This result conforms with the IRS’s Draft Instructions to Form 1065 Schedule D, released on September 13, 2018.
The proposed regulations also provide that if the partnership does not defer the gain, the partnership gain is allocated to the partners, who may defer their allocated gain with a partner-level QO Fund investment. The partner’s 180-day reinvestment period begins on the last day of the partnership’s taxable year, though a partner may elect to have the reinvestment period begin earlier on the partnership’s date of gain recognition.
purchaser of the property.18 The relationship requirement is stricter, however, if the partnership’s gain is allocated to the partners, because a partner-level QO Fund investment is allowed only if both the partner and the partnership are not 20% related to the purchaser.
benefits under the mixed investments bifurcation rule in §1400Z-2(e)(1).
up to a year later.
Example: A partnership sells land on January 1, 2019, for $1,000 of cash, all of which is transferredto a qualified intermediary as part of a §1031 exchange. The partnership fails to acquire any replacement properties within 180 days (by June 30, 2019). The qualified intermediary returns the $1,000 to the partnership on June 30, which is too late for the partnership to have made its QO Fund investment within the 180-day reinvestment period that ended on June 29, 2019.21 The partners, however, may make QO Fund investments by June 27, 2020, which is 179 days after December 31, 2019, and therefore within the partners’ 180-day reinvestment period.
that the capital gain may be deferred with a QO Fund investment,22 apparently without regard to whether the shareholder is related to the purchaser of the RIC’s or REIT’s property. The shareholder’s 180-day reinvestment period begins on the date that the dividend was received. However, the RIC or REIT does not have to designate its distributions as capital gain dividends until generally January of the next year,23 which may be after the end of the shareholder’s 180-day reinvestment period.
A taxpayer may be better off holding the RIC or REIT stock in a partnership, in order to use the 180-day reinvestment period for the partnership-allocated capital gain dividend that begins later.
$200 ordinary dividend, $300 capital gain dividend, and $100 return of capital. It is too late for the partnership to make a $300 QO Fund investment, which was required by September 25, 2018. Instead, the partners may defer their partnership-allocated $300 capital gain dividend with a QO Fund investment by June 28, 2019.
The proposed regulations provide that QOZ deferral is allowed only for an investor’s gain that is ‘‘treated as capital gain for Federal income tax purposes.’’ The deferred gain can be the investor’s gross amount of capital gain from a sale or exchange, without regard to the investor’s capital losses. No QOZ gain deferral is allowed for gain treated as ordinary income or dividend income, such as depreciation recapture, gain from the sale of inventory, §1248 deemed dividend from the sale of foreign stock, or ordinary income recapture under §467 from the disposition of certain leased property.
of §1231 property, which generally includes real property and depreciable personal property used in a trade or business and held for more than one year. If such §1231 gains exceed §1231 losses for the year, the gains and losses are treated as capital gains and capital losses, respectively, which should allow the gross amount of the §1231 gains to be deferred with a QO Fund investment, while the §1231 losses are allowed as losses. However, if §1231 gains do not exceed §1231 losses, the gains and losses are treated as ordinary income and ordinary losses, respectively, and perhaps none of the §1231 gains may be deferred.
§1231 losses for the year.
extent taken into account in computing gross income.
whether its partnership-level §1231 gain will eventually be treated as capital gain or as ordinary income at the partner level.
§1231 gain is capital gain or ordinary income depending on individual’s other §1231 gains or losses.
some §1231 gain to be recaptured as ordinary income under §1231(c).
§1250 gain may be subject to 20% recapture as ordinary income, which is not eligible for QOZ deferral.
It is possible that the final regulations will clarify that any partner-specific gain recharacterization does not apply at the partnership level, which would encourage partnership-level QO Fund investments.
If a taxpayer holds property for investment instead of using it in a trade or business, the property’s disposition generally gives rise to capital gain that can be deferred with a QO Fund investment. Whether real estate is held in a rental trade or business is a complex issue that arises in many contexts, such as under the 20% §199A deduction for certain income from a passthrough trade or business. The distinction is particularly acute for property held for one year or less: if a taxpayer disposes of property used in a trade or business and held for one year or less, the resulting ordinary income cannot be deferred with the QOZ rules, whereas short-term capital gain from an investment property can be deferred.
A partner who purchases a partnership interest may have a §743(b) adjustment, generally equal to the difference between the partner’s tax basis in its partnership interest and the partner’s share of the partnership’s tax basis in partnership assets. A positive §743(b) adjustment can reduce the partner’s allocable gain from the partnership’s disposition of a partnership asset. Conversely, a negative §743(b) adjustment can increase the partner’s allocable gain.
adjustment may be better off with a partnership-level QO Fund investment.
partner would normally be allocated $50 of the gain, which would increase to $150 with the §743(b) adjustment. If the partnership defers all $100 of partnership-level gain with a $100 QO Fund investment, the treatment of the negative $100 §743(b) adjustment is unclear. The adjustment may or may not be carried over into the QO Fund interest.
If a partnership borrows money, its partners normally increase their outside tax basis in their partnership interest under §752(a), as if the partners contributed money to the partnership. If a QO Fund partnership borrows money, the proposed regulations provide that the §752(a) tax basis increase is not a partner contribution of money that is subject to the mixed investment bifurcation rules for a non-gain QO Fund investment under §1400Z-2(e)(1). As a result, all of the partners’ gain from selling their interests in the leveraged QO Fund may be excluded after 10 years under §1400Z-2(c).
Example: A taxpayer recognizes $100 of gain in 2018, which is invested in a QO Fund. The QO Fund borrows $400 and acquires $500 of land in an Orange County QO Zone, for use in its parking lot and apiary trades or businesses. The taxpayer recognizes $85 of gain in 2026. The taxpayer may sell its QO Fund interest after 10 years, through 2047, with no taxable gain due to the basis step-up to fair market value under §1400Z-2(c). A QO Fund should substantially improve its purchased property that was previously used in the QO Zone, but the proposed regulations provide that land does not have to be substantially improved, although the QO Fund may or may not be required to constructa small building or other structure on the land within 30 months.
which may allow a QO Fund partnership to allocate depreciation and other tax losses to its investors.
Example: A partnership QO Fund borrows $420 of cash to acquire a single-purpose agricultural or horticultural structure, which was specifically designed, constructed, and used for the commercial production of plants in a Colorado QO Zone. Section 752(a) may increase the investors’ tax basis in their QO Fund interests by $420, which allows the QO Fund to allocate up to $420 of depreciation deductions or other losses to the investors. After 10 years, the investors may sell their QO Fund interests with a basis step-up to fair market value under §1400Z-2(c), without any taxable gain and apparently without any depreciation recapture.
by depreciation, in which case the substantial improvement can be done at less cost.
above example. A permanent tax basis of zero may have some collateral consequences under the partnership taxation rules. For instance, the investor may have gain under §752(b) when the QO Fund repays its loan. The investor may or may not also recognize too much taxable gain if it receives loan proceeds or other cash distributions, or if it sells its QO Fund interest and its amount realized includes the QO Fund’s liabilities.
the QO Fund also has to reduce the tax basis of its assets, including the QO Fund’s interests in lower-tier corporations and lower-tier partnerships (which may have their own tax basis reductions).
if the QO Fund sells its assets after 10 years and allocates or distributes its gain.
If a partner purchases an interest in a partnership that has previously made a QO Fund investment, whether the new partner may reduce its share of the partnership’s gain recognized in 2026 with its positive §743(b) adjustment.
rules in §6221 through §6241, as enacted by the Bipartisan Budget Act of 2015 (P.L. 114-74).
foreign source of the initial gain carries over into the QO Fund investment, whether the gain recognized in 2026 is subject to U.S. withholding tax, and other international tax issues.
CFCs, federal partnership rules, and Puerto Rican tax law.
treatment of §1202 qualified small business stock and other federal provisions suggests some reluctance to follow federal nonrecognition rules.
may also have $850 of state B taxable income in 2026, even if state B would have also taxed the investor on the initial 2018 gain had he been living in state B at the time. State B may be reluctant to provide a credit for the taxpayer’s state A income taxes paid in 2018, which may raise constitutional issues.
their investment, or otherwise find their QOZ tax benefits go up in smoke.

References: §1
 §1400
 §1031
 §1248
 §467
 §1231
 §1231
 §1231
 §1231
 §1231
 §1231
 §1231
 §1231

§1231
 §1231

§1231
 §1231
 §1231
 §1231

§1250
 §199
 §743
 §743
 §743
 §743
 §743
 §752
 §752
 §1400
 §1400
 §1400
 §1400
 §752
 §743
 §6221
 §6241
 §1202