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IRS Provides Relief for Opportunity Zone Investors in Light of COVID-19 Pandemic
In guidance released in June, the IRS relaxes certain regulations surrounding Qualified Opportunity Zone (QOZ) investments and Qualified Opportunity Funds (QOF).
The new guidelines provide relief for CRE investors in five important ways:
- The 180-day period for investors to reinvest in QOFs (allowing for commercial real estate tax deferral on capital gains) has been extended to December 31, 2020.
- Investors and QOFs will be granted reasonable cause relief if they fail to meet the 90% investment standard in 2020. “Reasonable cause relief” refers to the national emergency declared in all 50 states because of COVID-19.
- Suspends the requirement for a project to be “substantially improved” within a 30-month period for QOFs of Qualified Opportunity Zone Businesses (QOZBs) that purchased properties under the original Opportunity Zone rules.
- Grants an additional 24 months to the safe harbor period if a QOZB meets working capital safe harbor requirements under the original statute (added to the original 31-month safe harbor period for qualifying assets).
- Allows QOFs an additional 12 months to reinvest some or all of the proceeds gained by the QOF through the sale of qualifying properties into an additional Opportunity Zone property. This extends the total period to 24 months.
For more information about the commercial real estate tax considerations for Opportunity Zone investors during the COVID-19 pandemic, see the IRS release here.
Pre-Pandmic Commercial Real Estate Tax Regulations Regarding Opportunity Zones
In 2019, The United States Treasury Department released the second round of regulations regarding Opportunity Zones. When originally introduced in 2017, the prospect of commercial real estate tax incentives for commercial real estate investing in Opportunity Zones excited many investors. Yet initially, many of these same investors hesitated to invest due to uncertainty about these commercial real estate tax incentives. As a result, the Trump administration formulated this 169-page document to clarify matters for investors.
Opportunity Zones: The Basics
Originating in the 2017 Tax Cuts and Jobs Act, Opportunity Zones are economically-distressed communities where certain new investments could qualify for tax incentives. The goal of these zones is to stimulate economic development in these areas. For example, Houston alone has 150 Opportunity Zones like Hillcroft-Harwin on the Southwest Freeway and Downtown Houston.
Hurricane Harvey impacted many Houston areas in 2017. As a result, many still have a real need for capital investments.
5 Previous Changes to Opportunity Zone Commercial Real Estate Investing
To help you better understand Opportunity Zones and commercial real estate tax incentives, you should know the changes made to regulations as of 2019:
1. Business-friendly guidelines
Previously, the guidelines stated that 50% of a business’s total gross income must come from activity within a qualified Opportunity Zone. Yet this was not entirely clear. To clarify this 50% rule, the 2019 updated regulations offer several ways to meet the criteria:
- Employees or contractors must spend at least 50% of their working hours within the Opportunity Zone. These hours must total at least 50% of the business’ total hours worked.
- Also, 50% of the business’s services must be located within the Opportunity Zone. In addition, payments to employees and contractors must be 50% of the total dollars paid for these services.
- Business management operations based in the Opportunity Zones (or zones) must be necessary to generate 50% of all gross income.
On top of that, the new guidelines allow extra consideration for businesses under ‘facts and circumstances’ based on case-by-case scenarios.
2. Opportunity Zone Properties Straddling Non-Opportunity Zone Areas
Owners can receive tax benefits if the majority of the property lies within an Opportunity Zone.
Based on numerous questions about property locations, the 2019 regulations clarify whether a property can be partially located in a non-Opportunity Zone. The verdict is that owners can receive commercial real estate tax benefits as long as the majority of the property’s square footage lies within an Opportunity Zone. Furthermore, the square footage outside the zone must be contiguous to a portion or all of the property that is located within the zone.
3. Rules Regarding Reinvestment and Commercial Real Estate Tax
In the October 2018 regulations, investors originally inserted a 31-month ‘safe harbor’ period. During this period, an investor was able to invest in Opportunity Funds (OFs) before fully investing in real estate. The new regulations add a business development aspect which will also benefit from the 31-month safe harbor.
Before the COVID-19 pandemic, qualified QOFs had a one-year grace period. Within this time frame, investors had to sell assets and reinvest proceeds into other Opportunity Zone investments. Added protections under Coronavirus emergency declarations will reduce investors’ risk by giving them more time to make good investment choices. It also increases flexibility by allowing investors up to two years to sell assets and then reinvest those funds without tax penalties.
4. Vacant Properties
Previous guidelines stated that investors needed to meet a substantial improvement provision on properties in Opportunity Zones. Because of this provision, investors needed to undertake significant upgrades to certain types of properties. However, under the 2019 regulations, properties that have been vacant for a significant time period will qualify immediately for the commercial real estate tax breaks. Currently, any abandoned or run-down property purchased within an Opportunity Zone doesn’t need to meet the prior improvement provision.
5. Inheritance of Opportunity Zone Assets
According to the first round of regulations, your children would not benefit from your Qualified Opportunity Fund (QOF) investment in the event of your death. The new regulations have changed that completely. Now, a new mechanism prevents heirs from being penalized if an investor passes away. If an investor dies, the investment passes on to children (or other heirs) allowing them all the benefits of the original QOF investment.
A new mechanism prevents heirs from being penalized if an investor passes away.
Opportunity Zones Investment with Lumicre
Ready to invest in Opportunity Zones, but don’t know where to start? Confused about the new regulations in light of the COVID-19 pandemic? Let Lumicre’s team of commercial real estate professionals get you started. We can tell you more about commercial real estate tax breaks for Opportunity Zone investments.
Contact us today to learn more about investment opportunities in Houston and other cities.
Further Reading:
Lumicre Insight: 3 Things You Don’t Know About Houston’s Opportunity Zones — Lumicre Group
Lumicre Insight: Real Estate Investors Eye Opportunity Zones in Houston