Qualified Opportunity Funds and Investors Receive COVID-19 Related Tax ReliefJune 12, 2020
This alert was updated January 21, 2021.
On June 4, 2020, the Internal Revenue Service (IRS) released Notice 2020-39, providing COVID-19 related relief to Qualified Opportunity Funds (QOF) and their investors from certain requirements under Code Section 1400Z-2. On January 19, 2021, the IRS released Notice 2021-10, expanding upon the relief previously granted to QOFs and their investors under Notice 2020-39.
Extension of 180-Day Investment Requirement for QOF Investors
Taxpayers can elect to defer recognition of capital gains until December 31, 2026, by making a qualifying investment in a QOF in an amount equal to the realized gain within 180 days. Notice 2021-20 grants more time for certain QOF investors to satisfy this timing requirement. If a taxpayer’s 180-day period ends between April 1, 2020 and March 31, 2021, then such taxpayer has until March 31, 2021, to make a qualifying investment in a QOF. The extension is automatic and taxpayers do not need to do anything to take advantage of the extension. However, QOF investors will still need to make a valid deferral election using Form 8949 and Form 8997.
Temporary Exemption from 90% Test
Generally, if a QOF fails to hold at least 90% of its assets as qualified opportunity zone property (the “90% Test”), based on the average measurement taken on two semi-annual testing dates (typically June 30 and December 31), penalties are imposed on the QOF, unless the failure is due to reasonable cause. A QOF must certify annually that it meets the 90% Test, and calculate its penalty if it does not, on Form 8996. Under Notice 2021-10, any failure of a QOF to satisfy the 90% Test on a testing date that falls between April 1, 2020 and June 30, 2021, will be considered due to reasonable cause. Therefore, QOFs using the calendar year will not have to meet the 90% Test in 2020, allowing such QOFs additional time to find suitable investments. This relief is automatic, but the QOF must still accurately complete Form 8996. In Part IV, Line 8 of Form 8996, a QOF that fails the 90% Test during the relief period should put “0” as the penalty.
Working Capital Safe Harbor
For an entity to qualify as a qualified opportunity zone business, it must meet various requirements, including the requirement that no more than 5% of its assets can be nonqualified financial property (e.g., cash and equivalents). Qualified opportunity zone businesses may, however, qualify for an exclusion from this requirement under a safe harbor if the cash is held as working capital for the acquisition, construction or development of property or a trade or business, and the cash is used according to a written plan within certain timeframes, generally 31 months. Under Notice 2021-10, all qualified opportunity zone businesses with working capital intended to be covered by the working capital safe harbor prior to June 30, 2021, will receive an additional 24 months to spend the working capital, for a maximum safe harbor period of 55 months (86 months for start-up businesses).
12-Month Reinvestment Period Relief
A QOF generally has 12 months to reinvest proceeds it receives from the disposition of qualified opportunity zone property. Any proceeds not reinvested within this timeline are not considered qualified opportunity zone property for purposes of the 90% Test. Under Notice 2021-10, all QOFs have an additional 12 months to reinvest the proceeds so long as the original 12-month reinvestment period includes June 30, 2020, and the proceeds are invested in the manner originally intended before the disaster.
Relief from 30-Month Substantial Improvement Period
For property to be considered qualified opportunity zone business property, either the original use of the property must commence in the opportunity zone or the property must be substantially improved within 30 months of acquisition. Notice 2021-10 provides that the 30-month substantial improvement period is tolled from April 1, 2020, through March 31, 2021. While this relief is automatic, taxpayers will still need to make a valid deferral election on Form 8949 and complete Form 8997.
No Relief for Remote Workers Outside the Opportunity Zone
While the IRS has provided much welcomed relief to QOFs and investors, the IRS has not yet provided relief for the increase in remote work as a result of COVID-19. A qualified opportunity zone business must generate at least 50% of its gross income from the active conduct of a trade or business in an opportunity zone. This test can be satisfied based on the number of hours worked or the amounts paid to workers in the opportunity zone. Since most workers are working remotely, if they are working at all, the IRS’s failure to provide relief for this issue may prevent certain entities from qualifying as qualified opportunity zone businesses.
Our attorneys are closely monitoring these developments as they occur and will make regular updates to our COVID-19 Resource Center. If you have any questions concerning Notice 2020-39 or Notice 2021-10, investments in qualified opportunity zones, or the implications and disruptions of COVID-19 on your business, please contact any of the authors above or another member of the Task Force.