Qualified Opportunity Funds Receive Pandemic Relief from IRS
The IRS has been actively releasing various relief efforts in response to the COVID-19 pandemic. Qualified opportunity funds (QOFs) and qualified opportunity zone businesses (QOZBs) were also granted relief for certain compliance deadlines.
Section 1400Z-2 of the IRS code provides that taxpayers normally have 180 days to invest gain in a qualified opportunity fund in order to take advantage of the favorable opportunity zone tax treatment. In response to the coronavirus pandemic and President Trump’s disaster declaration, the IRS issued Notice 2020-23, which provided relief to taxpayers for postponing certain due dates to July 15, 2020. The July 15th extension applied to any IRS deadline that fell between April 1st and July 15th. Everything in that window received an automatic extension to July 15th, which includes taxpayers’ 180-day deadlines for rolling over capital gains into a QOF.
Effectively, if a taxpayer had a gain at any point toward the end of 2019, any time between October 4th and the end of 2019, then the taxpayer’s QOF investment deadline automatically got extended until July 15th. An additional notice, IRS Notice 2020-39, provides even further relief for QOFs and investors. It further extended the 180-day investment period deadline as any 180-day period that ends on or after April 1, 2020 and before December 31, 2020, the deadline is automatically extended to the end of 2020.
So, what does this really mean? Any capital gain recognized by an individual taxpayer on or after October 4, 2019 and before July 4, 2020 has a QOF investment deadline of December 31, 2020. Effectively there is no longer a 180-day period, but rather simply a year-end 2020 deadline. Any capital gain recognized on or after July 4th, 2020, the normal 180-day period will once again apply because then that starts taking you out into 2021.
What does this all mean for taxpayers who are investing capital gains reported from an investment in a partnership (Schedule K1)? There are special considerations because the QOZ regulations permit these taxpayers to elect different dates for when the gain was recognized. One of the dates allowed to be selected it the due date of the partnership return, not including extensions – which would be March 15, 2020 for 2019 tax year returns. The new December 31, 2020 deadline can apply to any capital gain recognized from the partnership on or after January 1, 2019. Investors recognizing capital gain through a 2019 Schedule K1 now have until the end of 2020 to invest that capital gain into a QOF.
For either type of taxpayer, there is a lot more flexibility and a lot more time now to decide what to do with those gains recognized. Taxpayers have until the end of 2020 to invest capital gains into a QOF: in the case of the partnership gain (Schedule K1), the taxpayer can go all the way back at the beginning of 2019; in the case of a non-partnership gain, the taxpayer can go all the way back to early October 2019.
What does this potentially mean for QOFs? The IRS extensions remove the urgency with which an investor might normally have to invest capital gain into a QOF, which could be good and bad. QOFs may have been expecting various waves of investments from investors throughout the year – however, with the extensions, all of these waves could be much smaller throughout the year and have a giant wave of investing at the end of 2020. With economic uncertainty, taxpayers may want to maximize the extension time and hold on to their money as long as possible, which could mean a significant amount of investment activity happening the final weeks of 2020.
In addition to the 180-day investment requirement extension, there are also four different relief measures provided for QOFs and QOZBs to comply with the regulations.
Number 1: If a QOF fails its 90% asset test during April 1, 2020 and December 31, 2020, it’s deemed to be due to reasonable cause. There would be no resulting penalty. When the fund prepares and files IRS form 8996, even if it failed the test, the QOF can calculate the penalty as just being zero. Effectively, this allows the QOF that much more time to get in compliance with the 90% test. This is a nice form of relief for QOF managers.
Number 2: The 30-month substantial improvement period for both QOFs and QOZBs is impacted. The period between April 1, 2020 and December 31, 2020 is completely disregarded for the purposes of measuring the 30-month period. That nine-month period doesn’t exist for the purposes of measuring the 30-month period. Essentially, the QOF and QOZB goes straight from March 31, 2020 to January 1, 2021 for purposes of this compliance requirement.
Number 3: The working capital safe harbor was granted relief. President Trump declared the entire nation a disaster area, which means every opportunity zone now falls within a disaster area. Therefore, any QOZB’ working capital safe harbor period, whether it’s 31 months or 62 months, is automatically extended by an additional 24 months. Essentially, this means a QOZB can have a working capital safe harbor period of at least 55 months and up to 86 months. This is a significant amount of time, especially relative to a potential 10 year holding period. This offers flexibility and time for QOZBs to deploy their working capital assets and meet this compliance requirement.
Number 4: The 12-month reinvestment period for QOFs was impacted. If a QOF’s 12-month reinvestment period includes January 20, 2020, then the QOF automatically is granted a 12-month extension to invest in qualified opportunity zone property.
This is a summary of the relief options available to QOFs and QOZBs. There are still some things being kicked around the political aisles and the IRS/Department of Treasury regarding the future of QOZ regulations. I think the biggest thing everyone wants to get closure on is the mitigation of capital gain tax rate risk – meaning if someone has deferred a capital gain at 20% in 2019, do they get to pick it up at 20% on the 2026 tax return when they are required to recognize the deferred gain, or do they have to pick it up at the capital gain rate in place during 2026? Trump’s tax plan is clear that he remains in support of the QOZ program and its tax benefits. Biden’s tax plan is unclear as it does talk about capital gain rate increases, but does not provide guidance on deferred gains, such as QOZ gains. So far, everything that continues to come out regarding QOZ regulations is taxpayer friendly – let’s hope that trend continues!
Please contact Brian Muia (btm@joneskolb.com) for any question you may have.