This is the third post in a series of articles diving into the new “Opportunity Fund” program. In our first post, we described the general framework for the new Opportunity Fund program which you can find here. In the second post, we discussed the tax benefits to taxpayers who invest in Opportunity Funds. Now, let’s look at the funds themselves.
What are Qualified Opportunity Funds?
Qualified Opportunity Funds are investment conduits that deploy equity capital to specific types of property which are located in Qualified Opportunity Zones. Sounds simple enough! Let’s unpack this and keep track of the definitions.
How Can Funds Be Organized?
Under the statute, funds must be organized as corporations or partnerships (we assume tiered partnerships are allowed). It is unclear whether limited liability companies are included, but we assume LLCs taxed as a corporation or partnership ought to meet the statutory requirement. If you are organizing an Opportunity Fund prior to guidance from the Treasury Department on this point, it is probably better to be safe than sorry and organize as a corporation or partnership.
Where are Qualified Opportunity Zones?
The zones were nominated by each state’s and U.S. territory’s governor and the mayor of D.C. and designated by the Treasury Department. Qualified Opportunity Zones generally consist of lower-income census tracks, and some zones are nestled within cities or counties that are overall economically strong. On June 20, 2018 the IRS published Notice 2018-48 which is a list of all Qualified Opportunity Zones.
What Can Qualified Opportunity Funds Invest In?
Opportunity Funds can invest in Qualified Opportunity Zone Property. There are three types of such property, (i) Opportunity Zone Business Property, (ii) Opportunity Zone Stock, and (iii) Opportunity Zone Partnership Interests. If an Opportunity Fund invests in Opportunity Zone Business Property, the fund is directly investing in tangible property located in a Qualified Opportunity Zone that the Opportunity Fund will use in a trade or business.
Qualified Opportunity Zone Business Property must have been purchased after December 31, 2017, not be a carryover basis transaction, and the seller must be unrelated to the Opportunity Fund. Further, the original use of the property must commence with the Opportunity Fund or the Opportunity Fund must substantially improve the property. In the case of real estate, this means that the cost of improvements on used property over a 30 month period must exceed the cost of purchasing the property.
Qualified Opportunity Zone Stock is original issued stock that was acquired for cash after December 31, 2017, and the corporation issuing the stock must have been a Qualified Opportunity Zone Business at the time of acquisition by the Opportunity Fund or be a new corporation formed for purposes of being a Qualified Opportunity Zone Business. The rules for Qualified Opportunity Zone Stock are generally the same for Qualified Opportunity Zone Partnership Interests, except the differences in tax rules for corporations and partnerships still apply.
What is a Qualified Opportunity Zone Business?
There are three requirements that a Qualified Opportunity Zone Business must meet. The first is that all of the same rules applicable to Qualified Opportunity Zone Business Property apply, e.g. original use commences with the Qualified Opportunity Zone Business or the property is substantially improved. Second, there is an active trade or business test. Third, the Qualified Opportunity Zone Business cannot be a “sin” business which consists of golf courses, country clubs, massage parlors, hot tub facilities, suntan facilities, racetrack or other gambling facilities, or liquor stores. Thus, it is important to note that an Opportunity Fund that invests in Qualified Opportunity Zone Stock or Partnership Interests has additional rules to comply with as opposed to the Opportunity Fund directly investing in Opportunity Zone Business Property. For example, under the statutory language, an Opportunity Fund could directly invest in a golf course, but it could not buy stock in one.
Keep watching for the next article where I will answer some of the nuanced and more frequent questions I receive regarding the program.
Vikram Agarwal is a shareholder with Bean Kinney & Korman with an expertise in tax law. Please contact Vikram if you would like to learn more about the Opportunity Fund program at email@example.com.
Any tax advice expressed above by Bean Kinney & Korman, PC was not intended or written to be used, and cannot be used, by any taxpayer to avoid U.S. federal tax penalties. If such advice was written or used to support the promotion or marketing of the matter addressed above, then each offeree should seek advice from an independent tax advisor.
This Bean Kinney & Korman publication provides information and comments on legal issues and developments. The foregoing is not a comprehensive treatment of the subject matter covered and is not intended to provide legal advice. Readers should seek legal advice before taking any action with respect to the matters discussed herein.