On June 4, 2020, the IRS published guidance in Notice 2020-39 extending critical deadlines and rules relating to investments in qualified opportunity zones. First, any investors facing a deadline between April 1, 2020 and December 31, 2020 to invest their qualified capital gains in a qualified opportunity fund (“QOF”) now have until December 31, 2020 to invest those gains. Second, QOFs having a testing date between April 1, 2020 through December 31, 2020 for the requirement that 90% of its assets be invested in qualified opportunity zone property, and fail the test, will automatically be granted relief from any penalty. The failure to meet the 90% test in 2020 will also be disregarded for purposes of determining whether the QOF meets the opportunity zone requirements for any tax year. The relief provided by these new rules is automatic, and no request or filings have to be made, though investors and QOFs must still file all required opportunity zone forms. The upshot is that essentially all QOFs are exempt from meeting the 90% test in 2020. Third, with respect to the requirement that existing property must be “substantially improved” within 30 months of its acquisition to be treated as qualified opportunity zone business property, the 9 months starting on April 1, 2020 and ending on December 31, 2020 is ignored in calculating the 30 month period.
Explanation of Provisions
180 Day Investment Standard. An investor must invest capital gains from the sale of any property to an unrelated party in a QOF to receive opportunity zone benefits. The investment must generally be made within 180 days of the date of the sale. In the case of sales by pass-through entities such as partnerships, limited liability companies taxed as partnerships, and S corporations, an owner of the pass-through entity may also invest the capital gains within 180 days starting on the last day of the pass-through entity’s tax year or within 180 days beginning on the due date, without extensions, of the entity’s tax return for the year of the sale.
Notice 2020-39 provides that the deadline for investor whose 180-day period runs out between April 1 and December 31, 2020 is postponed to December 31, 2020. Previously, in response to the COVID-19 crisis, the IRS had extended the deadline for investors whose investment deadline expired between April 15 and July 15, 2020 to July 15. This new rule extends that deadline to the end of 2020.
QOF Qualification. A QOF must hold 90% of its assets in qualified opportunity zone property. Most often the assets of a QOF consist of interests in a qualified opportunity zone business (”QOZB”). In any event, this 90% standard is measured annually by testing the percentage of qualified property held by the QOF on two test dates, usually June 30 and December 31 of each year, and taking the average of the two tests. A QOF that fails a test will be assessed a penalty for the year (basically an interest charge for each month the QOF fails to meet the 90% standard based on the shortfall). A QOF can avoid the penalty by showing it had “reasonable cause” for the failure.
Notice 2020-39 provides that any QOF that has a testing date between April 1 and December 31, 2020, and fails its test for the 2020 year will automatically be granted reasonable cause relief. Moreover, the failed test will be disregarded for all purposes relating to the qualification of the QOF under the opportunity zone rules. This is important because a failed test can cause a failure of other requirements, not only in the year of the test but in later years.
30-Month Substantial Improvement Period. As stated earlier, most QOFs hold interests in entities designed to qualify as QOZBs. One requirement of a QOZB is that 70 percent of the QOZB’s tangible property must be qualified opportunity zone property. This means that it must be purchased from an unrelated party after December 31, 2017, and either (i) the original use of the property in the qualified opportunity zone must commence with the QOZB or (ii) the QOZB must substantially improve the property within 30 months of the acquisition of the property.
Notice 2020-39 provides that the period between April 1, 2020 and December 31, 2020, is ignored in determining whether a QOZB has met the 30-month timetable for substantially improving a property. So, for example, if property is acquired January 1, 2020, the 30-month period will not run out on June 30, 2022, but instead 9 months later, on February 28, 2023.
Polsinelli Practice Tip
The momentum of opportunity zones was accelerating exponentially until the COVID-19 crisis, and the crisis has slowed it considerably. This is true even as the opportunity zone program has become more and more critical to these communities. The program was designed to encourage investments in low income struggling areas, and these areas have been hit very hard by the economic devastation of the crisis. The extension of the 180-day deadline allows investors to “wait until the smoke clears” and not forfeit their ability to participate in the program. The waiver of penalties associated with a QOFs failure to qualify in 2020, and the tolling of the substantial improvement period through the end of the year will also prevent the possible loss of opportunity zone benefits that would have been caused by the crisis, through no fault of QOF sponsors. It also reinforces the confidence investors should have in the long-term viability of the program. We expect that the opportunity zone program could accelerate again exponentially as the COVID-19 crisis eases and people get back to business.
 Substantial improvement is defined as investing funds sufficient to increase the owner’s adjusted basis in the improvement (not the land) by 100% -- essentially doubling the basis of the improvement.