Update April 10, 2020: The IRS has issued Notice 2020-23 which includes relief with respect to specified time-sensitive actions including the 180-day investment period of capital gains into Qualified Opportunity Zone Funds (QOF). The notice indicates if the deadline to invest the gain dollars into a QOF was on or after April 1, 2020 and before July 15, 2020, then the Taxpayer’s deadline is automatically extended to July 15, 2020. More information to be included at a later date.

Over two dozen governors — plus Puerto Rico, Guam and the District of Columbia — have made either Emergency or Major Disaster declarations related to the COVID-19 pandemic. This makes federal funding available to state, tribal and local governments to help combat COVID-19 and its impact.

What does this have to do with opportunity zones? There are actually two major impacts, depending on the IRS confirming and providing some clarification that they are applicable in an “emergency” instead of a “disaster,” as President Trump labeled them in his declarations under the Robert T. Stafford Disaster Relief and Emergency Assistance.

1. The working capital safe harbor

Qualified opportunity fund (QOF) investments have a 31-month working capital safe harbor, which allows a qualified opportunity zone business (QOZB) 31 months to utilize working capital held as cash and cash equivalents.

If a qualified opportunity zone (QOZ) is located in a federally declared disaster area, the QOZB may receive up to an additional 24 months (on top of that 31-month working capital safe harbor) to consume its working capital assets — provided, of course, the project is delayed due to that federally declared disaster.

It’s no doubt that many QOZBs are greatly impacted by COVID-19, which has temporarily closed businesses across the country under shelter in place orders or caused significant economic distress due to consumers’ efforts to social distance. As many QOZBs have just been getting started over the past year, they likely will be looking for some relief from the various testing requirements and would greatly appreciate having the extra 24 months added to their working capital safe harbor.

2. The 12-month reinvestment rule

Under the reinvestment rule, a QOF has 12 months to reinvest proceeds from the sale of QOZ assets into other QOZ assets.

But both the Department of the Treasury and the IRS agree that this reinvestment period should be expanded if delays are caused by a federally declared disaster. Although they had natural disasters like tornados, floods and forest fires in mind when they modified the reinvestment period rules to allow an expansion, COVID-19 has been declared a federal disaster in many states, and we hope the IRS will clarify this still will be applied.

It’s important to note that a QOF must invest proceeds as originally planned before the disaster. For example, if the QOF completed its application and was waiting on a response, but now it is unable to invest in a certain QOZB property because the property is located in a federally declared disaster area, the QOF must invest the proceeds in similar property located in that QOZ.

The benefits of opportunity zones

The recent market volatility triggered by COVID-19 has caused some investors to get out of the stock market. Now, those investors are looking at paying capital gains taxes.

However, QOZs present a unique opportunity for them to reinvest capital gains into an opportunity zone. If you have yet to invest in a QOZ, there are three main benefits to doing so:

1. Tax deferral: You can elect to defer the capital gain you invest until December 31, 2026 or when you sell your QOF investment — whichever comes first.
2. Step-up benefits: By holding the investment for five years prior to December 31, 2026, you can get a 10% reduction in the capital gain you are deferring.
3. No capital gain tax on appreciation: If you hold the QOF investment for 10 years or more, there is no capital gain tax when you sell the QOF investment on any appreciation that has occurred from the initial time of the investment.

Normally, capital gains must be reinvested within 180 days from the triggering event. But if your capital gain is triggered within a flow-through entity such as a partnership, you have some flexibility and can elect to start your 180-day reinvestment period at the entity’s year-end — meaning you could potentially reinvest those capital gains in 2021. COVID-19 is certainly having a huge impact, so gaining more time to decide where to reinvest capital gains is an added benefit.

Opportunity zone regulations

We’re hoping to see additional positive changes in opportunity zone regulations to take COVID-19 into account. As always, we are committed to keeping our clients updated on opportunity zone changes, as well as how COVID-19 is impacting individuals and businesses. Visit our COVID-19 resource center to learn more.