The IRS issued another set of proposed regulations (REG-120186-18) on Sec. 1400Z-2, a new provision added by the law known as the Tax Cuts and Jobs Act, P.L. 115-97, that establishes qualified opportunity funds (QOFs) to encourage investments in low-income communities. Sec. 1400Z-2 offers three federal income tax incentives to a taxpayer who invests in a business located within a qualified opportunity zone (QOZ): (1) the temporary deferral of capital gains to the extent the gains are reinvested into a QOF; (2) the partial exclusion of previously deferred gains when certain holding period requirements in a QOF are met; and (3) the permanent exclusion of post-acquisition gains from the sale of an investment in a QOF held longer than 10 years.
In October 2018, the IRS issued proposed regulations (REG-115420-18), but those regulations reserved the definition of "substantially all," which is relevant for the holding period requirement and the use of the tangible business property. In the new proposed regulations governing the use of the property, to meet the substantially all test, at least 70% of the property must be used in a QOZ. To meet the substantially all test for the holding period of the property, tangible property must be qualified opportunity zone business (QOZB) property for at least 90% of the QOF's or QOZB's holding period. And to meet the substantially all test for QOZ stock or QOZ partnership interests, the partnership or corporation must be a QOZB for at least 90% of the QOF's holding period for the stock or partnership interests.
The new proposed regulations also address transactions that may trigger the inclusion of gain that a taxpayer has elected to defer under Sec. 1400Z-2; the timing and amount of that deferred gain; the treatment of leased property used by a QOZB; the use of QOZB property in the QOZ; the sourcing of gross income to the QOZB; and what is a reasonable period for a QOF to reinvest proceeds from the sale of qualifying assets without paying a penalty.
Taxpayers may generally rely on the proposed regulations (except for Prop. Regs. Sec. 1.1400Z2(c)-1, regarding an investment held for 10 years) for periods prior to their finalization if the taxpayers apply the proposed regulations consistently and in their entirety.