Demolished structures and qualified opportunity zones

By Jonathan McGuire, CPA, MT, Aldrich CPAs + Advisors, Salem, Ore.

Editor: Marcy Lantz, CPA

Qualified opportunity zones (QOZs) have transformed the tax landscape of low-income communities by adding targeted investment to these disadvantaged areas. Many qualified opportunity funds (QOFs) have been set up to take advantage of the tax benefits. Late in 2019, final regulations were issued for these tax-advantaged investments. These rules clarified and cemented how to set up funds, how to maintain them, and what other consequences exist to gain deferral and recognition.

Qualified assets of funds and qualified opportunity zone businesses

Sec. 1400Z-2(d) requires that a QOF invest in qualified opportunity zone property (QOZP), which is QOZ stock, QOZ partnership interests, or QOZ business property (QOZBP). Focusing on the QOZ stock or partnership interest, substantially all (at least 70%) of the tangible property owned by one of these entities must be QOZBP. QOZBP is tangible property of a qualified opportunity zone business (QOZB) that meets the following requirements:

  • The property must be acquired by the business by purchase from an unrelated party after Dec. 31, 2017;
  • The original use of the property commences with the business, or the business substantially improves the property;
  • During substantially all (at least 90%) of the property's holding period by the business, substantially all of the property (at least 70%) is used in a QOZ; and
  • The property must be used by the business in a trade or business within the meaning of Sec. 162.

As noted above, to be a QOZB, at least 70% of the tangible property owned or leased by the business must be QOZBP. Regs. Sec. 1.1400Z2(d)-1(d) provides that whether a trade or business of the eligible entity satisfies the 70% test is determined by a fraction, the numerator of which is the total value of all tangible property that is QOZBP and the denominator of which is the total value of all tangible property held by the business.

Original use vs. substantially improved

As required by statute, the assets must either have their original use with, or be substantially improved by, the QOZB. "Original use" commences on the date on which the business (1) first places the property in service in the QOZ for purposes of depreciation or amortization, or (2) first uses the property in the QOZ in a manner that would allow depreciation or amortization if that business were the property's owner. Therefore, new assets purchased or constructed inside a QOZ after Dec. 31, 2017, will qualify. It is important to note that used assets may also qualify so long as they have not been used in a QOZ previously.

For an asset to be substantially improved, the improvements must equal or exceed the adjusted basis of the asset. This substantial-improvement requirement must be met during the 30-month period after the acquisition of the property; however, the improvement does not necessarily need to be completed. Unimproved land is the one asset that is excluded from the substantial-improvement requirement due to its inherent permanence. It is impossible to have land with original use, from a practical standpoint. Thus, land, if it is acquired by purchase after Dec. 31, 2017, and used in a QOZ, will be deemed to have its original use there.

Demolitions: Sec. 280B

The often-overlooked Sec. 280B states that any demolition of a structure is not to be allowed as a deductible loss and instead must be capitalized into the cost of the land on which the building was located. Rev. Proc. 95-27 uses a two-part test to define whether the modification of a building, other than a certified historic structure, is a demolition for purposes of Sec. 280B. A modification is not a demolition if (1) 75% or more of the existing external walls of the building are retained in place as internal or external walls and (2) 75% or more of the existing internal structural framework of the building is retained in place. To determine whether these tests are passed, a taxpayer will likely require an engineer or contractor to analyze and describe the work performed.

Mixing QOZ requirements with Sec. 280B

If there is a deemed demolition under Rev. Proc. 95-27, the taxpayer would be required to capitalize the demolished structure into land. This can change the outcome of a QOZ deal. As the adjusted basis of the demolished structure (plus demolition costs) is now deemed part of the land, it is subsequently included in the land cost when computing the 70% test. When applying the original-use vs. substantial-improvement requirement, the demolition of the asset shifts to original use, as the structure is deemed "new." This allows for avoiding the substantial-improvement requirement. Remember that land will always have original use due to its inherent permanence.

Technical Advice Memorandum (TAM) 9639009 states that "acquisition occurs progressively, in the case of a building under construction, as construction (erection) of the building is completed" (quoting Rev. Rul. 75-524). The TAM goes on to reason that "[d]emolition costs are not the costs of 'completed construction,' since demolition, standing alone, does not constitute a completed asset that is capable of being 'held.'"

As the demolition costs and assets therein are incapable of being held as part of completed construction of the building, the new construction is separate and set apart from the underlying land. A demolished building being capitalized into land would not be part of the new building, as there is nothing to hold structurally at demolition. Without a holding period, it is otherwise impossible to acquire a building; this brings the analysis back to the other factors previously discussed for meeting asset acquisition requirements and QOZ rules under Sec. 1400Z-2.

Under the rules mentioned above for both QOZs and Sec. 280B, it may be possible for an asset that previously was not QOZP, due to the purchase requirement or an ineligible acquisition date, to become QOZP, so long as the new construction exceeds 70% of the total tangible property value of the QOZB.

Example: A taxpayer contributes land and a building into ABC LLC, a limited liability company taxed as a partnership, on July 1, 2017. The land and building are in a QOZ as designated by Treasury beginning in 2018. The land and building would not qualify as eligible assets, as they were not acquired by purchase (contributed via Sec. 721), and the date was outside the eligible purchase period. On Jan. 1, 2019, X Co., a QOF, wishes to redevelop the site that ABC LLC holds, but the members of ABC LLC wish to maintain their ownership interest. X Co. is admitted as a member to ABC LLC and proceeds to demolish 60% of the internal structural framework and 30% of the exterior walls.

Under Rev. Proc. 95-27, neither test is met; thus, a deemed demolition under Sec. 280B occurs. After demolition, the total cost of land is $2 million. The rebuilt structure, a new asset, costs $10 million. Under the 70% test for a QOZB, the numerator would be $10 million, and the denominator would be $12 million ($10 million new building + $2 million land). The business would have about 83% of its tangible property as qualifying assets, therefore meeting the 70% test. Assuming all other relevant requirements are met, ABC LLC would be a QOZB with eligible property for a QOF to hold.

Each QOZ deal should be examined with utmost care and due diligence, as there are many fine details to check, and taxpayers must ensure they are met. There currently is no direct guidance on demolitions and QOZs; however, preexisting statutes and regulations can be relied upon and used in conjunction with QOZ law. It may be worth taking a second look at potential deals previously ruled out to determine whether they can be resurrected.


Marcy Lantz, CPA, CSEP, is a partner with Aldrich Group in Lake Oswego, Ore. Ms. Lantz would like to thank the following practitioners for their help editing the December Tax Clinic: Michael T. Odom, CPA, CVA, partner at Fouts & Morgan CPAs PC in Memphis, Tenn.; Carolyn Quill, CPA, J.D., LL.M., principal at Thompson Greenspon CPAs & Advisors in Fairfax, Va.; Kristine Boerboom, CPA, CMA, MBA, partner at Wegner CPAs in Madison, Wis.; and Todd Miller, CPA, partner at Maxwell Locke & Ritter in Austin, Texas.

For additional information about these items, contact Ms. Lantz at 503-620-4489 or

Contributors are members of or associated with CPAmerica, Inc.

Tax Insider Articles


Business meal deductions after the TCJA

This article discusses the history of the deduction of business meal expenses and the new rules under the TCJA and the regulations and provides a framework for documenting and substantiating the deduction.


Quirks spurred by COVID-19 tax relief

This article discusses some procedural and administrative quirks that have emerged with the new tax legislative, regulatory, and procedural guidance related to COVID-19.