The Treasury Department and Internal Revenue Service (IRS) have issued the much-awaited second tranche of guidance for Opportunity Zones (OZs), the community development tool that came out of the 2017 Tax Cuts and Jobs Act aimed at spurring investment in low-income communities.

Treasury secretary Steven Mnuchin
Treasury secretary Steven Mnuchin

“We are hopeful that we have provided enough guidance that investors and communities can start deploying capital in OZs,” said Treasury secretary Steve Mnuchin at a White House conference on OZs on Wednesday. “Now is the time to make sure prosperity reaches as many communities as possible. OZs will play a key role in making sure this occurs.”

Mnuchin added that Treasury and IRS, working together, have tried to create as much flexibility for communities and investors so that the economic development incentive is positioned for success.

John Gahan III, partner at law firm Sullivan & Worcester, said, “If we’re talking about OZ investments going into a housing development, we are going to see one-fund or one-project situations. The clarifications and amplifications issued should answer enough questions so people shouldn’t have concerns.”

According to Gahan, in the second round of guidance, Treasury provided clarity and specificity in areas where ambiguity previously existed, encouraged investment by “widening the lanes of allowable activity,” gently warned taxpayers that there will be anti-abuse oversight, and foreshadowed what comes next.

John W. Gahan III
John W. Gahan III

One of the most widely anticipated topics addressed relates to the test that 50% of the gross income of a qualified OZ business must be derived from activity in the OZ and what that means. The guidance has created three separate safe harbor tests and one general test. Options for measurements include how many hours are expended performing services in the OZ by employees and independent contractors, the amount of wages or payments for people performing those services, or a conjunctive test if the tangible property being in the OZ and the management/operations conducted in the zone each are necessary to generate 50% of the income. The guidance also provided that Treasury could, in addition, look at situations on a case-by-case basis to satisfy the 50% test.

“People who were hung up on the 50% of gross income test now have a road map for how to satisfy the test,” said Gahan. “The test seems fair and relatively easy to document.”

Additional clarity was provided on what “substantially all” means. For an entity to be a qualified OZ business, “substantially all” means at least 70% of the tangible property must be in a qualified OZ. But for the holding period of the property, “substantially all” means 90%.

Gahan said another topic addressed was “original use,” and, in particular, vacant buildings or buildings that had been abandoned. “Buildings vacant for five years or more can now be considered original use in the hands of a purchaser,” he said. “Treasury was concerned that a shorter time period would lead to land-banking of property without being active in the zone. In order to dissuade that, to get the benefits of the legislation when one acquires and then improves vacant buildings, the building must have been vacant for five years.”

According to Gahan, several pages in the regulations were devoted to leases in a favorable way. “But, a property owner leasing a property as a landlord under a triple net lease and doing nothing more probably wouldn’t be entitled to the benefits,” he added.

The written plan required for the working capital safe harbor and the details of capital deployments can include spending money on development. “In addition, if your 31-month deadline wasn’t met because of a failure by a government body to act in time, [such as delayed permits], you get an extension of the 31-month deadline,” he said.

However, what was not addressed was other delays, such as a natural disasters—for example, weather-related—or a local condition like a union strike. “One could conclude that, at least at this point, there is no allowable extension in an event of those circumstances or maybe that will be addressed later,” he added.

Treasury is asking for and accepting comments on these proposed regulations for 60 days. In addition to what will come out of those comments for the third round of guidance, Gahan also said to watch for reporting and informational disclosures for qualified opportunity funds, administrative rules describing the penalties for failing to satisfy the 90% test, and more detailed anti-abuse rules and regulations.