New OZ Regulations Clarify Key Issues for Fund Operations and Investments

In its second tranche of proposed regulations issued with respect to federal Opportunity Zones (“OZ”) legislation released last week, the U.S. Department of Treasury ("Treasury") and Internal Revenue Service ("IRS") sought to clarify certain key issues for qualified opportunity fund (“QOF”) operations and investments:
 
QOF Investment Timeframe. The OZ statute requires that a QOF hold at least 90% of its assets in qualified opportunity zone property. Prior to the issuance of the second tranche of proposed regulations, investors and fund managers feared this requirement could mean they would be required to invest capital almost immediately upon receipt. The Treasury and IRS provided relief to these concerns. When a OZ fund’s testing date occurs to determine if the 90% threshold is satisfied, the fund does not have to take into account investments received by the fund within the preceding six months so long as the new investments are held in cash, cash equivalents or debt instruments with terms no greater than 18 months.
 
Reinvestment of Interim Gains. Although qualified OZ property (whether it was property owned directly by a fund or an interest in a OZ business) sold for cash no longer qualifies as a “good” OZ investment for purposes of satisfying the 90% test described above, the proposed regulations clarified the amount of time the QOF has to reinvest those proceeds. The proposed regulations provide that QOFs shall have 12 months to reinvest such proceeds into another qualified OZ property. Similar to the rule above, to qualify, the proceeds must be held in cash, cash equivalents or debt instruments with terms no greater than 18 months prior to being redeployed. 
 
Investor Exit of OZ Fund. OZ fund managers and investors were particularly concerned with an investor’s ability to exit a QOF following the ten-year hold period. The OZ statute as enacted by Congress provided that the gain exclusion on the appreciated amount of an investor’s interest in the QOF could occur only upon the sale of the investor’s investment in the QOF. The proposed regulations provide more flexibility in that investors holding a qualifying QOF ownership interest may elect to exclude, from gross income, some or all of the capital gain from the disposition of OZ property owned by a OZ fund following the expiration of the ten-year hold period. This provides the OZ funds and investors the opportunity to allow the OZ funds to sell their interests in property and businesses after the ten-year hold period has expired as compared to investors trying to sell their entire interest in an OZ fund. 
 
Please contact the Ice Miller team with any questions you have with respect to OZ fund investments and operations or other OZ requirements.

This publication is intended for general information purposes only and does not and is not intended to constitute legal advice. The reader should consult with legal counsel to determine how laws or decisions discussed herein apply to the reader’s specific circumstances.