In a notice issued earlier this month, the IRS provided additional relief and addressed some of the concerns and open items that we noted in our alert dated April 14, 2020 by taking an additional step in allowing QOZ Funds (QOF) and their investors to meet various time-sensitive requirements and tests that were negatively impacted by the pandemic. In this alert, we summarize the recent relief issued and our takeaways.
Extension of the 180-day period for investing capital gain proceeds in a QOF
The IRS amplifies its April notice and further extends the 180-day period to invest deferred capital gains in a QOF to December 31, 2020, if the last day of the applicable 180-day period falls on or after April 1, 2020 and before December 31, 2020. The notice provides that the relief is automatic, but taxpayers still need to make the deferral election on a timely filed federal income tax return (including extensions) along with all relevant forms or on an amended federal income tax return. We note that this latter requirement of submitting all relevant forms with a timely filed tax return or an amended return may require taxpayers who have not identified qualified investments by the filing deadline (including extension) to later file amended returns to include such relevant forms.
Relief in connection with the QOF 90% investment test
In our April 14 alert, we discussed the possibility of using “reasonable cause” for possible penalty relief in connection with a failure of a QOF to meet its 90% investment test due to COVID-19 related delays and issues. We are glad to see that the IRS has taken this exact approach in the notice and provides that if (i) the last day of the first 6-month period of the taxable year or (ii) the last day of the taxable year falls between April 1, 2020 and December 31, 2020, a failure by a QOF to meet the 90% investment test for tax taxable year (i.e., in the case of a calendar year QOF in 2020) will not result in a penalty to the QOF. The notice goes a step further to state that the failure to meet the 90% investment test during 2020 would be disregarded for that year for purposes of determining whether the QOF or any otherwise qualifying investments in the QOF satisfy any of the QOZ requirements for any taxable year of the QOF (e.g., for purposes of the holding period requirement the QOF is presumed to have met the test in 2020). The result of this is that during 2020 (for a calendar year QOF), a QOF may have no qualifying investments at all, or even until the following year’s first testing date (June 30, 2021 for a calendar year QOF). In addition, it means that no penalty would be imposed on the QOF if an underlying investment fails its tests between April 1, 2020 and December 31, 2020 and such failure causes the QOF to fail its 90% asset test in this period. Meaning that the QOF would not need to use its one-time cure period during 2020. This relief is automatic, however, a QOF must still fully complete the relevant reporting form (Form 8996) with respect to each affected taxable year except that the QOF should place a “0” in Part IV, Line 8 (Penalty).
Tolling of the 30-Month Substantial Improvement Period
The notice provides a much-needed answer to one of the open questions mentioned in our April 14 alert by providing that for purposes of the “substantial improvement” requirement, the period beginning on April 1, 2020 and ending on December 31, 2020 is disregarded in determining any 30-month “substantial improvement” period (meaning that the 30-month substantial improvement period is tolled during the period beginning on April 1, 2020, and ending on December 31, 2020).
Clarification in connection with the 31-month “working capital” safe harbor
The notice confirms that COVID-19 is a federally declared disaster and thus, as provided in the final QOZ regulations, each Qualified Opportunity Zone Business (QOZB) holding working capital assets intended to be covered by the working capital safe harbor before December 31, 2020, are entitled to up to an additional 24 months to expend the working capital assets of the QOZB (beyond the 31-month period that would otherwise apply). All other requirements of the working capital safe harbor must still be met.
Clarification in connection with the 12-Month Reinvestment Period for QOFs
As mentioned in our April 14 alert, the final QOZ regulations allowed a QOF with an additional 12-month period for reinvestment of proceeds in case of a federally declared disaster. The notice confirms that COVID-19 is a federally declared disaster. However, the notice only provides for relief in the form of up to additional 12 months where a QOF’s 12-month reinvestment period includes January 20, 2020 (which is the date of the disaster identification). This means that the original 12-month reinvestment period must have already started before January 20, 2020. This would leave, for example, QOFs with returned capital from failed investment due to COVID after January 20, 2020 with only 12 months to reinvest. The reference to January 20, 2020 is an odd one considering the fact that the economy did not start shutting down until March and all other relief measures provided for in the notice span over the period of April 1 through December 31 and thus defeat the purpose behind the extra 12 month reinvestment period. We are hopeful that the IRS would correct this in the near future. We note that the proceeds must still be invested in the manner originally intended and all other requirements are met (for example the proceeds must continuously be held in cash, cash equivalents, or debt instruments with a term of 18 months or less).
The Coronavirus Task Force at Klehr Harrison stands ready to assist you in your business and legal needs. We will continue to provide additional information and guidance as the COVID-19 situation develops.
Author Sharon Shachar is a partner in the tax practice group at Klehr Harrison.