Because of COVID-19, the IRS decided to grant the following relief to Opportunity Funds and investors interested in capitalizing them:
- In general, taxpayers who had a gain from the sale of property after October 4, 2019 now have until Dec. 31, 2020, to invest that gain into a Qualified Opportunity Fund. This extension is automatically granted by IRS Notice 20-39.
- The subset of taxpayers who realized a gain through a partnership (as opposed to directly, as in the bullet above) at any time during 2019 also have until December 31, 2020 to invest that gain into a Qualified Opportunity Fund.
- Any Qualified Opportunity Fund formed in 2019 – which would typically have to deploy 90% of its capital by June 30, 2020 – gets an automatic extension on its deployment deadline for another full year (until June 30, 2021).
The pandemic caused by COVID-19 has caused disruption in nearly every aspect of the economy. Yet we’ve seen quality investments continue to happen across the country and deal flow substantially rebound in the past few weeks. While many projects have been put on hold, the crisis has created distressed and special situations that present attractive long-term investment opportunities.
Projects that have maintained momentum throughout the crisis stand to benefit from the long-term nature of the OZ incentive – investors with a ten year plus time horizon are more likely to take the long view, even in uncertain times. The Internal Revenue Service (IRS) recently has issued favorable guidance on investor deadlines to invest capital gains from both 2019 and 2020 into Opportunity Fund transactions.
We have prepared this FAQ to help investors understand how OZ investments may be advantageous in this current environment. This piece will outline:
- How investors can receive Opportunity Zone benefits realized for 2019 capital gains by investing any time before December 31, 2020;
- How investors who have harvested losses post-COVID or who have already spent money from gains can still realize Opportunity Zone benefits;
- How COVID impacts Opportunity Funds formed in 2019 or early 2020 who are looking to deploy capital; and
- Why investors who are familiar with 1031 Exchange investments have more flexibility to make Opportunity Zone investments.
We begin this with an important disclaimer: this article is not tax, legal or accounting advice. This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, tax, legal or accounting advice. Opportunity Alabama is a nonprofit organization dedicated to building an equitable Opportunity Zones investing ecosystem across Alabama; we encourage you to consult your own tax, legal and accounting advisors before engaging in any transaction. However, we encourage you and your professional service providers to reach out to us to discuss whether Opportunity Zone advantages could play a role in your tax planning strategy.
Has COVID-19 affected timelines for Opportunity Zone investors?
Yes. The IRS has now twice extended the deadlines for Opportunity Zone investors in response to the COVID-19 pandemic. These extensions may provide more flexibility for particular types of investors.
If I sold an asset (a stock, a real estate property, my company) sometime in 2019 or 2020, how long do I have to invest in an Opportunity Zone fund?
Typically, an investor has 180 days from the date they have a gain event to invest some or all of that gain into a Qualified Opportunity Fund. However, thanks to two rounds of Treasury guidance, some investors with 2019 gains can still make an Opportunity Fund investment any time in 2020. Specifically,
- Thanks to Notice 2020-39, investors who have gain from the sale of an asset any time after October 4, 2019, have until December 31, 2020 to invest in a Qualified Opportunity Fund.
- As a special subset of the rule above – investors with partnership/K-1 any time after January 1, 2019 now have until December 31, 2020 to invest in a QOF and receive the tax benefits.
The explanation for the second bullet is a bit more complicated than the first. Investors with 2019 partnership-based capital gains will get a K-1 reporting those gains in 2020, and the partnership will have to file its taxes in March. The Final Regulations allow the partners to start their 180-day investor clock on the day the partnership’s tax return is due – meaning the partners would normally have until September to invest in a Qualified Opportunity Fund. Now, thanks to Notice 2020-39, these partners have until December 31, 2020 to invest their share of any partnership gain from January 2019 or later.
What if I have more losses than gains in 2020? Can I still make Opportunity Fund investments?
As an added benefit to investors in a seesaw market, investors can invest gross capital gains, not net gains, even if they have offset gains with other losses as they look ahead towards their 2020 taxes. For example, assume an investor sold stock in February 2020 for a $1 million gain, then harvested $1 million in losses in March 2020. Even though that investor’s capital gains liability on that $1 million gain in February would have been eliminated, they are still eligible to qualify for the Opportunity Zone benefit on the gross gain realized if they invest $1 million in an Opportunity Zone Fund by December 31, 2020.
What if I already spent the gains from 2019 or from earlier in 2020?
Because Opportunity Fund investing comes without a direct tracing requirement, there is no need to hold the 2019 gain proceeds from 2019 or 2020 gains in any kind of special escrow. All the investor needs to do is (1) list the gain amount on their 2019 or 2020 tax return and (2) invest up to the gain amount into a Qualified Opportunity Fund (using the timeframes explained above).
To give an example:
- Assume a partnership comprised of three partners sold off an appreciated piece of property in January 2019 for a $3 million gain, leaving each of the partners with a $1 million gain.
- Assume one of the three partners spends part of the gain paying salaries for her business, invests a portion of the rest in stocks, then decides to invest $1 million into a Qualified Opportunity Fund sometime in the fall of 2020.
- As long as she had an extension in place, and had not yet paid capital gains taxes on the $1 million, she could invest $1 million investment into the Fund using cash from her bank account on December 31, 2020, and claim full OZ benefits on her investment.
What if I have already formed and capitalized my Opportunity Fund using 2019 or 2020 gains?
Qualified Opportunity Funds are tested twice a year – on June 30 and December 31 – to ensure that 90% of the capital invested is deployed to Qualified Opportunity Zone Businesses (real estate deals or operating business ventures). Under the Final Regulations, investors always get to ignore the first testing window after they capitalize a fund. For example, if an investor capitalized a fund on December 29, 2019, they would get to ignore the December 31 testing window – but would have to have 90% of their capital deployed by June 30, 2020.
Thanks to the guidance provided by Notice 2020-39, the IRS will disregard both the June 30 and December 31 testing dates in 2020. This means all funds formed in the second half of 2019 and beyond have until June 30, 2021 to deploy 90% of their capital.
How do these updated guidelines apply to 1031 Exchange investors?
IRC Section 1031, commonly known as a “1031 Exchange,” allows the deferral of capital gains from the sale of real estate if the proceeds are re-invested in a property that is (a) identified within 45 days of the sale, and (b) acquired within 180 days of the sale.
Many investors have found Qualified Opportunity Funds an attractive investment proposition to re-invest the proceeds from the sale of 1031 Exchange properties. Qualified Opportunity Funds provide many of the tax deferral benefits of 1031 Exchanges, with the added benefit of being able to sell properties, tax free, with no additional capital gains. In addition, Opportunity Zone investments provide considerable additional flexibility (like the lack of a direct tracing requirement, as discussed above).
The IRS guidance, Notice 2020-23, on April 9th provides investors several areas of flexibility: if the end date of either the 45-day identification period or the 180-day acquisition period falls between April 1, 2020, and July 15, 2020, that date is extended to July 15, 2020.
This extension of the 1031 Exchange deadline may give investors additional time to consider transitioning a 1031 investment into an Opportunity Fund structure.
Are there other provisions in Notice 2020-39 that impact OZ timing?
Yes. Acknowledging that some projects are seeing understandable delays due to COVID-19, the IRS has provided additional flexibility at the project level to account for this slowdown. For example, real estate projects have a working capital “safe harbor” period of 31 months. The IRS made it clear that this safe harbor extends for an additional 24 months because all fifty states are under a federal disaster declaration. Additionally, the IRS will suspend the substantial improvement requirement that most rehabilitation projects need to meet (doubling cost basis within a 30 month period) from April 1, 2020 and December 31, 2020.
The economic crisis resulting from the COVID-19 pandemic is highlighting many of the socio-economic disparities that the prompted the 2017 Investing in Opportunities Act and the creation of Opportunity Zones. It is imperative that historically underserved communities receive investment that encourage long-term, inclusive growth. Opportunity Alabama and our partners remain confident that our place-based, Opportunity Zones-oriented investment ecosystem can create better outcomes for Alabama’s low-income places. For additional information, please contact us at [email protected].
Check out the article on the July/August issue of ASCPA’s Connections Magazine.