What You Need To Know About Opportunity Funds

The gateway to the opportunity zone program and tax incentives happens through a “qualified opportunity fund” (QOF). According to §1400Z-2(d)(1), the term QOF means any investment vehicle which is organized as a corporation or a partnership for the purpose of investing in qualified opportunity zone property (QOZP) that holds at least 90 percent of its assets in QOZP, determined by the average of the percentage of QOZP held in the fund as measured- (A) on the last day of the first 6-month period of the taxable year of the fund, and (B) on the last day of the taxable year of the fund. Additionally, Reg §1.1400Z2(d)-1(a)(2) requires self-certification of an entity as a QOF by filing a Form 8996 with the IRS where the QOF identifies the first taxable year for which the self-certification takes effect and the first month (in that initial taxable year) in which the self-certification takes effect.

According to Form 8996 and the accompanying instructions, by the end of the first QOF year, the organizing documents of the QOF are also required to include a statement that the purpose of the entity is to invest in QOZP and to include a ‘‘description of the qualified opportunity zone business(es) that the QOF expects to engage in either directly or through a first-tier operating entity.’’ In order to qualify for the opportunity zone tax incentives, eligible taxpayers must invest their eligible gains into the QOF within 180 days from the date the gain would be recognized for federal income tax purposes, and in exchange for an eligible interest in the QOF. According to Reg §1.1400Z2(a)-1(b)(12), eligible interest in a QOF is an equity interest issued by the QOF, including preferred stock or a partnership interest with special allocations. Thus, the term eligible interest excludes any debt instrument including those within the meaning of section 1275(a)(1) and § 1.1275–1(d).

As previously mentioned, QOFs only have one mandatory test to comply with, §1400Z-2(d)(1) which requires QOFs to hold at least 90 percent of assets in QOZP (the “90% investment standard), determined by the average of the percentage of QOZP held in the QOF as measured- (A) on the last day of the first 6-month period of the taxable year of the fund, and (B) on the last day of the taxable year of the fund. For first year QOFs, the date on which the QOF tests compliance with the 90% investment standard will vary depending upon when the QOF certifies its first month as a QOF.

For QOFs certifying as a QOF in a month that occurs before July, the QOF will have to test compliance with the 90% investment standard twice. The first testing date will be on the last day of the month that occurs 6 months from the month the QOF certified as a QOF. For example, a QOF that certifies in January will first be required to test compliance six months later on June 30, and a QOF that certifies in February will first be required to test compliance six months later on July 31. The second testing date for QOFs that certify before July will always be December 31. This means that if a QOF certifies in June, the QOF will be required to test compliance with the 90% investment standard for the first taxable year on November 30 and December 31. For QOFs that certify as a QOF in a month that occurs after July, the QOF will only test compliance with the 90% investment standard once in the first taxable year, on December 31. After the first taxable year, QOFs will always test compliance semi-annually on the same dates each year, June 30, and December 31.

According to §1400Z-2(d)(2)(A), QOZP means property which is: (i) qualified opportunity zone stock, (ii) qualified opportunity zone partnership interest, or (iii) qualified opportunity zone business property (QOZBP). According to §1400Z-2(d)(2)(B)(i), the term “qualified opportunity zone stock” means any stock in a domestic corporation if- (I) such stock is acquired by the QOF after December 31, 2017, at its original issue (directly or through an underwriter) from the corporation solely in exchange for cash, (II) as of the time such stock was issued, such corporation was a qualified opportunity zone business (QOZB) (or, in the case of a new corporation, such corporation was being organized for purposes of being a QOZB), and (III) during substantially all of the QOF’s holding period for such stock, such corporation qualified as a QOZB.

According to §1400Z-2(d)(2)(C), The term “qualified opportunity zone partnership interest” means any capital or profits interest in a domestic partnership if- (i) such interest is acquired by the QOF after December 31, 2017, from the partnership solely in exchange for cash, (ii) as of the time such interest was acquired, such partnership was a QOZB (or, in the case of a new partnership, such partnership was being organized for purposes of being a QOZB), and (iii) during substantially all of the QOF’s holding period for such interest, such partnership qualified as a QOZB. According to §1400Z-2(d)(2)(D), The term QOZBP means tangible property used in a trade or business of the QOF or QOZB if- (I) such property was acquired by the QOF or QOZB by purchase (as defined in section 179(d)(2)) after December 31, 2017, (II) the original use of such property in the qualified opportunity zone commences with the QOF or QOZB, or the QOF or QOZB substantially improves the property, and (III) during substantially all of the QOF’s or QOZB’s holding period for such property, substantially all of the use of such property was in a qualified opportunity zone.