Over the last few weeks, the IRS has provided taxpayers with extensions of time to file various tax returns and pay certain taxes. On April 9, 2020 the IRS issued Notice 2020-23, which further expands on past extensions and adds additional time to perform time-sensitive actions. Time-sensitive actions that have been extended include the 180-day period for investing qualified capital gains into a Qualified Opportunity Zone (QOZ) Fund. In addition, certain sections of the Internal Revenue Code already provide taxpayers built-in relief for deadlines if the taxpayer is affected by a presidentially-declared federal disaster. Consequently, by virtue of the president’s recent pronouncement that the COVID-19 pandemic is a federal disaster, QOZ businesses utilizing the working capital safe harbor may also have an extended deadline for deployment of capital. The declaration may also impact penalty relief for reasonable cause.
180-Day QOZ Fund Investment Period
Generally, taxpayers have 180 days to reinvest qualifying capital gains into a QOZ Fund pursuant to section 1400Z-2(a)(1)(A) of the Code. The mechanics of how this 180-day period is computed is discussed in prior blog post, and can get somewhat complicated for flow through entities. Now, pursuant to Notice 2020-23, if that 180-day period expires on or after April 1, 2020 and before July 15, 2020, that period does not expire until July 15, 2020. This extension of time is automatic and no election or other filing is required. Individuals, trusts, estates, corporations, partnerships and other non-corporate tax filers qualify for the extra time.
Working Capital Safe Harbor
The QOZ rules provide a QOZ business with a 31-month window in which it can maintain and deploy working capital funds to acquire, construct or rehabilitate tangible business property in the QOZ. The 31-month working capital safe harbor exists because qualifying as an QOZ investment is predicated on engaging in a trade or business inside of a QOZ, and some trades or businesses or startup businesses require a lead time for converting invested capital into assets to be used in the trade or business. If that QOZ business is located in a federally-declared disaster area, the period over which the invested capital is converted into assets could be delayed for reasons outside the control of the QOZ Fund. Treasury Regulation section 1.1400Z2(d)-1(3)(v)(D) provides the QOZ business an additional 24 months to complete the acquisition, construction and/or rehabilitation of the tangible business property if the QOZ business is located in a federally-declared disaster area. Notably, as of April 3, 2020 every state and most territories are subject to a disaster declaration, so most QOZ businesses should have an additional 24 months added to the working capital safe harbor period.
A QOZ Fund is penalized if at least 90 percent of its assets do not consist of QOZ property. However, these penalties are waived if the QOZ Fund can show that such failure is due to reasonable cause. The related Treasury regulations do not define what constitutes reasonable cause. Other sections of the Code provide similar reasonable cause relief from penalties. In those cases, such relief is generally permitted where the taxpayer can show that the penalized failure was due to circumstances outside the control of the taxpayer. A failure to maintain the 90 percent investment standard for reasons related to COVID-19 may potentially qualify for this reasonable cause penalty relief.
If your QOZ Fund is experiencing any delays due to COVID-19, contact Varnum’s tax team to determine how that delay may impact the QOZ Fund’s qualifications.