On April 17, 2019, the U.S. Department of the Treasury released the second tranche of proposed regulations on the Opportunity Zone program. While many important questions remain, the new rules remove many of the barriers that have deterred investment in Opportunity Zones (QOZs) since they were signed into law in December 2017. In particular, the regulations remove much of the uncertainty that held back investments in businesses. To date, much of the activity in Opportunity Zones has been centered on real estate, in large part because the rules for investors and developers of real estate were better defined. Now, the clarity around business investment provided by the new regulations promises to generate investments focusing on economic development, business growth and job creation – all key parts of building economic resilience.
Under the first set of regulations, in order to qualify as an Opportunity Zone business and secure the associated tax benefits, all companies – from startups to manufacturers – had to prove that 50% of their gross income came from the “active conduct” of their business within an Opportunity Zone. Business owners and investors were concerned that businesses headquartered in Opportunity Zones might not be able to satisfy this requirement if their sales were mostly to customers physically located outside of the zones. Eligible businesses appeared limited to those that conducted their business solely in the zone, such as retail stores and restaurants. The second set of regulations addresses this concern by laying out how businesses can comply with the 50% rule. Businesses qualify as Opportunity Zone businesses as long as 50% of the hours worked by employees or contractors are completed within the zone, 50% of the business’s services are provided within the zone, or if management and operations (enough to generate 50% of gross income) are located within the zone. These safe harbors open the doors for investments in a greater variety of economic activity in QOZs, especially with regard to service-oriented and internet-based businesses.
The new regulations also increase the minimum amount of time Qualified Opportunity Funds (QOFs) have to invest capital they receive from investors to six months, which gives them more flexibility to deploy capital to projects in Opportunity Zones. Prior to this, QOFs could have as little as one day to invest capital received from investors.
Regarding properties that straddle the boundary of an Opportunity Zone, the new rules clarify that if the part of the property (in square footage) that is located within the zone is substantial compared to the property outside of the zone, the entire property will be deemed to be located within the zone.
The first set of regulations also required that investors who acquire property in an Opportunity Zone must substantially improve the property in order to be eligible for the associated tax benefits. The second round of proposed regulations states that substantial improvement will be measured on an asset-by-asset basis, which will be complex and burdensome for businesses. The Treasury Department is considering changing this method so that substantial improvement is measured on an aggregate basis, and is requesting comments from stakeholders on the advantages and disadvantages of this approach. The new rules do clarify, however, that if a property in a QOZ has been vacant for at least five years before an investor acquires it, use of it qualifies as original use, meaning the investor will not have to meet the substantial improvement provision.
Along with the regulations, The White House Opportunity and Revitalization Council released its implementation plan, which organizes cabinet agencies around five focus areas: entrepreneurship, safe neighborhoods, education and workforce development, measurement, and economic development. The Council has already identified 160 programs that can be directed towards entities in Opportunity Zones through the use of loan qualifications, grant preference points and reduced fees. The Department of Education, for example, is giving preference to career and technical education programs in Opportunity Zones under the Perkins Innovation and Modernization Grant Program. The Council’s plan may also serve to further reduce risk for investors in Opportunity Zones.
The main takeaway from these regulations is that there are now fewer hurdles and more clarity around investing in businesses in Opportunity Zones. While some key questions remain, such as those on the details of anti-abuse policies and reporting requirements, the new regulations will likely trigger an acceleration in QOF activity focused on business and economic development, which, if paired with resilience best practices, has the potential to have a significant positive social impact on the country’s most underserved communities.
Sources and Further Reading
Refreshed regulations may give Opportunity Zones new life – American Enterprise Institute
IRS Publishes Second Round of Proposed OZ Guidance – Economic Innovation Group