Second Round of Treasury Guidance: Key Provisions

Opportunity Zones Client Alert
April 19, 2019

The long-awaited second round of Opportunity Zone-related Proposed Regulations were issued Wednesday, April 17, 2019. It is clear that Treasury’s goals, in its second round of guidance, were to:

  1. Provide clarity and/or specificity in certain key areas where ambiguity previously existed;
  2. Encourage investment in qualified opportunity zones (QOZs) by widening the lanes of allowable activity;
  3. Warn taxpayers that there will be anti-abuse oversight; and
  4. Foreshadow what may come next.

The new guidance picks up where the last round left off, in that the Proposed Regulations are investor-friendly and will likely pull previously reluctant investors off the sidelines. In the following summary, we have divided the subject matter into three categories:

  1. Topics Treasury had previously announced it would address and/or clarify;
  2. Subjects newly addressed – in large measure, based on comments received by Treasury; and
  3. Preview of coming attractions – what to expect in future Treasury guidance.

Our summary is not a comprehensive analysis of the entire 160+ pages of Proposed Regulations and is not intended to be comprehensive legal or tax advice. Taxpayers should seek tax and legal advice before making any decisions relating to investments involving Opportunity Zones. 

The Sullivan O-Zone Working Group exists to provide such tax and legal advice to our clients. Our team is implementing innovative structures and creative approaches to help our clients take full advantage of the Opportunity Zone tax incentives.

Treasury’s amplification of previously identified topics

Original Use

Treasury explains what qualifies and what does not qualify as "original use" and applies a "placed in service" test. "Original use" of tangible property acquired by purchase commences when the property is "placed in service" for purposes of depreciation or amortization. Vacant buildings purchased by a QOF or QOZB after five (5) years of vacancy can also satisfy the "original use" requirement.

Meaning of "Substantially All" – Qualified Opportunity Zone Business Property

The term "substantially all" is used in several places in the legislation. In the initial guidance released in October 2018, Treasury clarified that 70% of tangible property owned or leased by a taxpayer needed to be QOZBP to satisfy the "substantially all" test under the OZ legislation. In this second round of guidance, Treasury (a) reiterates the 70% threshold and makes clear that leased property (as well as purchased property) is eligible to be "good" QOZBP and (b) establishes that such property must be used in an Opportunity Zone for 90% of the time of ownership (thereby defining for this purpose what "substantially all" means under certain tests other than the tangible property test).

Reinvesting Proceeds Derived From A Sale Which Occurs Sooner Than The Ten Year Hold Period

Although one of (if not the) key tax benefits provided by the legislation – the exclusion from tax of appreciation on the original qualifying QOF investment – requires a ten-year hold, realistically there will be sales of assets held by a QOF sooner than the end of the ten-year holding period. Many potential investors have waited for an answer on how such sales would be treated.

The second tranche of guidance provides some answers:

  1. Such sales or dispositions of assets held by a QOF will not impact the investors’ QOF holding periods nor result in gain inclusion of the original investment if the investor has not sold or disposed of its QOF investment.
  2. However, Treasury did not grant a general tax-free rollover status that would have allowed a taxpayer to avoid any gain recognition on such sales. Instead, the gain on the disposition of assets will be included as income to the taxpayer (unless, of course, the new capital gain is invested in the same or another QOF in exchange for a new QOF interest).

Treasury has asked for further comments on non-recognition events.

Additionally, Item 4 below captures Treasury’s proposed relief regarding such sales as it concerns the QOF’s 90% tests.

Other Important Topics – Newly Addressed

50% of gross income test – Application to Opportunity Zone Businesses

Taxpayers were clamoring for guidance with respect to the requirement that 50% of the gross income of a QOZB must be derived from the active conduct of a trade or business "within" the QOZ. The Proposed Regulations establish three specific safe harbors and one general fallback test to satisfy the 50% test. Businesses need only meet one of these safe harbors to satisfy the test.

The three "safe harbors" are:

  1. An "hours" test, tracking hours expended by those performing services within the QOZ. The first safe harbor test ratio is determined by dividing the total hours worked by employees and independent contractors (and employees of independent contractors) performing services within the QOZ during the taxable year by the total hours worked by employees and independent contractors (and employees of independent contractors) during that tax year;
  2. A "wages" test, tracking payments of wages for services performed within the QOZ. The second safe harbor test ratio is determined in a similar fashion to the first (above), by dividing the amounts paid by the business entity to employees and independent contractors (and employees of independent contractors) for the services performed within the QOZ during the taxable year by the total amount paid by the business entity to employees and independent contractors (and employees of independent contractors) for all services performed by them during that tax year; and
  3. A conjunctive test requiring that the tangible property in the QOZ AND the management/function performed in the QOZ are each necessary to produce 50% of the gross income of the QOZB.

If one does not specifically qualify for any of the three safe harbors, Treasury will also allow for a "facts and circumstances" evaluation of whether 50% or more of the gross income of a trade or business is derived from active conduct of a trade or business in the QOZ.


Overall, leases received very favorable treatment and welcome clarity.

Leased tangible property can be QOZBP if the lease is dated after December 31, 2017 and substantially all of the use of the leased property occurs in a QOZ for substantially all of the lease period.

There is no "original use" requirement (recognizing that generally the lessee is not the owner of the tangible property).

Opening the door for certain structures, leases are permitted between "related parties," albeit with some safeguards and specific requirements.  Methods for valuing leased property are also spelled out.

For purposes of opportunity zones, the term "trade or business" has the meaning set forth in Section 162 of the Code. However, Treasury went on to state that "merely entering into a triple-net-lease with respect to real property owned by a taxpayer is not the active conduct of a trade or business."

Working Capital Safe Harbor

In the first round of guidance, Treasury allowed the holding of working capital at the QOZB level for up to 31 months, provided that (i) there is a written plan identifying the assets held for deployment, (ii) a written schedule of when the held capital will be spent, and (iii) the plan is substantially followed. However, various concerns were expressed, including for what uses (other than purchasing tangible property) could money be spent and various "what happens if" scenarios.

Treasury addressed both of these areas of concern (but not others) by making it clear that:

Relief with respect to the 90% Test

90% of a QOF’s assets must be invested in QOZP as tested twice annually.

This raised concerns on (a) what happens when investments are made into a QOF just before a test date (i.e. when there would be concern as to whether the new investment could be immediately deployed) and (b) what happens if a QOF sells an asset just prior to a test date (what happens vis-à-vis the proceeds now held at the QOF level).

Treasury provided two key elements of relief:

In both cases, the funds must be held in cash, cash equivalents or debt instruments with maturity of less than 18 months.

What happens when a QOF taxable as a partnership sells an asset sooner than ten years?

Sale proceeds from the asset sale can be temporarily included to satisfy the 90% Test, provided the proceeds are reinvested in twelve (12) months.

Sale after Ten Years – Election to Exclude Gain

If the sale of an asset held by a QOF partnership occurs after the 10-year holding period is satisfied and the partnership reports the gain on Schedule K-1, the investor can elect to exclude the gain shown on K-1, and the investor gets a corresponding step-up in outside tax basis in the QOF interest. This means a real estate partnership can sell its underlying real estate and the QOF investors can enjoy the exclusion of gain without having to sell the QOF interests. It also means the QOF can sell its assets at different times, allowing for multiple asset QOFs.

Combating Potential Abuse

Permeating throughout the guidance are not-so-subtle warnings that Treasury will be providing oversight to ensure that transactions are not undertaken with abusive intent or results. An entire section, while short in detail, is powerful in content, stating:

"if a significant purpose of a transaction is to achieve a tax result that is inconsistent with the purposes of section 1400Z-2, the Commissioner can recast a transaction (or series of transactions) for Federal tax purposes as appropriate to achieve tax results that are consistent with the purposes of section 1400Z-2. Whether a tax result is inconsistent with the purposes of section 1400Z-2 must be determined based on all the facts and circumstances."

Further, anti-abuse rules and regulations will be the subject of future guidance from Treasury.

Inclusion/Exclusion Events

The guidance provides abundant details with respect to various transactions which will result in the inclusion of income on an investor’s tax return, and identifies certain important circumstances that do not result in income inclusion (and therefore safeguard the Opportunity Zone tax benefits). Treasury made clear that a testamentary transfer of a qualifying investment following the death of an investor who made the qualifying investment retains the tax benefits attributable to original QOF investment, but carries with it income in respect of a decedent under Code Section 691. In contrast, gifts of QOF interests are treated as a taxable transaction to a transferor.

Carried Interests

An interest in a QOF received in exchange for services is not an eligible opportunity zone investment. Therefore that interest is not entitled to the opportunity zone tax benefits. An investor who both makes an eligible investment and also receives a "carried interest" for services has an interest in a mixed fund, with respect to which Treasury has proposed rules for allocations between the eligible and ineligible interests.

Overlap Of Real Property Partially In An Opportunity Zone

Opportunity zones were designated using census tracts. Treasury recognized that sometimes real property may straddle more than one census tract and therefore is partially in and partially out of a designated opportunity zone.

The guidance creates a generous rule for inclusion of the entirety of such property as opportunity zone property. If the square footage of a parcel within a zone is "substantial," when compared to the square footage outside the zone AND the real property outside the zone is contiguous to part or all of the real property in the zone, the entirety of real property will be deemed to be within the opportunity zone. The test for "substantial" in this circumstance is satisfied if the unadjusted cost of the real property in the zone exceeds the unadjusted cost basis of the outside the zone portion of the property.

What Comes Next?

As it did when issuing the October 2018 guidance, Treasury has foreshadowed future guidance. In addition to responding to comments it receives, both on subjects Treasury has specifically identified and to the continuing concerns which likely will be raised during the comment period, we can expect Treasury to address:


In combination with the earlier guidance, this second set of Treasury proposed regulations provide a workable, stream-lined roadmap, with reasonable limitations, "out of bounds" stakes and numerical tests, to encourage and incentivize the making of investments in QOZs in a manner consistent with the intent of law.

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