Final Opportunity Zone Regulations Released By Trump Administration

Two years after the opportunity zone program became law, the final round of regulations about how they will be implemented has been released to the public.

The Treasury Department and the IRS published the 544-page document Thursday afternoon with a number of substantial changes and additions from previous iterations of guidance. Treasury Secretary Steven Mnuchin said in a statement that the new regulations will provide "clarity and certainty" to investors that will allow for more capital to flow into opportunity zones.

The regulations address rules surrounding aggregation of developments on one property to meet the substantial improvement requirement and what happens to investments pulled out of opportunity zone funds before the 10-year hold period is over.

Also addressed in the document are qualified opportunity zone businesses, or QOBs, including a 5% maximum investment in "sin businesses" that would otherwise be disqualified from the tax break.

One of the most significant themes of the final regulations is that the IRS and Treasury allowed for qualified opportunity funds to be structured like most funds that invest in multiple businesses or properties, Javelin 19 Investments President Jill Homan told Bisnow. Language in previous guidelines requiring the entirety of a QOF to be sold all at once in order to qualify for the maximum capital gains tax discount was seen as one of the largest deterrents to OZ investment. 

At the public hearing held by the IRS and Treasury in July to solicit comments and questions on the second round of regulations, Homan noted that when a QOF sells an individual asset or an LLC that it created to control such assets, different and smaller tax benefits are applied — a nuance that few seemed to fully grasp, Homan said.

Going forward, qualified opportunity zone funds can sell individual properties, rather than being forced to sell the entire QOF — which includes the LLCs a QOF creates in order to hold properties.

“So QOFs have the ability to hold multiple property LLCs, and multiple assets within those, and exit those assets without creating taxable events or losing the OZ benefits,” Homan said. “That was a significant concern about selling underlying real estate assets … If you exit early, you have the potential to reinvest into other assets, but you could create a taxable event by exiting [the QOF] before 10 years.”

In preliminary versions of the regulations, only alterations to an original building on an OZ property would count toward the threshold of “substantial improvement,” which requires owners to essentially double the value of a property with its investment. The final regulations allow for the improvement threshold to apply to the property in aggregate, meaning additional buildings and development can be counted as adding value to the lot itself.

“If you have a property that had a multifamily building on it and you had the intention of adding another multifamily building, under the old regulations that would not be considered a substantial improvement because you were not improving that first building,” Homan said. “Now, you can say that the new building that you’re adding qualifies as substantial improvement.”

Previous rounds of guidance had also left the question of qualified QOBs under-explained. As the law is written, any capital gains realized from QOBs after a hold period of 10 years is completely exempt from taxes, making clarity on that form of investment crucial to the program's success.

Though qualified opportunity funds, or QOFs, have already raised over $4.5B in capital, many in the investment industry have said that the lack of finality on several issues has kept investors from committing billions more.

Though the industry hasn't yet had time to fully digest the new rules, the updates included in the final regulations seem to already have put stakeholders’ minds at ease. Economic Innovation Group President and CEO John Lettieri, whose organization helped craft the original bill that Scott and Booker introduced in the Senate, released a statement praising the new rules and predicting that investment activity will increase as a result.

“Everything I’ve seen so far is really encouraging in how it strikes the right balance and stays true to the policy intent while acknowledging the reality of how capital moves,” Homan said. “I think people are going to digest it and take a little bit of time to go through it, but on a net basis, I think this will really help investors move capital into these neighborhoods.”

But with this latest release coming so late in the year, it is unlikely that any investor will be able to use this new information in time to invest before Dec. 31, the deadline for capital gains to be placed in QOFs in order to receive the maximum 15% discount after a 10-year hold, Develop LLC founder and opportunity zone program architect Steve Glickman told Bisnow Thursday, before the final rules were released.

Since the second round of regulations and guidance was released in April, the only official update to opportunity zone rules came in November — a new IRS tax form, Form 8996, outlining some reporting requirements for tax documents relating to QOFs. True to form for this process, only a draft of Form 8996 has been published, with no timetable for the release of a finalized version.

In its current iteration, Form 8996 requires disclosure of all of the investments the QOF has made, the census tract in which those assets are primarily located, and the value of those assets as measured at certain specific times in the year. Should an investor pull his or her stake out of a QOF, Form 8996 requires the fund's filer to disclose the investor's name, the value of their investment and the percentage of the fund that investment represented.

The IRS has said that it doesn't have the authority to require any information related to the impact of an investment, such as the jobs it creates, any change to the income levels or demographics in the area or any indicators of gentrification, which Glickman and others have said are crucial to the program's ultimate success.

The two original sponsors of the opportunity zone law, Sen. Cory Booker (D-NJ) and Sen. Tim Scott (R-SC), introduced a bill in November that would require reporting of much of that socioeconomic data, but other members of Congress have introduced bills that would go much further — leading Scott to decry what he saw as partisan politics.

Bills introduced in both houses of Congress would disqualify certain census tracts deemed too affluent to need the help of a tax break in order to attract investment. Other zones targeted by the bill, as well as a letter sent by a group of senators to the Treasury Department Inspector General, have ties to personal friends and political allies of key figures in the program, such as Mnuchin.