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April 17, 2020

Stroock Special Bulletin

By: Jeffrey D. Uffner, Michelle M. Jewett, Brian J. Senie

There have been two recent and noteworthy developments in connection with the rules relating to the rollover of gains into a Qualified Opportunity Fund (a “QOF,” and such rules, the “QOZ Rules”).[1]  The first is that on April 1, 2020, the United States Treasury Department and the Internal Revenue Service (the “IRS”) published corrective amendments (the “Corrective Amendments”) to the final regulations issued in December 2019 (the “Final Regulations”). The corrective amendments provide several useful corrections and significant changes relating to concerns and considerations that existed prior to the recent COVID-19 pandemic.  Additionally, last week, and in direct response to the pandemic, the IRS announced that it was extending the 180-day period for reinvestment of rollover gain into a QOF in IRS Notice 2020-23.[2]  This Bulletin begins with a discussion of Notice 2020-23 below.

Notice 2020-23 

Notice 2020-23 expands upon the relief offered in previous notices for general income tax return deadlines by providing an extension for taxpayers of many other tax-filing or election deadlines in connection with the COVID-19 pandemic.

Such deadlines include certain time-sensitive actions that are required to be taken by a taxpayer between April 1 and July 15, 2020, and Notice 2020-23 extends those deadlines until July 15, 2020.  The Notice expressly includes, as a time-sensitive action, the requisite election to rollover eligible gains into a QOF during the 180-day period specified in Section 1400Z-2(a)(1)(A) of the Code.

What This Means

This extension applies to taxpayers with 180-day periods beginning between October 4, 2019 and January 17, 2020, as these 180-day periods would end between April 1, 2020 and July 15, 2020 (respectively).  Accordingly, taxpayers who sold or exchanged property on or after October 4, 2019, or who had rollover gain recognized on December 31, 2019[3] pursuant to a special QOZ rule (such as through a partnership or as a capital gain dividend from a REIT), will be able to take advantage of this provision and make an election as late as July 15, 2020 (subject to the further extension for partnership gains based on the due date of the partnership tax return, as permitted under the Final Regulations).

This extension to the 180-day rollover  requirement may provide a corresponding benefit to the QOF itself.  The QOZ Rules provide that a QOF need not include, for purposes of its 90% Asset Test calculations, cash invested within the 6 months prior to a testing date.  Even with this 6-month grace period,  cash invested in a QOF in June 2020 would still need to be contributed into a QOZ Business (“QOZB”)  by the December 31, 2020 testing date that is applicable to all QOFs.  Cash invested in July 2020, however, would still be within the 6-month period as of December 31, 2020, and would give the QOF until June 2021 to deploy the cash into a QOZB.

Corrective Amendments – Taxpayer Information in Form 8997; Rebuttable Presumptions for Taxpayer Reinvestment

Under the Final Regulations, taxpayers must file a Form 8997 annually in connection with their QOZ investments.  The Corrective Amendments clarify that the form must be filed annually for any investment in a QOF held by a taxpayer at any point during a taxable year, and that failure to do so would create a rebuttable presumption of an inclusion event for the taxpayer in that year.  An inclusion event would cause the taxpayer to recognize the deferred gain of the applicable investment immediately and be ineligible for future QOZ benefits with respect to such investment.

What This Means

In order to preserve their QOZ benefits, taxpayers investing in QOFs should make sure to file Form 8997 and provide the information required on such form.  The form is available on the Treasury website ([4]

Corrective Amendments – Transitional Rules

The Final Regulations provided that a taxpayer may rely on either the Proposed Regulations previously issued or the Final Regulations, provided that the taxpayer does so consistently.  The Corrective Amendments provide that reliance on an individual section of the Proposed or Final Regulations is disregarded for purposes of the term “consistently.”

What This Means

This language appears to permit taxpayers to rely alternatively on different provisions of the Proposed Regulations and Final Regulations, so long as they consistently apply the same set of regulations to those provisions.  For example, a taxpayer may rely on the rules in the Proposed Regulations regarding Section 1231 gains, as well as on the generally more favorable rules regarding working capital accounts in the Final Regulations.

Corrective Amendments – QOZB Property Does Not Include Working Capital

The Final Regulations contain provisions permitting a QOZB’s property to de facto qualify as QOZB property under the QOZ Rules (“QOZB Property”), if constructed with working capital.  Some practitioners viewed this language as permitting the working capital itself to qualify as QOZB Property.  The Corrective Amendments, however, clarify that while working capital under a permitted plan does not cause a QOZB to violate the requirement that it not hold cash or other “nonqualified financial assets” in excess of 5% of its assets, the working capital itself does not count as QOZB Property for purposes of the 70% tangible property test.

What This Means

For many taxpayers and their advisors, this provision simply offers confirmation.  While an alternative position may have significantly expanded the opportunities available to a QOZB,  transactions to date generally have been structured in a manner that satisfy the tangible property test without regard to working capital.

Corrective Amendments – Cost Basis Applicable to QOF Interests in QOZBs

In general, the QOZ Rules provide two options for QOFs and QOZBs to value their assets: (i) a financial statement method pursuant to which the value is the value stated on the entity’s audited financial statements, or (ii) an “alternative” method which permits the use of the asset’s unadjusted cost basis as its value, provided that the property was purchased on arm’s-length terms or constructed for fair market value. If the property was neither purchased on arm’s-length terms nor constructed for fair market value, then the alternative method requires the value to be set at the actual fair market value at each testing period. While the Preamble to the Final Regulations provides that the alternative method may not be used with respect to an investment in a partnership (as well as other intangible assets with a tax basis not based on cost), the IRS appears to have softened this stance, as the Corrective Amendments provide that a QOF that acquires an interest in a QOZB formed as a partnership (even if in exchange for a contribution of cash to the QOZB, as is typical in the formation of such entities) may treat the acquisition of such QOZB interest as having been “purchased” for purposes of the alternative valuation method. Accordingly, a QOF may choose to use the unadjusted cost basis of a QOZB interest in satisfying its 90% Asset Test.

What This Means

This provision likely will ease the administrative burden of recurring valuations for many QOFs. However, it remains unclear how this might apply to scenarios involving additional capital or debt, which might otherwise impact the basis of a partnership interest.

Corrective Amendments – Additions to Anti-Abuse Example

The Corrective Amendments contain an additional example on the application of the anti-abuse provisions in the Final Regulations.  The original example[5] involved a sale of property by “Individual S” to a QOF or QOZB, and an immediate contribution of the sale proceeds by Individual S to such QOF or QOZB in a manner that would cause Individual S to become related to such QOF or QOZB.  This example specified that the seller became a related party in connection with the sale, and concluded that the sale did not qualify as an arm’s-length purchase under the related-party rules.[6]  Under the related-party restriction, property sold to a QOF or QOZB by a party with a 20% or greater common ownership with the QOF or QOZB fails to qualify as QOZB Property, and may also cause gain recognized on the sale to be ineligible for QOZ treatment if reinvested.

The additional example in the Corrective Amendments provides that Individual S does not have to become a related party in order for the property or reinvestment to fail to meet the relevant QOZ tests, so long as the transaction results in what is viewed as a “circular cash flow” (i.e., if the proceeds of the sale are immediately, or as part of a plan, contributed to the QOF or QOZB).  In this event, common law tax principles such as the step-transaction doctrine might apply, and recharacterize this transaction as a contribution of the property by Individual S to the QOF or QOZB. As a result, Individual S would not recognize gain from such contribution[7] and the property, having been acquired by contribution rather than by purchase, would be ineligible to qualify as QOZB Property in the hands of the QOF or QOZB.

What This Means

The Corrective Amendments’ additional example in the attempts to present a scenario in which, consistent with language contained in the preamble to Final Regulations, common law tax principles would dictate that the circularity of cash flow implies a deemed contribution.  However, the example provides that the entire amount of cash received in the purported sale was reinvested in the QOF, and does not consider the result if only a portion of the proceeds were reinvested.  In that case, common law tax principles would instead suggest that the transaction be treated as a part sale and part contribution, with the sale portion still treated as qualified QOZB Property.  In light of the complex nature of the analysis of whether a sale might be recast as a contribution, taxpayers should consult a tax advisor for further information as to how this may apply to any transactions they are contemplating.


For More Information

Jeffrey D. Uffner

Michelle M. Jewett

Brian J. Senie

[1] Defined terms herein generally have the meaning ascribed to them in the QOZ Rules unless otherwise indicated.  References to the “Code” refer to the Internal Revenue Code of 1986, as amended.  The QOZ provisions were enacted by the Tax Cuts and Jobs Act in December 2017 and are encoded as Sections 1400Z-1 and -Z-2 of the Code.

[2] For all guidance discussed in this Bulletin, taxpayers should confirm that any applicable state and local taxing authorities conform to the Federal guidance.

[3] A 180-day period beginning on December 31, 2019 would expire June 28, 2020 – but as the 28th is a Sunday, Friday, June 26 would likely have been the date for most practical purposes.


[5] 1.1400Z-2(f)-1(c)(iii)(3), Example 3.

[6] Sections 1400Z-2(d)(2)(D)(i)(I), -2(d)(2)(D)(iii), and -2(e)(2).

[7] Code Section 721.

This Stroock publication offers general information and should not be taken or used as legal advice for specific situations, which depend on the evaluation of precise factual circumstances. Please note that Stroock does not undertake to update its publications after their publication date to reflect subsequent developments. This Stroock publication may contain attorney advertising. Prior results do not guarantee a similar outcome.