Key Points

• IRS releases new COVID-19 relief for Qualified Opportunity Funds
• Taxpayers granted significant postponement of various timing requirements to ensure compliance with
  IRC section 1400Z-2

---

The IRS released Notice 2020-39 on June 4, 2020, providing significant relief for investors in qualified opportunity funds (QOFs). The notice contains five new extensions for QOF investors to meet the timing requirements to obtain the deferral and exclusion provisions of IRC section 1400Z-2.

The new notice expands on the general COVID-19 extensions already announced by the IRS. In particular, Notice 2020-39, further extends the filing extensions announced in Notice 2020-23. That notice allowed taxpayers until July 15, 2020, to reinvest their gain in a QOF provided the 180-day QOF reinvestment window closed on or after April 1, 2020, and before July 15, 2020.

Notice 2020-39 provides the following five extensions for investors in QOFs:

1. 180-Day Investment Requirement for QOF Investors

In order to take advantage of the opportunity zone benefits, taxpayers must reinvest gain from the sale of capital assets in a QOF within180 days of the disposition of such assets. Notice 2020-39 automatically extends that 180-day period where the 180 period ends on or after April 1, 2020, and before December 31, 2020. In such a case, the taxpayer has until December 31, 2020, to reinvest gain into a QOF. For taxpayers seeking to shelter gain from partnerships and S corps, Notice 2020-39 is welcome relief. The extension in Notice 2020-23 (to reinvest gains by July 15, 2020) did not actually provide much help for these taxpayers. For partners and S corp shareholders, the final QOF regulations provide a starting date of April 15, 2020, with the 180-day window closing on October 12, 2020. Now, with Notice 2020-9, such taxpayers have an additional 2 1/2 months to reinvest their gain in a QOF.

2. 90% Investment Standard for QOFs

A QOF must maintain at least 90% of its assets in qualified opportunity zone property (including qualified opportunity zone businesses (QOZBs)) or direct investments in assets in the zone. Where a QOF drops below the 90% threshold, it is subject to penalties that the investors ultimately must bear.

Testing for the 90% compliance occurs semi-annually. In general, the assets are tested (1) on the last day of the first 6-month period of the taxable year of the QOF, and (2) on the last day of the taxable year of the QOF. Notice 2020-39 provides for significant relief regarding this 90% investment requirement. In essence, the guidance states that as long as a QOF has a reasonable basis for failing to meet the 90% test during the 2020 calendar year, no penalties will be imposed. This penalty abatement is welcome relief, especially for taxpayers who formed QOFs and purchased property in the zone, but cannot spend adequate capital to build on the property because of the COVID activity.

3. 30-Month Substantial Improvement Period for QOFs and QOZBs

One of the most important requirements for a QOF (or a QOZB) is that it must "substantially improve" or make "original use" of tangible property in the zone. In the case of property that is substantially improved, the QOF must make additions to the property so that it doubles the basis of the property (excluding the land value) within 30 months. This requirement has created significant confusion and risk, but the liberal rules of the working capital safe harbor (discussed below) and the guidance in the final QOF regulations (including the treatment of newly purchased "original use" assets as counting toward the 30-month substantial improvement threshold) have mitigated much of this risk.

Notice 2020-39 goes farther in providing relief. It states that the 30-month substantial improvement requirement period is tolled during the period beginning on April 1, 2020, and ending on December 31, 2020). In short, the notice gives taxpayers another eight months to meet the substantial improvement threshold.

4. Working Capital Safe Harbor for QOZBs

Most taxpayer now structure their QOF investments in a two-tiered manner (i.e., the taxpayer rolls into a QOF, which then invests in a QOZB). The major advantage of this structure is that the QOZB is privy to a working capital safe harbor (whereas a QOF is not). In many cases, the working capital safe harbor allows a QOZB to up to 62 months to expend funds, provided various documentation requirements are met. During such time period, the funds held in the working capital reserve do not count against the QOZB for various testing purposes.

Notice 2020-30 adds another 24 months to the working capital safe harbor (provided the QOZB maintains the requisite documentation). This means that a QOF, through a QOZB investment, could arguably have 86 months (more than seven years) to effectively hold cash as working capital. Such a result seems ripe for potential abuse. While the working capital rules require taxpayers to maintain a schedule to deploy the funds, we envision situations where a taxpayer may attempt to simply hold cash for nearly all the 10-year holding period to get to QOF exclusion benefits.

5. 12-Month Reinvestment Period for QOFs

Where a QOF disposes of property located in the zone, there is no tax result to the QOF members, provided the QOF reinvests that gain in other qualified opportunity zone property within 12 months. This is only true at the QOF level (if it disposes of a QOZB or zone property itself) but not true of QOZBs (QOZBs can't sell assets in the zone and reinvest).

Notice 2020-39 states that if a QOF's 12-month reinvestment period includes January 20, 2020 (the date President Trump issued a major disaster declaration for COVID), then the QOF receives an additional 12 months to reinvest proceeds from the sale of qualified opportunity zone property. In other words, QOFs currently have two years, rather than one, to reinvest if they wish to dispose of a particular zone investment.

Taxpayers with questions regarding QOF investments can contact Christopher Karachale or Daren Shaver.