3 Biggest Changes in the IRS Correcting Amendments to OZ Regs, with Jessica Millett and Ashley Tison

Ashley Tison and Jessica Millett

In April, the IRS published correcting amendments to the final regulations on Qualified Opportunity Funds. What are the key changes that Opportunity Zone participants need to be aware of?

Jessica Millett is partner and chair of Duval & Stachenfeld’s tax practice group. Ashley Tison is co-founder at OZ Pros.

Click the play button below to listen to my conversation with Jessica and Ashley.

Episode Highlights

  • The purpose of the IRS correcting amendments to the final regulations on Qualified Opportunity Funds.
  • A review of the three most substantive changes that the correcting amendments made to the final regulations on Opportunity Zones.
    1. Favorable changes to the effective date provisions: the correcting amendments confirmed that you could pick and choose from proposed regulations and final regulations until 2021.
    2. Favorable changes to the working capital safe harbor provisions: QOZBs essentially get a pass for meeting the 70% tangible property test during the working capital safe harbor period. Why more clarification is still needed on the working capital safe harbor and 70% asset test issue.
    3. Expansion of an example in the anti-abuse section about circular cash flow, in regards to the related party rule, and how the solution for existing owners may be a ground lease transaction.
  • How the cure period provision was further clarified.
  • The potential 24-month extension for QOZBs located in a declared disaster area, and the importance of documenting any such delays.

Featured on This Episode

Industry Spotlight: Duval & Stachenfeld

Duval & Stachenfeld

Founded in 1997, Duval & Stachenfeld is a New York-based law firm that specializes in complex real estate transactions. Their practice areas include corporate, finance, fund formation, joint ventures, tax, and of course Opportunity Zones.

Learn more about Duval & Stachenfeld

Industry Spotlight: OZ Pros

OZ Pros

Founded by Jimmy Atkinson and Ashley Tison, OZ Pros is an Opportunity Zone advisory firm that offers a simple document generation tool for quick and easy QOF and QOZB formation. PPMs, subscription agreements, pitch decks, pro formas, business plans, and capital raising assistance available as well.

Learn more about OZ Pros

About the Opportunity Zones Podcast

Hosted by OpportunityDb.com founder Jimmy Atkinson, the Opportunity Zones Podcast features guest interviews from fund managers, advisors, policymakers, tax professionals, and other foremost experts in opportunity zones.

Show Transcript

Jimmy: Welcome to the Opportunity Zones Podcast. I’m your host, Jimmy Atkinson, and today I’m surrounded by lawyers. Jessica Millett is partner and chair of New York city-based Duval & Stachenfeld’s tax practice group. Jessica specializes in tax, real estate, and opportunity zone law. And she joins us today from her home office in Long Island City, Queens, New York.

Ashley Tison is also with us today. He is a business attorney with extensive real estate experience. To date, he has helped form over 100 opportunity zone entities, and he is my partner and co-founder of OZ Pros. And today Ashley joins us from his home office in Charlotte, North Carolina. Jessica and Ashley, you’ve both been on the show before so thank you both so much for joining me again today. Welcome back to the podcast.

Jessica: Thank you.

Ashley: Yeah. Thanks for having us, Jimmy. It’s always a pleasure to be on and to talk to your listeners.

Jimmy: Yeah, absolutely. And today we’ve got a good one, a rather timely episode today. Just a few weeks ago, back in April, the IRS published correcting amendments to the final regulations. So that’s gonna be the topic of today’s show. Jessica, I’ll turn to you first. What are these correcting amendments? I think a lot of people, when we received the final regulations back in December of 2019, we were kind of thinking, “Okay, this is it. These are the final regulations.” And now a few months later, the IRS has published some correcting amendments, which have actually tweaked the regulations in some areas. So, answer this question for me, what are these exactly and how do they relate to the final regs?

Jessica: Sure. So again, as most of your listeners are probably aware, we did get final regulations from Treasury on the opportunity zone program back in December of 2019. Even when things are final, they’re never really quite done. So it’s certainly not unusual for Treasury to make small tweaks after the fact in terms of, you know, fixing mistakes that they’ve made in the process. These correcting amendments, while they do fix some just kind of typos and knits and cross-references that didn’t work and things of that nature, they do contain a few substantive changes, which Ashley and I will go over. And one of the things that I think took the tax community and the opportunity zone community by surprise is the fact that there were some pretty significant changes in these amendments, but the amendments are intended to be kind of, again, correction to these final regulations.

One of the things that I think has frustrated a number of people when they try to look at this is, first, if you try and read the amendments on their own, it’s incredibly difficult to parse. They basically say, you know, “Remove sub-section D2 and add a new section I, cap F.” And so it’s really hard to read them on their own.

The other aspect of the amendments that is pretty frustrating is that there no preamble. There was no explanation in terms of why they changed the things that they changed. They just dropped and you have this new regulatory language. So that’s left a lot of practitioners scratching their heads about a few of the changes, and we may even see some further clarification on at least one of these issues in particular. I hope that we do, but I know we’ll get to that in a second.

Jimmy: Yeah. So I want to bring that up now, actually. I kind of want the bulk of this episode to be a back and forth with you and Ashley discussing maybe three, four, or five of the biggest effects of the correcting amendments that were issued in April. So Jessica and Ashley, maybe you can kind of walk us through those one at a time. What really stuck out for you in terms of some of the biggest changes here?

Jessica: All right, so the three that I definitely want to make sure that we hit, and then if we have time we can do a few others. The first is some changes to the effective date provisions. And just to give everybody a sense of what’s coming, the second will be a change to some provisions relating to the working capital safe harbor, which is applicable to cash held by qualified opportunity zone businesses. And the last is the expansion of an example in the anti-abuse sections about circular cash flows.

The first one I’ll just kick off is the effective date. When the final regulations came out, there was, I guess, not surprising given our whole history with this roller-coaster here, there was some inconsistent language between the preamble and the actual operative language and the regulations about effective dates of the final regulations and, in particular, a taxpayer’s ability to rely on the proposed regulations before the final regulations are fully effective.

The final regulations made pretty clear that the final regulations are gonna be fully in effect for most taxpayers in calendar year 2021. But before 2021, taxpayers seem to have an ability either in whole or in part to rely on the proposed regulations. But it wasn’t really clear whether you had to use all or nothing approach, meaning you could rely entirely on the proposed regulations or entirely on final regulations, or whether you could pick and choose and rely on certain sections of the proposed regulations and certain sections of the final regulations. They kind of mucked up the discussion there, and so a lot of people were questioning how to handle that.

In the correcting amendments, they did clarify that there is essentially this pick and choose approach. So, for example, if you want to rely on a section of the proposed regulations relating to, for example, the calculation and timing of the investment of a taxpayer’s eligible gain into a qualified opportunity fund, you could do that, and separately you could rely on the final regulations, the rest of the sections of the final regulations.

And I think that this was welcome news to a lot of taxpayers, especially relating to taxpayers who had 1231 gains, because if you remember the rule in the proposed regulations about 1231 gains is that you had to wait until December 31st of the year the gain was triggered to invest the net amount of your 1231 gain.

So if you think about a taxpayer that sold an asset, a 1231 asset back in January of 2019, for example, they didn’t think that they could invest that until December 31st of 2019. So they may have been waiting all year to invest that gain and then the final regulations come out and say, “Oh, no, you can invest it in the 180-day period beginning on the date of sale.” So that’s an example of a situation where the taxpayer would want to be able to rely on a particular section of the post regulations to invest their 1231 gain according to those rules, but they may want to rely on the final regulations for other provisions. Ashley, I don’t know if you have any insights into that one or experience with some of your clients needing that flexibility.

Ashley: Yeah, no, I think that you’ve summed it up perfectly. And I think that the key is that it eliminated the all or nothing. And all or nothing is tough, particularly when you’re talking about, you know, stuff as complex as this. So I think it’s crucial that people, especially with the timing of when the regulations came out, that they have the flexibility to be able to say, “Well, no, I was planning on doing this,” but then now they can actually rely on the final reg. So I agree completely with what you said, particularly, how beneficial that all or nothing function of that is.

Jessica: Yeah. Yeah. So that was one that I think you can sort of put in the positive camp in terms of helpful clarifications in the correcting amendments. Ashley, anything else you wanna say about that one or should we move on to the next one?

Ashley: Yeah, no, I was just going to say, I think that another positive one that they identified was the correction to the safe harbor for working capital, specifically on where working capital’s being expended. And that QOZB is satisfying the requirement on QOZB business property during the working capital safe harbor. Even though that it’s not actually satisfying, it’s tangible property requirements.

And so I think it’s very favorable because it’s treated as satisfying it, even though that it doesn’t have the 70%. So I was actually very pleased that they ended up bouncing that one out and, specifically, because it eliminates that concern about a zero over zero calculation, and I know that that was one of the things was of concern for folks.

Jessica: Yeah. And just for any of Jimmy’s listeners who aren’t familiar with the zero over zero, as we call it, this relates to the fact that, you know, a qualified opportunity zone business has to meet a 70% test with respect to its tangible property. At least 70% of the tangible property in a QOZB needs to be good qualified opportunity zone business property, QOZBP. Everybody loves the alphabet soup in the land of OZ.

And the concern was, well, if early on you don’t have any tangible property in your QOZB yet, do you have a zero over zero problem there? And so that’s the issue that Ashley actually just mentioned. It’s interesting because, well, Ashley, I certainly agree with you to the extent that what Treasury was trying to say in the correcting amendments was that qualified opportunity zones businesses essentially get a pass on meeting the 70% tangible property test during the working capital safe harbor period. That would be a huge swing and it would take a lot of pressure off of some of the delicate structuring issues that a lot of us have been struggling with. I think a lot of practitioners, myself included, are still struggling a bit with the words in the amendments because the way that they did it, and I don’t want to get too technical…

Jimmy: I know what you’re talking about.

Jessica: You really have to go look at the words on the page very hard. It seems like they were trying to get there. They didn’t frankly do a very good job of it. So I do know that a couple of folks at some of the big accounting firms are pushing to get some clarity from Treasury if that’s really what they meant to do.

And just so that, so Jimmy, you and your audience can understand some of the nuances here, in one of the new paragraphs that they added in this working capital safe harbor section, on the one hand, they added in this language that implies that a qualified opportunity zone business meets the requirements of perhaps the 70% test during a working capital safe harbor period. They also added in a sentence that says that working capital assets in the QOZB are not that qualified opportunity zone business property for purposes of the 70% test.

So, for example, if you have cash in your working capital safe harbor, they basically are staying with this new sentence that you cannot treat that cash as a proxy for the tangible property that you’re going to build or construct or improve with it. The cash is basically just out. You do not count it at all in your 70% test. So it’s a little bit difficult to square for all the tax peeps who like to dig into the regulations and try and understand what Treasury meant. Why, on the one hand, they’re saying your cash is not going to be counted as a tangible property, and on the other hand in the exact same paragraph, you know, if they’re saying that your QOZB doesn’t even need to worry about meeting its 70% test during the working capital safe harbor period. So that’s the reason why I think some people are struggling to really clarify what Treasury was trying to accomplish.

Ashley: It’s almost like they gave us the good with the bad. I think that the key takeaway in that is that you better make sure that you meet the 70% after your working capital safe harbor is done. And then we can probably argue it out relative to the language and that kind of thing in the meantime, but that is certainly important that you definitely have it locked and loaded after the working capital safe harbor period.

Jessica: Yeah. I think that you’re absolutely right. So, you know, even if we can get some comfort that treasury is gonna give you a little bit of a pass during that initial startup period, you shouldn’t take that for granted. You should make sure that you’re doing everything that you need to do to make sure that at the end of it, you can pass your 70% test without any issues.

Ashley: Absolutely.

Jessica: Should we move on to the last one, the circular cash flow example?

Jimmy: We’ve discussed the top two, the updates in terms of effective date provisions, and then we just discussed changes to working capital safe harbor language. And there’s a third big one, Jessica, that I know you wanted to get to. So please go ahead.

Ashley: Real fast before you hit that big one. There’s a little one that was kind of snuck in there that they allowed, they corrected the cure provision, basically said that for each QOZB that you have inside of the QOF, you have a cure period for each one of those QOZBs. But that’s great because we’re kind of wondering about that but that’s a minor one compared to what you’re talking about. So hit us with the circular cash flow, Jessica.

Jessica: Yeah. So this one, to set the stage a little bit, in order for property to be good property in the hands of a QOF or a QOZB, one of the requirements is that the property needs to have been acquired by purchase from an unrelated party. And they set the related party threshold here at 20%. So that means that the buyer and the seller cannot have more than 20% over that being ownership.

And a lot of people were looking at that related party requirement and trying to structure transactions, keeping that in mind obviously so it’s not to run afoul of it. And you ran into, at least, was a fairly common fact pattern with respect to some of my clients and contacts and other people I spoke with, is if you had an existing owner of property in an opportunity zone and they wanted to develop it and they wanted to be able to develop it through an opportunity zone structure, the question was, well, could they sell it to the QOZB, trigger gain from the sale, and then reinvest the proceeds from the sale into a qualified opportunity fund that then invested back into that QOZB?

And on the one hand, you have this 20% related party tests, which seems to imply, well, look, if you’re on the right side of the line in terms of the numbers, if that seller does not come back in and end up owning more than 20% of the new structure, then you’re in compliance with the related party rule requirement, and so you should be all good.

And when the final regulations were released back in December of 2019, there was some language in the preamble where Treasury was responding to a comment that they’d received asking about this particular fact pattern where a seller reinvesting back into the deal. And the Treasury came out in the preamble and they said that those structures to the extent that circular cash flow principles and the step transaction doctrine would be implicated that that would be an abusive situation.

And then they put some language actually into the regulations themselves. They included a new example in the anti-abuse section. And, again, this was all back in December with the final regulations. And in that example, in the final regulations, they had a situation where a seller sold property, triggered a gain, and pursuant to a plan reinvested that gain into a qualified opportunity fund that invested back into the project. And in that example that was included in the December 2019 final regulations, the seller had a plan to reinvest in a manner that would cause the seller to become a related party. So more than 20%.

So, again, a lot of practitioners looked at that and started scratching their heads and say, “Well, the preamble seemed perhaps a little bit harsher,” but the example really indicates that maybe they’re only concerned with the reinvestment of more than 20%. And I guess enough people called Treasury or the IRS to ask about exactly what they meant by this, that Treasury took the opportunity with these correcting amendments to expand upon that example.

And what they did is they expanded the example and they added some new language about the step transaction doctrine and circular cash flows. And they said… And by the way, this would still be problematic even if the seller reinvests in a manner that would cause the seller not to be a related party. So meaning if you had a less than 20% reinvestment, you’d still be caught up in this example.

Now, if you’re caught up in this example, two bad things happen. The first bad thing that happens is that the seller who reinvested gain into a qualified opportunity fund is treated as not actually having that eligible gain to invest because the recharacterization of this transaction is that instead of selling the property and triggering a gain and reinvesting the gain, the seller is treated as having contributed at least a portion of the property down into the qualified opportunity fund in exchange for an interest in the qualified opportunity fund. And then the qualified opportunity fund is treated as having contributed the property down to the QOZB.

So, as I said, in the first instance, the re-investing seller ceases to have an eligible QOF investment because they didn’t actually put gain in. The second bad thing that happens is that all of that property, even if, you know, 80%-plus of the property was, really, having been acquired by purchase, you would think, loses its status of having been acquired by purchase. If there is even a small, de minimis portion of the property that is characterized as having been contributed pursuant to the recharacterization, then all of the property’s bad, which is arguably unfair and unjust to the investors that really contributed eligible gain into the structure and thought the QOZB was gonna use that cash to acquire the property.

So, you know, for whatever reason, treasury and the IRS really do not like these reinvestment structures. The thing that gets a little bit nuanced which we probably can’t go into too much depth on during this call is the step transaction doctrine and what that’s really all about and when you’ll be implicated by it and when you won’t be. But if you’re considering a structure involving the seller of the property, tread very carefully and make sure that you kind of talk that through with someone who is well versed in the step transaction doctrine and those issues and how to navigate them.

Jimmy: Yeah. Thanks for all the clarifications there, Jessica. Ashley, I know you have plenty to say about circular cash flow. What are some of your thoughts here?

Ashley: Well, it’d be interesting to run an analysis on if they weren’t reinvesting proceeds from the sale of that piece of property, could they invest outside money into it and would that be violative? So if the seller had cash from a different transaction, could they at that point do the deal? I think that Jessica is correct that, at the end of the day, you really got to take a look at exactly the details of what your transaction looks like to make sure you don’t run afoul of it.

This is kind of the double unfortunate piece about the final regs, is that everything in the final regs or almost everything in the final regs was great until we got to this part about related parties in this step transaction piece, where it kind of cut out sellers from being able to participate in the upside of a deal. And it was kind of unfortunate. And there was lots of feedback on that and lots of questions.

And then, you know, the clarifications that came out came out, and it was almost like it made it worse. And so this is kind of along those lines of like, it’s like, man, that’s a bummer because there could have been lots of ways that you could have creatively done this and I think not violated the spirit of the rule or what they’re trying to accomplish, but, unfortunately, the additional kind of classification relative to that step transaction piece just further exacerbates the problem.

Jimmy: Right. Right. So those are three of the biggest issues that the two of you identified in the correcting amendments. Ashley, you snuck in a fourth one there with the cure right, being applicable for each trader business under the QOF. Question I’d like to pose to both of you, what does this all mean really for just the average qualified opportunity fund participant? Whether it’s the fund manager or an investor or a developer receiving funds for their deals, what is the end result here? What’s the big takeaway?

Ashley: I think that, to Jessica’s point, that if you’re dealing with a seller that you gotta be really careful about that transaction in that more than likely, you’re probably gonna end up in some kind of ground lease transaction in order to make it work. I think that as a lion’s share of what we’re talking about, that it just kind of confirmed and it gave more the practitioner’s comfort relative to some of the head-scratching that was going on to some of the nuanced conversations about structures gave them, you know, substantially more comfort.

I think that as well, is that one of the things that, and this was kind of a minor change relative to the timing of it and as to whether or not this was intended to change, but they changed receive up to and they replaced it with received not more than relative to the 24 months of additional time for governmental…you know, for something outside of their control or if they were in a disaster. And based upon the presidential declaration that the whole United States are under a disaster area, arguably, the QOZBs that are executing and working capital safe harbor during the COVID crisis, I think that there’s an argument that they get additional 24 months to effect that working capital safe harbor plan.

And Jessica, I’d be interested to hear your take relative to, like, kind of true impact that this is going to have on QOFs and fund managers, but I think that a lot of it kind of more goes to the practitioners.

Jessica: I think that you’re probably right, Ashley, because aside from the circular cash flow language that we’ve discussed, for the most part, all of the other clarifications were helpful, I think, just in terms of things that they clearly got wrong and that they needed to fix and certainly the effective date in the reliance provisions.

The one thing that I’m really hopeful that we will get additional clarity out of Treasure on is this working capital safe harbor and the 70% test issue that we discussed. Just one kind of practical note for anybody setting up a call to opportunity fund or having a QOZB underway with respect to this 24-month possible extension that Ashley mentioned, the regulations do say that you can get…I guess they changed it now to…essentially you can get up to or not more than 24 months, but you should make sure that you are documenting any actual delays that are caused by the current COVID-19 coronavirus pandemic.

Because if you look at the language in the preamble surrounding that 24-month extension of the working capital safe harbor period, the language in the preamble is a little bit different from the language in the actual regulations and talks about getting that extra time if there are delays attributable to a federal disaster. So it may not be that everybody poof gets an automatic 24 months, no matter what.

Ashley: That’s a good point.

Jessica: You may need to actually show how your project was delayed. And this isn’t just government applications in terms of the normal tolling periods. This could be anything. This could be, well, my law firm shut down or my architecture firm closed, and everybody was working from home or the site was shut, or it was locked down and nobody could get there. All of those things which go towards actually delaying your project, which I’m sure virtually every opportunity zone project across the country is experiencing right now, is keep very, very good records and make sure that you have that in case you ever need to show it to the IRS.

Jimmy: Yeah. Great, great points, Jessica. Thank you for clarifying that. Well, both of you, this conversation has been very insightful. Jessica Millett and Ashley Tison, thank you both for joining me today and helping to distill these correcting amendments for our audience and making it as easy to understand as possible. Before we go, could each of you tell our listeners where they can go to learn more about you? And Jessica, I’ll let you go first. How can our listeners learn more about you and Duval & Stachenfeld?

Jessica: Sure. So the best place to go, of course, is our website. It’s dsllp.com, and you’ll find there the links to our opportunity zone webpage, which has a number of resources, including roadmaps and white papers and all of that. So we are happy to share whatever knowledge that we have. The land of OZ can be a little confusing at times, and I just encourage anybody to reach out if they have questions or want to chat through any of their projects.

Jimmy: Land of OZ. And Jessica is known internally, at least at Duval & Stachenfeld as the wizard of OZ also. So she’s very sharp about this. And we appreciate your insights today, Jessica. Thank you. And Ashley, where can our listeners go to learn more about you and OZ Pros?

Ashley: Yeah. At www.ozpros.com. And we’ve got lots of information on that site, a couple of videos and different things there, and also ability to be able to just click on there and schedule a call. So look forward to talking with anybody about these specifics or just kind of general OZ strategies or any kind of questions that you have from structuring to potential issues. We’d love to talk and continue our conversations with as many people as we can.

Jimmy: Perfect. Thank you. And for listeners out there today, I will have show notes for this episode on the Opportunity Zones Database website. You can find those show notes at opportunitydb.com/podcast. And there you’ll find links to all of the resources that Jessica, Ashley, and I discussed on today’s show. And I’ll be sure, of course, to link to the full text of the correcting amendments, although I wouldn’t recommend reading them necessarily. That’s why we’ve got Jessica and Ashley here. So, again, Jessica and Ashley, thanks so much for your time today. Appreciate it.

Jessica: Of course. Happy to help out.

Ashley: My pleasure, Jimmy.


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