Based on the latest proposed regulations, the Opportunity Zone industry has become much more vital given the responses received from the Treasury Department that have provided more certainty to the program. However, there are still pending issues that need to be resolved and it is expected that, in the near future, the Treasury will issue final regulations. It is noteworthy that the Treasury is not allowed to legislate and, therefore, it can provide guidance and interpretations but it cannot issue regulations that are contrary to the pending legislation.
The key issues to be addressed include:
The issue here is what counts for a substantial completion and the Treasury, based on the narrow interpretation of the statute, has indicated that improvements must be done to the existing property with respect to renovations and that would not include additions, adding amenities or building additional units for an apartment project or additional hotel units for a hotel project. The viability and the appropriateness of that position can be questioned and I understand from my direct discussion with Chief Counsel Daniel Kowalski of Treasury that the issue has received significant attention and should be clarified shortly.
Prior Ownership Issue
The new regulations at least provide guidance as to how to address prior ownership issues. There are three options, which include complying with the 80/20 ownership rule for the new purchaser entity if a purchase and sale transaction takes place. The other approach is a direct contribution by the developer to a new entity, subject to otherwise complying with the 70/30 test with respect to qualified and not qualified OZ assets. The third method is a ground lease proposal whereby a new entity would be formed to ground lease the property and any improvements thereon. Based upon this standard, the 80/20 test would not be included, all the assets of the ground lessee would be included as good assets providing they otherwise qualify and it would be permissible that the fee interest is subordinated to financing the other ground lease.
Social Responsibility of the OZ Program
Many state and local jurisdictions are conditioning approvals in grants and incentives based upon the social responsibility nature of an OZ developing project and what effect it has on the neighborhood and the environment. Treasury needs to expand on its notice of regulating QOFs to provide annual reporting to track the social responsibility accomplishments of the OZ project.
The key here is for funds to structure the transaction based upon the normal real estate syndication model so that the amount of the extra participation (the promote interest) and the fee changes are in accordance with industry standards.
Deadline of Dec. 31, 2019
In order to obtain the maximum benefits of the OZ program, investors will need to invest their capital contribution by Dec. 31, 2019, in order to be able to hold the investment for at least 7 years in order to obtain the maximum 15% capital gain reduction based upon the statutory provisions. Many investors are funding their own funds in order to accommodate the situation by placing monies in the fund and thereafter looking for an appropriate business to invest in within the applicable timeframe.