Brett Siglin
Jennings Strouss & SalmonJune 29, 2019
No.
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Can you contribute a note payable instead of cash to an QOF?
Could those funds count towards the 90% test via the working capital exception?
Answers
No.
I am not sure, but I believe it has to be cash. Also, even if a note payable were possible (which I think it unlikely), the QOF must use cash to acquire its interest in a lower-tier entity that is a QOZB. Therefore, it will be best to invest with cash.
I think your question is can you fund your QOF contribution with cash and a note paying off the note overtime to complete the contribution. Further, I think you want to know if the portion of the contribution that is a note qualifies for the working capital exception. First, you have to contribute cash to your QOF equal to the amount of the gain you're deferring. The amount of the note does not qualify as a QOF investment. If the note represents amounts you consider future gain deferrals paying off the note as the gains are realized, there are structuring options but they are more complex than I can explain here. Second, only assets contributed to a Qualified Opportunity Zone Business or a Qualified Opportunity Zone Property are eligible for the 31-month working capital exception. Moreover, the 90% test and the working capital exception are generally unrelated tests. 90% of the QOF assets must be invested in a QOZB or QOZP generally within 180 days of the contribution to the QOF. The working capital exception relates to the assets held by the QOZB or QOZP that have been downstreamed from the QOF entity.
The working capital safe harbor is for a Qualified Opportunity Zone business, not for a fund. Investors must contribute cash or property to a fund. No debt.
As to the first question, nothing in the proposed regulations specifically addresses the concept of a contribution of a note payable to a QOF. However, because such a note is not cash, it should fall into the general rules associated with the contribution of non-cash assets to a QOF. If the taxpayer contributes his/her own note payable to a QOF (I am assuming for this purpose that the note is not readily tradeable on a public securities market, although that may not make a difference here), the amount of the investment (which corresponds to the amount of gain eligible for deferral under the QOZ program, as well as the investment amount that can qualify for the 10-year gain exclusion) is the lesser of the taxpayer’s basis or the fair market value of the property contributed to the QOF. In this case, if you or I contribute our own promissory note to a partnership/QOF, our basis in that note (and in the partnership interest) is zero. We establish basis by actually making payments. By the same reasoning, my interpretation of the regulations is that if a taxpayer contributes what is effectively the taxpayer’s own promise to pay cash to a QOF rather than cash, the amount of the investment will be treated as zero (meaning that there is no investment qualifying for the QOZ benefits). The answer to the second is no. You only get into that through a lower tier investment made solely with cash. If for the first question you can treat a debt instrument as property, that would invalidate the investment in the lower tier.
A note will generally not qualify as a qualified OZ business asset.
In order to qualify for the OZ tax benefits, deferred capital gains need to be placed in the QOF account no later than 180 days after they are realized. A note payable could not be used in place of cash, though OZ funds (and/or the lower-tier OZ businesses) can also use debt to fund the purchase of Qualified Opportunity Zone property. The 90% asset test is at the fund level, while the working capital exception applies to Qualified Opportunity Zone businesses. I think there may be some confusion in this question about how the rules apply to first- and second-tier entities.
Probably not. Notes payable will not get you credit for tax deferral unless and until they're funded within the 180-day window.
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