Opportunity Zones Update for Contractors
Tuesday, May 28, 2019
Posted by: Hilary Korabik
Opportunity Zones Update for Contractors
By Robert Nowak, CPA, MST, partner with Baker Tilly
The Tax Cuts and Jobs Act created various tax benefits for investors in designated Qualified Opportunity Zones (QOZs). Through an investment vehicle called a Qualified Opportunity Fund (QOF), a taxpayer can invest realized capital gains into a QOF in exchange for three tax benefits:
1. Deferral of tax on invested gains generally until the earlier of 2026 or disposition of the QOF
2. Forgiveness of tax on ten percent of the invested gains if the QOF is held for at least five years and an additional five percent if the investment is held at least seven years
3. An exemption for any gain upon the sale of the QOF investment if held for at least ten years
Understanding the QOZ rules is critical to a successful QOZ bid and project delivery. While the QOZ program provides incentives for investors, the program presents challenges and opportunities for contractors. By understanding the rules, contractors can add value to client projects and prevent QOZ projects from failing to qualify for the program.
In April 2019, the Department of Treasury issued new regulations to clarify certain provisions of the QOZ program. The most significant takeaways from the new proposed regulations applicable to contractors are:
Clarification of original use requirement: To qualify as QOZ business property, the property must be either substantially improved or originally used in a QOZ. Original use generally commences when the property is first placed in service within the QOZ for purposes of depreciation or amortization. Consequently, existing structures being depreciated within the QOZ will not qualify under the original use requirement. However, the new proposed regulations establish an exception for buildings that have been vacant for at least five years.
While this clarification seems to be a developer concern, the contractor can add value during the bid process by confirming the historic use and ownership of the subject property. Asking the right questions during the bid process communicates to the developer/owner that the contractor is knowledgeable of potential QOZ project pitfalls.
Substantial improvement determined on an asset-by-asset basis: The new proposed regulations establish that substantial improvement to QOZ business property applies on an asset-by-asset basis. In short, each asset must be substantially improved to qualify as QOZ business property. Assets cannot be aggregated. The preamble to the new proposed regulations acknowledges the administrative difficulty of asset tracking and requests public commentary on this issue.
When reviewing project scope involving multiple asset developments, contractors should work with owners/developers to understand the extent to which project costs need to be allocated among multiple assets. Carefully review budgets and architectural concepts to assess and determine if each building in a development will meet the QOZ substantial improvement test.
Working capital safe harbor: Development timelines for QOZ projects must meet strict guidelines to prevent a developer’s working capital from failing an annual qualifying asset test. Generally, projects must be delivered within 31 months to avoid failure and the corresponding assessment of substantial penalties.
The new proposed regulations make two changes to the 31-month working capital safe harbor:
1. Only the acquisition or construction of and substantial improvements to tangible property were permissible over a 31-month period. In effect, the prior safe harbor was generally applicable to real estate development projects. Under the new proposed regulations, the safe harbor applies to the development of a trade or business as well, making the safe harbor more useful for operating companies
2. The 31-month safe harbor can be extended if a written plan is not completed due to government delays
While the regulations provide an escape hatch for a project delayed due to governmental or regulatory issues, there is no exception for projects delayed due to change orders, material labor issues or structural/architectural challenges. Contractors must carefully review and understand the project timeline and build in delay contingencies. Failure to complete the project within the prescribed timeline can result in the entire project failing to qualify as QOZ property.
About the author: Rob Nowak is a tax partner with Baker Tilly, specializing in work with construction companies. He has more than 20 years of experience in providing proactive tax consulting and planning services.