Opportunity Zone Investment Structure

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Opportunity zone investments are as complex as they are lucrative, and require a specific investment structure. To structure a Qualified Opportunity Zone (QOZ) investment that qualifies for the tax incentives, opportunity zone investors are required to set up an investment vehicle called a Qualified Opportunity Fund (QOF) into which they will invest their capital gains with 180 days. 

To be considered a Qualified Opportunity Fund there are five requirements: 

1. Qualified Opportunity Fund must be an investment vehicle organized as a partnership, LLC (with 2+ members), S Corporation, or C Corporation for tax purposes; 
2. Qualified Opportunity Fund must be a legal entity organized under laws of United States, laws of one of the 50 states, or D.C.;
3. Qualified Opportunity Fund organizing documents (Operating Agreement/Partnership Agreement/Articles of Incorporation) must state that the purpose of the entity is to “invest in  Qualified Opportunity Zone Property” 
4. Qualified Opportunity Fund organizing documents must include a ‘‘description of the Qualified Opportunity Zone Business that the QOF expects to engage in either  directly or through a first-tier operating entity”;  and
5. Qualified Opportunity Fund must self-certify by annually filing a Form 8996 upon the conclusion of its taxable year. 

Opportunity zone investors must contribute cash or other property to the Qualified Opportunity Fund (QOF) in exchange for an eligible interest (equity interest) in the QOF. While opportunity zone investors are free to invest an unlimited amount of capital into a Qualified Opportunity Fund, only the portion equaling their capital gains will qualify for tax-free growth. The portion of an investor's eligible interest qualifying for tax incentives is known as a qualifying interest. Additionally, to qualify for the opportunity zone tax incentives, contributions to the Qualified Opportunity Fund must be made within 180 days following the date capital gain would be recognized for federal income tax purposes (the sale date or distribution date).

After making a capital contribution to the Qualified Opportunity Fund, opportunity zone investors are required to make a deferral election. Opportunity zone investors make a valid deferral election by completing a Form 8997. A deferral election discloses to the IRS the opportunity zone investment and covers only qualifying interests in a QOF. By making a deferral election, an eligible interest in the QOF becomes a qualifying interest to which the opportunity zone tax benefits apply. Additionally, opportunity zone investors are required to file a Form 8949 in the taxable year capital gains would be initially included if not deferred. 

Upon contributing capital to the Qualified Opportunity Fund (QOF), the QOF will need to create a Qualified Opportunity Zone Business (QOZB). The QOF is required to begin testing compliance with the 90% Investment Standard at the end of its first tax year. The 90% Investment Standard requires that at least 90% of a QOF’s assets be Qualified Opportunity Zone Property (QOZP). Compliance with the 90% Investment Standard is tested semi-annually throughout opportunity zone investment. Failure to comply results in harsh penalties. 

Qualified Opportunity Zone Property (QOZP) Includes: (i) QOZ Stock in a QOZB; (ii) QOZ Partnership Interests in a QOZB; and (iii) Qualified Opportunity Zone Business Property (QOZBP).

Qualified Opportunity Zone Business (QOZB) Requirements: 

1. Eligible entity;
2. Engaged in a trade or business within the meaning of § 162; and 
3. That satisfies all of the requirements in § 1400Z2(d)(3)(A) as determined at the end of its taxable year (5 Tests).

 5 Tests (QOZB) that must be met to satisfy all requirements in § 1400Z2(d)(3)(A):

1. Substantially all (at least 70%) of the tangible property owned or leased by the QOZB is QOZBP;
2. At least 50% of QOZB’s total gross income is derived from the active conduct of a trade or business in QOZs;
3. Substantial portion (at least 40%) of the QOZB’s intangible property be  used in the active conduct of a trade or business in a QOZ;
4. Less than 5% of average of the aggregate unadjusted bases of property is attributable to nonqualified financial property (NQFP); and
5. Less than 5% of the gross income of the QOZB derived from operation of a private or commercial golf course, a country club, a massage parlor, a hot tub facility, a suntan facility, a racetrack, a gambling establishment or a store if the principal business is the sale of alcohol for consumption off premises.

Opportunity Zone Business Property (QOZBP): SEE STEP 5

After creating an Opportunity Zone Business (QOZB), the Qualified Opportunity Fund (QOF) will acquire Qualified Opportunity Zone Property (QOZP). The Qualified Opportunity Fund will transfer cash contributed by investors with any debt proceeds into the Qualified Opportunity Zone Business (QOZB) in exchange for QOZ stock or QOZ partnership interests.

QOZ stock: includes stock in a domestic entity classified as a corporation for federal tax purposes if all of the following requirements are met: (i) The QOF acquired the stock after December 31, 2017, at its original issue (directly or through an underwriter) from the corporation solely in exchange for cash; (ii) At the time the corporation issues the stock, the corporation is a QOZB (see § 1400Z-2(d)(3) and Reg. § 1.1400Z2(d)-1(d)) or, if the corporation is a new corporation, it was being organized for purposes of being a QOZB; and (iii) During substantially all (90%) of the QOF’s holding period for the stock, determined on a cumulative basis pursuant to Reg. § 1400Z2(d)-1(c)(2)(i)(C)(2), the corporation qualified as a QOZB.

QOZ partnership interest is a capital or profits interest in a domestic entity classified as a partnership for federal tax purposes if all of the following requirements are met: (i) The QOF acquired the partnership interest from the partnership solely in exchange for cash; (ii) At the time the QOF acquired the interest, the partnership is a QOZB or, if the partnership is a new partnership, it was being organized for purposes of being a QOZB; and (iii) During substantially all  (90%) of the QOF’s holding period for interest, determined on a cumulative basis, the partnership qualified as a QOZB.

An Opportunity Zone Business (QOZB) must satisfy 5 Tests for the Qualified Opportunity Fund (QOF) investment into the QOZB to qualify as QOZP when testing compliance with the 90% Investment Standard. Compliance with the 5 test tests is determined each year at the end of the QOZB’s taxable year. However, a QOZB with a valid working capital safe harbor allows a QOZB to be in automatic compliance with QOZB Tests 1-4 for up to 31 months or up to 62 months with sequential overlapping working capital safe harbors. Still, remember that one of the 5 Tests for QOZB compliance requires that 70% of all of the tangible property owned or leased by the QOZB must be Qualified Opportunity Zone Business Property (QOZBP). While testing compliance with this requirement is suspended when a valid working capital safe harbor is in effect, QOZBs will ultimately have to satisfy this 70% tangible property standard each year for the remainder of the opportunity zone investment.  

 QOZBP: is tangible property used in a trade or business; that meets the following requirements: 

1. Property must acquired by purchase after December 31, 2017 (‘‘acquisition test’’) from an unrelated person; 
2. Either: (i) the original use of the property in the QOZ commences with the QOZB; or (ii) the QOZB substantially improves the property; and 
3. During substantially all (90%) of QOZB’s holding period for property, substantially all (70%) of the property is used in QOZ.

Substantial improvement: if during any 30-month period beginning after  the date of acquisition, additions to basis of property exceed an amount equal to the portion of purchase price allocated to existing buildings at the beginning of the 30-month period.