As part of the Tax Cuts and Jobs Act, signed into law by President Trump on December 22, 2017, Congress introduced new tax incentives designed to encourage long-term investments in low-income American communities. States were eligible to nominate certain economically distressed areas to the Treasury Department to be designated as "qualified opportunity zones." Investors in qualified opportunity zones, facilitated by investing in "qualified opportunity funds," can achieve a range of tax benefits. For an in-depth overview of these tax benefits, see our earlier publication here.
Private fund managers have expressed an understandable eagerness to create qualified opportunity funds, but many tax advisors have realized that the rules governing qualified opportunity zones (under new Section 1400Z of the Internal Revenue Code) provide an imperfect roadmap. The rules contain a litany of uncertainties and ambiguities that leave fund managers and investors to navigate at their own peril. The Internal Revenue Service is expected to issue regulations that will attempt to clear up many of these issues, but the timing and substance of those regulations remain uncertain, making it difficult for fund managers and investors to sit on the sideline waiting for answers. As of September 2018, proposed rules are under review by the Office of Management and Budget's Office of Information and Regulatory Affairs.
Fund managers and potential investors are already facing a running clock to take advantage of one of the most significant tax benefits of the qualified opportunity program. Investors must invest in a qualified opportunity fund by December 31, 2019, in order to be eligible for the cumulative 15 percent basis step-up with respect to the invested gains. Complicating this timing element further is that for those investors seeking to invest in a committed capital fund, there is an open question about when an investor's capital commitment is deemed to be "invested" for purposes of Section 1400Z. Accordingly, investors who have already realized gains or may realize significant gains in the near future must ensure that the terms of any private investment fund in which they are seeking to invest not only adequately address the asset tests for the fund's own compliance with Section 1400Z, but also permit the investors to fully invest their gains within the required timeframe set out by Section 1400Z. An investor who commits to a private investment fund, but is not deemed to have invested within the required timeframe, may be faced with not only paying taxes on gains that the investor expected to have been deferred pursuant to the new tax incentives under Section 1400Z, but may also require additional capital to fund capital calls if the investor was relying on its full pre-tax gain for fulfilling its commitment to the fund.
This article highlights some of the unanswered questions that fund managers who are interested in launching qualified opportunity funds will need to contend with until the Treasury Department addresses the issues in its anticipated regulations. The following list is not intended to be comprehensive or exhaustive but rather to illustrate that a number of key issues regarding investing in opportunity zone funds remain open.
There are many unanswered questions posed by Section 1400Z with respect to investments in qualified opportunity zone funds. Those considering organizing or investing in entities that intend to certify as qualified opportunity funds would be well served by consulting with knowledgeable legal counsel prior to organizing or investing in qualified opportunity funds.
Should you have any questions concerning this legislation or qualified opportunity zones in general, please contact any of the authors of this alert or any members of the Day Pitney Investment Management and Private Funds group or Tax group.
 Under the 90 percent asset test of Section 1400Z, the assets of a qualified opportunity fund must be comprised of at least 90 percent "qualified opportunity property," to which cash does not qualify.
 Under Section 1400Z, investors may defer capital gains that would otherwise be recognized in that taxable year by investing such gains in qualified opportunity funds.
 These businesses include private or commercial golf courses, country clubs, massage parlors, hot tub facilities, suntan facilities, racetrack or other facilities used for gambling, or any store the principal business of which is the sale of alcoholic beverages for consumption off premises.
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Day Pitney Alert
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