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Editorial 9 MIN READ

Opportunity Zones, designated: the map is set, the regulations are not

Treasury has locked in roughly 8,700 census tracts across all 50 states, DC, and five territories; California, Maryland, and Nevada are already raising funds against rules that have not yet been written

The Editors
Staff, Incorporator.org
9 min read Updated
Contents 7 sections
  1. Where the statute came from, and what it does
  2. How the tracts got designated
  3. What a QOF has to look like
  4. Who moved first
  5. What remains unclear
  6. The practical read for a founder
  7. Sources

he Opportunity Zone map is finished. On July 9, 2018, Treasury released Notice 2018-48, the official list of every census tract designated as a Qualified Opportunity Zone under the Tax Cuts and Jobs Act. The list runs across all 50 states, the District of Columbia, and five territories, and it freezes in place roughly 8,700 tracts that will hold their designation until December 31, 2028.

Proposed regulations have not yet issued. Treasury sent REG-115420-18 to OMB review in early August, and the industry has been told to expect the package imminently. A handful of sponsors in California, Maryland, and Nevada are not waiting.

Where the statute came from, and what it does

Opportunity Zones were added to the Internal Revenue Code by Public Law 115-97, § 13823, which enacted new §§1400Z-1 and 1400Z-2 effective for sales and exchanges after December 31, 2017. The program does three things that no other deferral regime in the Code does in the same combination.

First, §1400Z-2(a)(1) lets a taxpayer who has realized a capital gain defer that gain by reinvesting the amount of the gain (not the full proceeds, just the gain) into a Qualified Opportunity Fund within 180 days. The deferred gain is recognized on the earlier of December 31, 2026 or the date the QOF interest is sold.

Second, §1400Z-2(b)(2)(B) reduces the basis of the deferred gain on a holding-period ladder: a 10 percent step-up at five years, an additional 5 percent step-up at seven years. A taxpayer who rolls a gain into a QOF in 2018 and holds through December 31, 2026, reduces the ultimately recognized amount by 15 percent.

Third, and this is the structural feature that makes the program different from anything Congress has done before, §1400Z-2(c) allows a taxpayer who holds the QOF interest for at least ten years to elect a basis equal to fair market value at the time of sale, so that the appreciation inside the fund is itself permanently excluded from gross income. The deferred 2018 gain still comes due in 2026; the post-2018 appreciation on the QOF investment does not.

The statute is 13 pages. It is underspecified in roughly a dozen places that matter operationally, which is why sponsors are waiting on REG-115420-18 before closing most of the money that has been raised.

How the tracts got designated

Section 1400Z-1(b)(1) set the universe: any low-income community census tract eligible for the New Markets Tax Credit under IRC § 45D(e), plus (by § 1400Z-1(b)(1)(B)) tracts contiguous to a low-income tract if their median family income does not exceed 125 percent of the adjacent low-income tract. Governors nominated up to 25 percent of the eligible tracts in their state, with a floor of 25 tracts for states that had fewer than 100 eligible tracts. The Secretary of the Treasury then certified the nominations.

Treasury published the designation procedure in Revenue Procedure 2018-16, 2018-09 I.R.B. 383, on February 8, 2018. Rev. Proc. 2018-16 gave each chief executive officer of a state 90 days (extendable by 30 days on request) from the statute's December 22, 2017 effective date to submit nominations. Nearly every state took the extension. The last batch of certifications was announced on June 14, 2018; Notice 2018-48, published July 9 at 2018-28 I.R.B. 9, is the consolidated list.

The map is larger than it looks. Of roughly 42,000 low-income community tracts nationally, about 8,762 made the final cut. Every state is represented. Puerto Rico was certified as 100 percent designated, which matters because an unusual provision in § 1400Z-1(b)(3) treated the entire commonwealth as eligible without the 25 percent cap. American Samoa, Guam, the Northern Mariana Islands, and the U.S. Virgin Islands are also in.

Once designated, a tract is a Qualified Opportunity Zone for ten years. Designations are not revocable by a subsequent governor and cannot be amended to add tracts. If your fund's project is in a tract that missed the nomination window, that tract is out for the life of the program.

What a QOF has to look like

A Qualified Opportunity Fund is defined in § 1400Z-2(d)(1) as a corporation or partnership organized for the purpose of investing in QOZ property, which self-certifies with the IRS on a form Treasury has said will be Form 8996. The self-certification is the key architectural decision: there is no pre-clearance, no application, no approval. A sponsor files a form with its federal return, and the entity is a QOF.

The operating test is strict. Under § 1400Z-2(d)(1), 90 percent of the fund's assets, measured twice a year, must be qualified opportunity zone property. Qualified property is defined in § 1400Z-2(d)(2) and breaks into three categories: QOZ stock, QOZ partnership interests, and QOZ business property. The first two flow through a QOZ business; the third is direct.

A QOZ business, in turn, must satisfy five conditions under § 1400Z-2(d)(3), the two that drive deal structure being (A) that substantially all of its tangible property is QOZ business property and (B) that at least 50 percent of the total gross income of the business is derived from the active conduct of a trade or business in the zone. "Substantially all" is not defined in the statute; it is one of the open items practitioners are waiting for Treasury to quantify in REG-115420-18.

QOZ business property, defined in § 1400Z-2(d)(2)(D), must be tangible property used in a trade or business that was acquired by purchase from an unrelated party after December 31, 2017, and either (I) have its original use in the zone commence with the QOF or (II) be substantially improved by the QOF. "Substantially improved" is defined: additions to basis during any 30-month period must exceed the adjusted basis of the property at the start of that period. For a building purchased by a QOF, that means roughly doubling the basis through capital improvements inside 30 months.

The substantial-improvement test applied to acquired real estate is the provision that, more than any other, shaped how the first wave of funds are underwriting. Stabilized multifamily with modest capex budgets does not qualify. Ground-up development and heavy-value-add repositioning do.

Who moved first

California announced the Breakthrough Properties Opportunity Zone Fund in mid-September and positioned it as a life-sciences real estate vehicle focused on tracts in San Diego and the Bay Area; the state Governor's Office of Business and Economic Development published a tract-level map in August that industry brokers are using as a shopping list. California nominated 879 tracts, at the high end of the per-state totals, and received Treasury certification in the April round.

Maryland stood up its designation list early, with Governor Hogan announcing 149 certified tracts on May 18, 2018, and the state has since been meeting with sponsors at the Department of Housing and Community Development to steer capital toward Baltimore and the Eastern Shore. An early Baltimore-focused fund raised its first commitments in September on a rolling-close structure.

Nevada was certified with 61 tracts, concentrated in Clark and Washoe counties, and has been the venue for one of the first publicly announced real estate QOFs targeted at Las Vegas-area mixed-use. Nevada's Governor's Office of Economic Development published a navigator tool in July, which has shortened the time sponsors spend verifying eligibility at the parcel level.

A handful of other states have announced designations with some fanfare; the operational reality is that until REG-115420-18 is on the street, most counsel is advising sponsors to accept capital but hold it in escrow or delay deployment until the substantial-improvement, working-capital, and 90-percent-asset rules are settled.

What remains unclear

The statute does not define, and Notice 2018-48 does not address, several questions that shape every deal.

The 90-percent asset test is measured on two dates each year, under § 1400Z-2(d)(1)(B). Sponsors asked in comments whether cash raised and not yet deployed counts against the test. Industry expects a working- capital safe harbor, measured in months, to appear in the proposed regs; nothing has been promulgated.

The meaning of "substantially all" in § 1400Z-2(d)(3)(A)(i) is used in at least three distinct places in the statute. Different thresholds for different uses (70 percent is one possibility for the tangible-property test, with tighter thresholds elsewhere) are what practitioners are watching for.

The rules around interim gains inside a QOF are unwritten. If a fund sells an asset in year three and reinvests, does the selling event trigger a taxable event for investors, or does a reinvestment window cure it? The statute is silent. Comments submitted under the Rev. Proc. 2018-16 docket and to IRS Notice 2018-48 raised the question; it has not been answered.

Leasing, intangibles, and the original-use test as applied to vacant property are all on the list of open items. Sponsors with empty buildings in zones are proceeding on the theory that original use commences with the QOF if the building has been vacant for a sufficient period, but there is no regulation to point to.

And the interaction with the Tax Cuts and Jobs Act's other pass-through provisions, notably §199A and the §163(j) interest limitation, is its own thicket. A QOF structured as a partnership will have to navigate both regimes concurrently.

The practical read for a founder

If you have a 2018 capital gain and you are wondering whether to roll it, the 180-day clock from § 1400Z-2(a)(1) starts on the date of the sale. You have time to wait for the October regulations before locking in a fund, provided the sale itself is recent enough. If the sale was in the spring, the window is closing, and the realistic options are to (a) commit to a sponsor you trust and accept reg risk, or (b) recognize the gain and move on.

If you are forming the QOF yourself, do it as a partnership or a C-corp under a state statute you already understand. Delaware and the other common choices work; there is no special opportunity-zone entity form. The self-certification is on Form 8996 with the entity's first federal return. A Delaware LLC electing partnership tax treatment is the most common structure the early fund counsel has used, because it isolates the QOF's assets from the sponsor's other holdings and preserves the ten-year hold mechanics cleanly.

The one thing worth doing before the regulations drop is the tract verification. The official Notice 2018-48 list is the binding document; state maps are helpful but not controlling. A parcel that sits on a tract boundary requires a hard look. The CDFI Fund's public mapping tool, built for New Markets, now carries the QOZ overlay and is the cleanest place to confirm a specific address.

The program is a ten-year commitment with its most valuable provision, the basis-to-FMV election at year ten, sitting beyond 2028. The tract designations that Notice 2018-48 just locked in run until the end of 2028, which means the last year in which a qualifying investment can trigger the ten-year holding-period benefit is 2018 through 2026. That compression, more than anything in the proposed regs, is the constraint that will shape which deals get done and which get passed on.

Sources

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