Expiration of IRS Relief Provisions for Qualified Opportunity Funds
The IRS previously announced various extensions of testing and other deadlines for Qualified Opportunity Funds (QOFs) and their investors due to the COVID-19 pandemic. The initial relief provisions were communicated in Notice 2020-39; as a follow-up, the IRS further extended some of those relief provisions in Notice 2021-10.
Notices 2020-39 and 2021-10 provided relief for QOFs and their investors in response to the COVID-19 pandemic and addressed the application of certain relief provisions in the income tax regulations. QOFs can no longer rely on these relief provisions with respect to failures to satisfy the 90% investment standard in tax years after 2021.
QOFs Must Meet 90% Investment Standard for Testing Periods That Fall During 2022.
A QOF must generally hold at least 90% of its assets in Qualified Opportunity Zone (QOZ) property as of each semi-annual testing date of the QOF’s taxable year. QOZ property can include a newly issued equity interest in a partnership or corporation that satisfies the Qualified Opportunity Zone Business rules. The requirement to hold 90% or more of its assets in QOZ property is referred to as the “90% investment standard.” Generally, the QOF must pay a penalty for each month that it fails to meet that standard. However, if there is reasonable cause for the failure, the penalty is waived. The IRS relief guidance provided that a QOF’s failure to satisfy this standard on any semi-annual testing date that fell on or after April 1, 2020, and on or before June 30, 2021, was due to reasonable cause on account of the COVID-19 pandemic. A QOF’s failure to satisfy this 90% investment standard for the taxable year that included testing dates that fell during the period beginning April 1, 2020, and ending June 30, 2021, did not affect the entity’s status as a QOF or prevent an investment in the entity from being a qualified investment, and any applicable penalties were to be waived for such taxable year. Effectively, this meant that any failure to satisfy the 90% investment standard for the tax year 2020 or 2021 would automatically be due to reasonable cause to the extent that its first semi-annual testing date occurred on or before June 30, 2021.
Therefore, failure to satisfy the 90% investment standard for the 2022 tax year will not be eligible for prior IRS relief. To avoid penalties, all QOFs are encouraged to pay close attention to each semi-annual testing date that falls within the 2022 tax year to ensure that Qualified Opportunity Zone Business (QOZB) rules and the 90% investment standard are met.
Safe Harbor – Cure Period for QOZBs
As stated, QOFs that do not meet the 90% investment standard test could be subject to penalties. However, a QOF can still satisfy the investment standard test under safe harbor regulations if an entity the QOF invests in fails to meet the QOZB rules at the end of its last taxable year ending on or before a semiannual testing date of the QOF, and such failure is cured within 6 months of the failure date. Alternatively, the QOF could satisfy the 90% investment standard if the QOZB entity meets the rules for being a QOZB for at least 90% of the QOFs cumulative holding period for the entity. Planning ahead and testing early can ensure there is time to address these complex rules and perform related analysis, potentially avoiding penalties for not meeting the 90% investment standard.
Please contact a Cherry Bekaert team member for additional information about the requirements that a QOF must meet.