Opportunity Zone Investments: The Importance of a Working Capital Safe Harbor Plan

August 28, 2023

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Key Takeaways

  • A common structure involves a Qualified Opportunity Fund investing in a subsidiary entity with the subsidiary entity, called a Qualified Opportunity Zone Business (QOZB), making qualified investments.
  • The Treasury allows a QOZB to hold cash as “working capital” for a period of up to 31 months provided all requirements are met.
  • The Covid public health emergency was declared “over” on May 11, 2023, meaning a QOZB can modify or replace an existing working capital safe harbor plan until September 8, 2023.

Many organizations continue to pursue investments in Opportunity Zones (OZ). Among the numerous requirements to hold a qualified investment, a taxpayer must timely invest eligible capital gains into a Qualified Opportunity Fund (QOF) and then the QOF must make qualified investments.

A common structure involves a QOF investing in a subsidiary entity (Qualified Opportunity Zone Business, or QOZB), with the QOZB then making the qualified investments. Note: Both the QOF and QOZB generally must be regarded tax partnerships (with two regarded owners). However, no more than 10% of a QOF’s assets, and no more than 5% of a QOZB’s assets, can consist of so called “non-qualified financial property,” including cash. The QOF reports its asset base (and any penalties) on a Form 8996 filed with its annual Form 1065, and the asset base is tested generally at the mid-year mark at end-of-year.

Here’s what you need to know about opportunity zones and their tax benefits. READ THE INSIGHT

The Power of the Working Capital Safe Harbor Plan

The Treasury Department, recognizing that businesses need time to raise and invest capital, created an exception, allowing a QOZB (and only a QOZB, not a QOF) to hold cash as “working capital” for a period of up to 31 months. This “working capital” does not count as a “bad” asset for annual testing so long as a “working capital safe harbor plan” (WCSH plan) is in place.  For WCSH plans in place as of June 2021, the IRS has granted up to an additional 24 months (for a total of up to 55 months) to hold and deploy working capital.

The regulatory requirements for a WCSH plan are:

  • Designated in writing: These amounts are designated in writing for the development of a trade or business in a qualified opportunity zone, including when appropriate the acquisition, construction, and/or substantial improvement of tangible property in such a zone.
  • Reasonable written schedule: There is a written schedule consistent with the ordinary start-up of a trade or business for the expenditure of the working capital assets. Under the schedule, the working capital assets must be spent within 31 months of the receipt by the business of the assets.
  • Property consumption consistent: The working capital assets are used in a manner substantially consistent with the writing and written schedule. If consumption of the working capital assets is delayed by waiting for governmental action, the application for which is complete, that delay does not cause a failure of the WCSH plan.

A QOZB lacking any of the above elements does not have a valid WCSH plan, meaning if the QOZB holds more than 5% of its assets as cash (likely for most QOZBs that are not yet operational), a substantial penalty could be due. The regulations do not provide any guidance on how specific a WCSH plan must be, but a recommended approach could involve a written exhibit, with a schedule, attached to the QOZB operating agreement.

Amending WCSH Plans

It is unclear whether, and to what extent, a QOZB can modify an existing WCSH plan. However, proposed regulations allow a QOZB impacted by a federally declared disaster (like the Covid pandemic) to amend or replace an existing WCSH plan, provided the new or revised plan is adopted no later than 120 days after the close of the disaster. The Covid public health emergency was declared “over” on May 11, 2023, meaning a QOZB can modify or replace an existing WCSH plan up until September 8, 2023.

Next Steps for WCSH Plans

All QOF’s that invest into QOZBs should consider whether the QOZB’s existing WCSH plan is adequate or whether changes are needed.  September 8, 2023 is the deadline to materially change or amend a WCSH plan already in effect.

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