INSIGHT: Can Tangible Property Drive Outside the Opportunity Zone?

Suppose a company owns or is the lessee of its headquarters building in a qualified opportunity zone (QOZ), from which its employees manage its active business. Suppose the company also owns or is the lessee of several vehicles, which are based in a garage owned or leased by the company in the QOZ. Suppose the vehicles travel to destinations throughout the metropolitan area, and that only a small portion of those destinations are located in QOZs.

This fact pattern describes many QOZ-headquartered businesses. These include businesses, like landscaping firms, that use pickup trucks and vans to transport their employee crews and tools to client locations. It also includes businesses, like retailers or wholesalers, which use their vehicles to transport their merchandise sales to their buyers’ locations. It also includes businesses, like limousine services, that supply both the vehicles and their drivers to customers. It also includes businesses, like rent-a-car businesses, which rent their vehicles on short-term leases to consumers.

What will often determine whether such a business can qualify as a qualified opportunity zone business (QOZB) is whether the vehicles can qualify as qualified tangible property (QTP). Treasury Regulation Section 1.1400Z2(d)-1(d)(2)(i) requires that 70% of a QOZB’s tangible assets be qualified opportunity zone property (QOZBP). One requirement of QOZBP status, found in Treas. Reg. Sections 1.1400Z2(d)-2(d)(3) and 1.1400Z2(d)-2(d)(4), is that such property be treated as QTP during 90% of the QOZB’s holding period of such tangible property.

QTP

The regulations provide a general rule, and two safe harbors, for tangible property to qualify as QTP. The general rule, contained in Treas. Reg. Section 1.1400Z2(d)-2(d)(4)(ii), is that QTP status is achieved by demonstrating that, based on days in the testing period, at least 70% of the utilization of the tangible property by the QOZB occurs at a location within the geographic borders of a QOZ. For example, the headquarters building and garage of an active business, being tangible property, if located in a QOZ, will constitute QTP under this general rule, and will favorably help towards meeting the QTP test. See Jafarpour v. Commissioner.

With respect to vehicles, for purposes of applying Treas. Reg. Section 1.1400Z2(d)-2(d)(4)(ii), there is some question how utilization will be measured. Only about 12% of U.S. census tracts are QOZs. If each vehicle is viewed as utilized by the QOZB fairly uniformly throughout a metropolitan area, the 70% QOZ utilization test is likely to be failed.

There is considerable doubt about how days of utilization in a QOZ will be determined. For example, will part of a single day be bifurcated based on a fraction of QOZ use or non-QOZ use, or be classified by primary location during that day, or be favorably counted if there is any QOZ use? FAQ 50 of the IRS August 2020 QOZ Frequently Asked Questions, dealing with mobile equipment of a landscaping business, states that if the equipment is used in a QOZ 70% of the days, each day will favorably count to enable the equipment to satisfy the 70% test. However, the facts of FAQ 50 are that each day the equipment is returned to the QOZ headquarters at the end of a “job” (singular), and the question of multiple job use on a single day is not addressed. Example 9 of the January 2020 IRS Form 8996 instructions, to which FAQ 50 refers, recites that the mobile tangible property is used in QOZs 75% of the days, and outside QOZs 25% of the days, so the question of multiple use on a single day does not arise. The preamble to the final regulations refers to apportionment based on “time,” leaving open the possibility of apportionment within a single day.

Treas. Reg. Section 1.1400Z2(d)-1(d)(3)(i)(E)(1), favorably holding that a landscaping business met the 50% QOZ gross income test, could be read as supporting the proposition that storage of equipment at a QOZ headquarters facility causes the equipment to be located there and to generate income there. However, that regulation does not mention the Treas. Reg. Section 1.1400Z2(d)-2(d)(4) QTP tests.

IRS Notice 2006-77, interpreting a requirement of percentage use in a tax-incentivized zone, recited that the delivery truck, of a furniture store located in a tax-incentivized zone, lacked the requisite percentage of use in that zone, but did not provide a methodology of determining such percentage. If one assumes that the delivery truck was stored in the same tax-incentivized zone as the store, Notice 2006-77 would suggest that the IRS will not conclude that a day will be favorably counted as a day of QOZ utilization merely because the vehicle is parked in the QOZ headquarters’ garage after business hours.

For situations in which the vehicle is used for deliveries, perhaps utilization will be based on the QOZ or non-QOZ location of the customer. Query whether possibly weighting such delivery, by time, package value, or distance could be allowed. Similarly, it is unclear is whether any weight is to be given to the time spent stopping in a QOZ restaurant or QOZ gas station traveling through a QOZ on the way to a non-QOZ destination; or for daily time spent traveling through a QOZ on the way to a non-QOZ destination; and vice-versa.

Likewise, can a QOZB claim QOZ utilization for time spent in the QOZ garage during business hours on days on which there is no travel, due to lack of customers? In Blakeney v. Commissioner, the Tax Court, in dictum, found that days on which a boat was docked in a tax-incentivized zone, and was available for charter to customers but awaiting a customer, could favorably be counted as days of use in the zone.

Another question is how to deal with unknown use. For example, how does a car-rental company, unless it maintains GPS tracking system, know whether its customers are using the car within or without a QOZ?

In view of the difficulties in constructing a 70% QOZ utilization test of general applicability, Treas. Reg. Section 1.1400Z2(d)-2(d)(4) provides two safe harbor tests whereby vehicles or other moveable property, although perhaps arguably otherwise having more than 30% utilization outside QOZs, can nevertheless qualify as QTP. The first safe harbor, in Treas. Reg. Sections 1.1400Z2(d)-2(d)(4)(iii) and (iv), relates to movable property that “directly” generates gross income for the QOZB, is operated by a QOZB’s employees who regularly use the QOZB’s QOZ office, and are supervised day-to-day by QOZ office management, in rendering services both within and without QOZs, and that is not used outside QOZs for more than 14 consecutive days. The requirement of direct generation of gross income would presumably be interpreted to include vehicles transporting employees to a job site, and merchandise delivery vehicles, even if there is no separately stated optional price charged the customer for the employee transportation or delivery services. The preamble refers to delivery trucks as qualifying for this safe harbor, and recites that such trucks contribute, though the preamble does not say directly contribute, to the earning of gross income.

However, this safe harbor cannot be utilized to treat more than 20% of the aspiring QOZB’s tangible property as QTP. Because of the 20% limitation, this safe harbor will often be unhelpful. For example, suppose a business’s vehicles constitute 65% of its tangible assets, and its QOZ office and garage constitute 35% of its tangible assets. Then application of this safe harbor to all the vehicles will produce the result of 20% plus 35% = 55%, i.e. less than 70%, of tangible assets, as QTP. Absent the business’s showing that other vehicles satisfy the alternative Treas. Reg. Section 1.1400Z2(d)-2(d)(4)(ii) 70% QOZ utilization test, the business will be disqualified from QOZB status.

The second safe harbor, in Treas. Reg. Sections 1.1400Z2(d)-2(d)(4)(v), applies where there is a lease, arranged through the QOZB́s QOZ leasing office, of vehicles parked at the QOZB’s office when not leased, to lessees whose lease term, including extensions, is always less than 31 days. In sharp contrast to the exception for property used in rendering services, the lease exception can be used to create QTP status for up to 100%, not just 20%, of the QOZB́s tangible property.

Therefore, a key question for QOZBs is when a vehicle is leased, and when a vehicle is used for rendering services. For example, if a QOZB operates a rent-a-car business from offices in QOZs, where the lessee drives the car away for up to 30 days, the lease exception could apply, so as to qualify all the vehicles as QTP. But suppose the QOZB provides its vehicles and chauffeurs, to its customers, for up to 30 days, for its customers’ use to then choose destinations. Does supplying the chauffeur trigger a service, which is to be tested under Treas. Reg. Sections 1.1400Z2(d)-2(d)(4)(iii) and (iv), rather than a lease, which is to be tested under Treas. Reg. Sections 1.1400Z2(d)-2(d)(4)(v)? The service rules, which require that the chauffeurs be employees and not independent contractors, who regularly use the QOZ office, and which rules limit the vehicles eligible for that services safe harbor to 20% of tangible property, may fail to result in the desired QOZB status. In Tidewater Inc. v. United States, the U.S. Court of Appeals for the Fifth Circuit, relying on the factors in Section 7701(e), expressed the pro-lessor view that if, hypothetically, the rent-a-car business supplied the chauffeur, its customer contract would still be a lease and not a service agreement.

Following the Fifth Circuit’s Tidewater analysis, even some companies providing drivers, as well as vehicles, outside the QOZ could perhaps take the position their equipment can be QTP, so as to permit the company to qualify as a QOZB. However, Tidewater was non-acquiesced by the IRS, in AOD 2010-22.

Conclusion

QOZBs often need to send their vehicles outside QOZs in order to meet the QOZB’s contractual obligations to its non-QOZ customers. It would be helpful if the IRS clarified its position on how such vehicles can be viewed as utilized 70% within a QOZ so as to maintain those vehicles’ QTP qualification.

This column doesn’t necessarily reflect the opinion of The Bureau of National Affairs Inc. or its owners.

Author Information

Alan S. Lederman is a shareholder at Gunster, Yoakley & Stewart, P.A. in Fort Lauderdale, Fla.