Treasury guidance offering blanket relief for investors in tax-advantaged opportunity funds was widely lauded by proponents of the tax breaks and those who advise on them.
The Thursday guidance is meant to help investors who are financing developments in case they are suffering under the economic effects of the coronavirus pandemic. It extends the period for investors to funnel profits into the funds after triggering the gains—relief many, including some lawmakers, have requested.
“With all this turmoil that’s going on, it’s delaying investment,” said Reid Thomas, chief revenue officer and managing director of NES Financial, which caters to the funds. “We saw a good start to the year in terms of investment continuing to ramp up into opportunity zones, then it went dead quiet. Now it’s starting to trickle up again.”
The 2017 tax law created the capital gains tax breaks for funds that finance businesses and projects in nearly 9,000 chosen opportunity zone census tracts nationwide. Investors must plug profits into the funds 180 days after triggering the gains. The new guidance extends that period through the end of 2020 for any would-be investor whose 180th day fell on or after April 1, expanding on an extension issued in April.
Opportunity funds face a litany of tests and requirements to ensure they qualify for tax deferrals and reductions without penalty. Treasury’s latest guidance allows those who flunk a critical biannual test—during testing periods ending from April 1 through the end of the year—to avoid penalty due to “reasonable cause” and be “disregarded.”
“They made it easy for taxpayers, and also for the Service to effectively bless opportunity funds for this year,” said Richard LaFalce, a former Internal Revenue Service official and now a partner at Morgan Lewis & Bockius LLP in Washington. LaFalce also said the opportunity funds he’s advising haven’t been significantly affected by the pandemic
Treasury’s approach was in some ways broader than what Sen. Tim Scott (R-S.C.) and other Republican senators requested in a May 4 letter to Treasury and IRS officials. They wanted a penalty-free period for testing dates spanning March 13 to July 15. For July 15 through the end of the year, they asked for a requirement that funds “sufficiently demonstrate that the failure” to pass the test “is a result of the effects of the Covid-19 pandemic” in order to avoid penalties.
While “the vast majority” of funds will follow the rules, this broad exemption could let some bad actors go without penalty, said Richard Lieberman, senior counsel at Dykema Gossett PLLC in Chicago, who works with opportunity funds.
“It can open the door to abuse, but perhaps they are willing to accept a certain level of abuse from an administrative convenience perspective,” he said of the IRS.
Telework, Tax Triggers
The rules left out some requests from Scott. He asked, for instance, for Treasury to help businesses financed by opportunity funds to avoid flunking a requirement that at least half of their gross income stem from activities in a zone if their employees are now teleworking.
Scott, who praised the guidance in a tweet, also wanted Treasury to extend the emergency declaration-related relief to situations in which funds return capital to their investors, ensuring they get another 180 days to reinvest the returns without triggering tax liability.
A group of law firms, consultants, investors, and others led by the firm Novogradac & Co. LLP made those requests in its April 7 letter to IRS officials.
The IRS may have only had the bandwidth to quickly address a handful of big issues, said Forrest Milder, a partner at Nixon Peabody LLP in Boston. Some of the opportunity zone investors he’s been advising have slowed their activities, such as buying property and spending their money, he said, in part because of pandemic-related hurdles and in part because they were waiting for positive changes to the policy—administrative or otherwise.
“Yes, we could’ve asked the IRS to dream up every conceivable situation,” he said of unaddressed issues like out-of-zone telework. But it’s important, he added, for the agency not to “let the perfect be the enemy of the good.”
The guidance confirmed that a national emergency declaration from President Donald Trump automatically triggers extensions of deadlines for funds to use their capital and to reinvest gains from sales of opportunity zone property.
It’s not completely clear whether those extensions will remain in place if the disaster declaration is lifted. But those who advise on and study the incentives doubt Treasury will pull the rug out from under investors.
“Tax planning doesn’t happen on a dime and investment planning doesn’t happen on a dime,” said John Lettieri, head of the Economic Innovation Group, which helped develop the policy and sent IRS officials its own Covid-19 relief letter. “I think this is meant to be a solid framework that people can rely on regardless of whether any near-term changes may occur. But I think people will look for additional clarity around that.”