The December 2017 Tax Cut and Jobs Act ("TCJA") created a new program designed to promote economic development by providing investors with significant tax benefits for investments in designated distressed communities known as qualified opportunity zone ("QZone"). Generally speaking, a qualified opportunity fund ("QFund") is an entity taxed as a corporation or partnership that invests at least 90% of its assets in QZone property which can be direct investments in property in a QZone or indirect investments in an entity (i.e., stock or partnership interests) where substantially all of the tangible property of such entity, whether leased or owned, is a QZone property.

Under the TCJA, investors in a QFund can potentially receive three principal tax benefits:

1. a deferral of current gain recognition,
2. partial exclusion from federal income tax of such reinvested gains, and
3. potential permanent exclusion of all gains realized subsequent to investment in the QFund.

The program is designed to incentivize long-term investment, as the benefits that may be realized increase with the length of the holding period.

Investment Length	Tax Benefit
< 5 years	Deferred payment of capital gains until QFund investment is sold or exchanged
5 to 7 years	Deferred payment of capital gains until QFund investment is sold or exchanged + 10% increase in the tax basis of the initial QFund investment
7 to 10 years	Deferred payment of capital gains until earlier of: (i) date QFund investment is sold or exchanged or (ii) December 31, 2026 + 15% increase in the tax basis of the initial QFund investment   Note: Tax on 85% of the deferred gain is due regardless of whether the taxpayer actually realizes the gain
10+ years	Deferred payment of capital gains until December 31, 2026 + Exclusion of the taxable gain on the appreciation in value of the investment

The language of the TCJA left open several issues that were expected to be addressed by subsequent regulations. The Proposed Regulations explicitly state that taxpayers may rely on them "if the taxpayer applies the rules in their entirety and in a consistent manner."

The Proposed Regulations provide investors and developers with much needed answers to certain issues which should allow investors to move forward with projects located in opportunity zones. However, the Proposed Regulations do not address all of the ambiguities created by the language of the TCJA. Recognizing these outstanding concerns, the IRS indicated that it expects to issue further guidance before the end of 2018. Our Qualified Opportunity Fund Group will continue to monitor these developments and provide updates as they occur.

Below are key aspects of the Proposed Regulations:

What Gains Are Eligible?

Only capital gains are eligible for deferral - The Proposed Regulations clarify that only capital gains are eligible for deferral under section 1400Z-2(a)(1). This clarification likely precludes gains from a sale of a capital asset that are characterized as ordinary income (such as gain characterized as ordinary under recapture rules) from being eligible for deferral.

What Types of Taxpayers Are Eligible to Defer?

Individuals, corporations, RICs, REITs, partnerships, and funds - The Proposed Regulations clarify that individuals, C corporations (including regulated investment companies (RICs) and real estate investment trusts (REITs)), partnerships, and certain other pass-through entities, including common trust funds are eligible to elect deferral under 1400Z-2. The Proposed Regulations include special rules for partnerships, other pass-through entities, and for taxpayers receiving pass through income and other tax items. These taxpayers can invest in a QFund and defer recognition of eligible gain. For example, partners in a partnership may reinvest any capital gains that flow through to them due to their ownership in the partnership provided they otherwise meet the rules applicable to deferral of gain.

Qualified Opportunity Funds

The Proposed Regulations generally provide that a QFund is required to be classified as a corporation or partnership for U.S. federal income tax purposes, must be created or organized in one of the 50 States, the District of Columbia, or, in certain cases a U.S. possession, and whose sole purpose of formation is to invest at least 90% of its assets into QZone property. In addition, the QFund must have acquired the property after December 31, 2017. The 90% requirement is tested bi-annually, and carries a penalty for each month a QFund fails to meet this threshold.

Note: limited liability companies (LLCs) should be permissible, provided they are treated as a partnership for tax purposes.

Forms

IRS Form 8949 - It is currently anticipated that taxpayers will make deferral elections on Form 8949. Instructions for such Form are expected to be released soon.

IRS Form 8996 - A draft of Form 8996 was issued contemporaneously with the issuance of the Proposed Regulations, and establishes a self-certification process for qualification as a QFund and for annual reporting of compliance with the 90% asset test.

What About Land Values?

The value of land is excluded for purposes of the substantial improvement test - Section 1400Z-2 requires that if a QFund purchases existing property in a QZone that it must "substantially improve" such property within a 30-month period from the time of its acquisition.

Existing buildings in a QZone can qualify as QZone business property only if the building is substantially improved, a standard that requires the tax basis of the building to be doubled within 30 months from the date the property is acquired. Thus, for the substantial improvement test, a QFund only needs to substantially improve the building and not the land.

In other words, the cost of the land is immaterial for the substantial improvement test. This ruling is very friendly to real estate investment, and allows renovation projects to qualify for QZone tax benefits, without the need to substantially improve the value of the land.

How to Dispose and Realize Tax Benefits?

Investments can be held past the expiration of the QZone Designation and qualify for tax benefits until December 31, 2047 - Under section 1400Z-1(f), a designated QZone now in existence expires on December 31, 2028. Thus, there was concern as to whether investors could receive the full tax benefit of the new tax law, after the expiration of the QZone designation. The Proposed Regulations provide the full tax benefit to any investment made on or before June 30, 2027, and terminate all tax benefits on December 31, 2047.

Disposition Basics?

If a taxpayer disposes only a portion of their QFund interests, the interests disposed are identified on a "first-in, first-out" (FIFO) method. If a taxpayer disposes of all of its interest at a gain prior to 2027, it can (if it chooses) make a new election and roll over this new gain if it once again meets the various requirements for investment in a QFund.

Timing Concerns for New Construction and Development?

There is a working capital "Safe Harbor" of up to 31 months - The Proposed Regulations provide that cash and other working capital assets (as defined in section 1397(c)(e)(1)) will count as QZone business property, for up to 31 months, if:

1. the cash and/or working capital are held by the QFund for the acquisition, construction and/or substantial improvement of tangible property in an opportunity zone,
2. there is a written plan that identifies the financial property as property held for these purposes, and
3. the cash and/or working capital is expended consistent with the stated plan and business operations.

Timing Concerns for Testing the Fund's Eligibility?

The bi-annual 90% test is assessed 6 months after the Fund's start date and December 31 - The TCJA establishes that the Fund's assets are evaluated both at the end of the first six-month period of the QFund's taxable year, and always on December 31. If the first testing date would arise after December 31st (e.g. a QFund starting in July or later), then the QFund is only tested on the last day of the calendar year.

What Can a QFund Invest in?

Funds can own QZone businesses directly, or indirectly, through partnership interests or stock in QZone business entities - For shares or interests in a corporation or partnership to qualify as QZone stock or a QZone partnership interest, "substantially all" of the corporation's or partnership's assets must be comprised of QZone business property.

The Proposed Regulations provide that "substantially all" means at least 70% of the tangible property owned or leased by the Fund must be QZone business property.

• If a QFund sells QZone property shortly before a bi-annual testing date, should the QFund have a reasonable amount of time to bring itself back into compliance with the 90% test?
• The IRS has stated that it will provide additional guidance on this issue, which is anticipated to permit a reasonable period of time which presumably will extend beyond the testing date in this event.

Eligibility with Debt Financing?

Debt incurred by a QFund will not impact the portion of a partner's investment in the QFund - The Proposed Regulations clarify that an eligible interest is not impaired by the taxpayer's use of the interest as collateral for a loan, provided that the eligible taxpayer is the owner of the equity interest.

What is next?

While the Proposed Regulations are not yet finalized, the IRS has explicitly stated that taxpayers may rely on them "if the taxpayer applies the rules in their entirety and in a consistent manner." To that end, this round of guidance answered some important questions; however, there still are significant unanswered questions and issues that need additional clarification.

As discussed above, the IRS indicated that it expects to issue further guidance before the end of 2018. Our Qualified Opportunity Fund Group will continue to monitor these developments and provide updates as they occur.

For more information, please contact our Qualified Opportunity Fund Group comprised of attorneys in our Tax, Corporate, Real Estate and Land Development practice groups. Our attorneys are ready to assist you with setting up the fund and provide you with the latest information regarding creating a Qualified Opportunity Fund and investing in a Qualified Opportunity Zone.

In the State of Florida, there are 427 certified qualified opportunity zones. We have launched a web-based tool for searching and verifying locations within qualified opportunity zones. Launch the map here and search by address, municipality, county, or census tract.