Opportunity Zones (I.R.C. 1400Z-1, etc.)

January 19, 2018

From the Senate Amendment summary stated in the Conference Report for the Tax Cuts and Jobs Act, H.R. 1:

The provision provides for the temporary deferral of inclusion in gross income for capital gains reinvested in a qualified opportunity fund and the permanent exclusion of capital gains from the sale or exchange of an investment in the qualified opportunity fund.

The provision allows for the designation of certain low-income community population census tracts as qualified opportunity zones, where low-income communities are defined in Section 45D(e). The designation of a population census tract as a qualified opportunity zone remains in effect for the period beginning on the date of the designation and ending at the close of the tenth calendar year beginning on or after the date of designation.

Governors may submit nominations for a limited number of opportunity zones to the Secretary for certification and designation. If the number of low-income communities in a State is less than 100, the Governor may designate up to 25 tracts, otherwise the Governor may designate tracts not exceeding 25 percent of the number of low-income communities in the State. Governors are required to provide particular consideration to areas that: (1) are currently the focus of mutually reinforcing state, local, or private economic development initiatives to attract investment and foster startup activity; (2) have demonstrated success in geographically targeted development programs such as promise zones, the new markets tax credit, empowerment zones, and renewal communities; and (3) have recently experienced significant layoffs due to business closures or relocations.

The provision provides two main tax incentives to encourage investment in qualified opportunity zones. First, it allows for the temporary deferral of inclusion in gross income for capital gains that are reinvested in a qualified opportunity fund. A qualified opportunity fund is an investment vehicle organized as a corporation or a partnership for the purpose of investing in qualified opportunity zone property (other than another qualified opportunity fund) that holds at least 90 percent of its assets in qualified opportunity zone property. The provision intends that the certification process for a qualified opportunity fund will be done in a manner similar to the process for allocating the new markets tax credit. The provision provides the Secretary authority to carry out the process.

If a qualified opportunity fund fails to meet the 90 percent requirement and unless the fund establishes reasonable cause, the fund is required to pay a monthly penalty of the excess of the amount equal to 90 percent of its aggregate assets, over the aggregate amount of qualified opportunity zone property held by the fund multiplied by the underpayment rate in the Code. If the fund is a partnership, the penalty is taken into account proportionately as part of each partner’s distributive share.

Qualified opportunity zone property includes: any qualified opportunity zone stock, any qualified opportunity zone partnership interest, and any qualified opportunity zone business property.

The maximum amount of the deferred gain is equal to the amount invested in a qualified opportunity fund by the taxpayer during the 180-day period beginning on the date of sale of the asset to which the deferral pertains. For amounts of the capital gains that exceed the maximum deferral amount, the capital gains must be recognized and included in gross income as under present law.

If the investment in the qualified opportunity zone fund is held by the taxpayer for at least five years, the basis on the original gain is increased by 10 percent of the original gain. If the opportunity zone asset or investment is held by the taxpayer for at least seven years, the basis on the original gain is increased by an additional 5 percent of the original gain. The deferred gain is recognized on the earlier of the date on which the qualified opportunity zone investment is disposed of or December 31, 2026. Only taxpayers who rollover capital gains of non-zone assets before December 31, 2026, will be able to take advantage of the special treatment of capital gains for non-zone and zone realizations under the provision.

The basis of an investment in a qualified opportunity zone fund immediately after its acquisition is zero. If the investment is held by the taxpayer for at least five years, the basis on the investment is increased by 10 percent of the deferred gain. If the investment is held by the taxpayer for at least seven years, the basis on the investment is increased by an additional five percent of the deferred gain. If the investment is held by the taxpayer until at least December 31, 2026, the basis in the investment increases by the remaining 85 percent of the deferred gain.

The second main tax incentive in the bill excludes from gross income the post-acquisition capital gains on investments in opportunity zone funds that are held for at least 10 years. Specifically, in the case of the sale or exchange of an investment in a qualified opportunity zone fund held for more than 10 years, at the election of the taxpayer the basis of such investment in the hands of the taxpayer shall be the fair market value of the investment at the date of such sale or exchange. Taxpayers can continue to recognize losses associated with investments in qualified opportunity zone funds as under current law.

The Secretary or the Secretary’s delegate is required to report annually to Congress on the opportunity zone incentives beginning 5 years after the date of enactment. The report is to include an assessment of investments held by the qualified opportunity fund nationally and at the State level. To the extent the information is available, the report is to include the number of qualified opportunity funds, the amount of assets held in qualified opportunity funds, the composition of qualified opportunity fund investments by asset class, and the percentage of qualified opportunity zone census tracts designated under the provision that have received qualified opportunity fund investments. The report is also to include an assessment of the impacts and outcomes of the investments in those areas on economic indicators including job creation, poverty reduction and new business starts, and other metrics as determined by the Secretary.

(See the Conference Report for a further discussion.)

Novogradac has published an informative client alert regarding opportunity zones:  https://www.novoco.com/sites/default/files/atoms/files/client_alert_opportunity_zone_updated_011118.pdf

February 8, 2018, the Internal Revenue Service published Rev. Proc. 2018-16 describing procedures for designating Qualified Opportunity Zones.

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Establishment Clause

October 14, 2017

Gaylor v. Mnuchin, DC Wisc. (Oct. 12, 2017):  “A federal district court has once again decided that the exemption for housing allowances provided to ministers under Code Sec. 107(2) violates the Establishment Clause. The court determined that the purpose and effect of the statute was to provide financial assistance to ministers without any consideration for similarly situated secular employees. Therefore, the statute has no secular purpose and could not be justified on secular grounds.” (CCH)


Trust Classification (I.R.C. 7701)

April 18, 2016

General Discussion:

Section 301.7701-4(c)(1) of the regulations (part of the “Sears Regulations”) provides that an investment trust that has multiple classes of ownership interests is ordinarily classified as a business entity under section 301.7701-2.  An investment trust that has multiple classes of ownership interest, however, is classified as a trust for tax purposes if (1) there is no power under the trust agreement to vary the investment of the certificate holders, and (2) the trust is formed to facilitate direct investment in the assets of the trust and the existence of multiple classes of ownership interest is incidental to that purpose.

See TAM 200512020, describing the use of a trust purportedly to accomplish the stripping of interest from underlying securities. The trust, through a side agreement, provided multiple classes of ownership interest.

Why are trust arrangements that are commonly used in connection with certificated municipal lease financings not classified as business entities under the Sears Regulations?  See Announcement 84-62 (Jan. 1, 1984).  Although a “grantor trust” is used in these financings, the grantor trust rules are not applicable.  The IRS announced in Ann. 84-62 that the multiple-class investment trusts do not apply to certain state and local government financing arrangements.  “The financing arrangements, which are an alternative to the direct issuance of serial and/or term obligations by state and local government obligors, are used to satisfy exceptions to debt limitations imposed under state law. […] The substance of these financing arrangements is the same as if a state or local government obligor directly issued a series of separate debt obligations.  Under such arrangements, the trustee serves in the same capacity as an indenture trustee in a typical secured bond issue by making payments from the state or local government obligor to the COPs owners.”  Darrell R. Larsen, American Bar Association, Secondary Market Tax-Exempt Asset Securitization for Sponsors, Investors, Other Market Participants and their Counsel.


Qualified Zone Academy Bonds (I.R.C. 54E)

March 3, 2016

Private Business Contribution Requirement

Under Section 54E(a)(3)(B), the issuer must certify that it has written assurances that the “private business contribution” requirement will be met with respect to the academy.  The private business contribution requirement is described in Section 54E(b) of the Code.  Under that section, the requirement is met with respect to any issue if the eligible local education agency that established the qualified zone academy has written commitments from private entities to make “qualified contributions” having a “present value” (as of the date of issuance of the issue) of not less than 10% of the “sale proceeds” (see Treas. Reg. 1.1397E-1(a)(2)(ii)(B)) of the issue.

A “qualified contribution” is any contribution (of a type and quality acceptable to the eligible local education agency) of:

  1. equipment for use in the qualified zone academy (including state-of-the-art technology and vocational equipment);
  2. technical assistance in developing curriculum or in training teachers in order to promote appropriate market driven technology in the classroom;
  3. services of employees as volunteer mentors;
  4. internships, field trips or other educational opportunities outside the academy for students; or
  5. any other “property” or service specified by the eligible local education agency.

Treas. Reg. 1.1397E-1(c)(3) explains that cash received with respect to a qualified zone academy from a private entity (other than cash received indirectly from a person that is not a private entity as part of a plan to avoid the requirements of section 1397E [and 54E]) constitutes a “qualified contribution” only if it is to be used to purchase any property or service described in the list above.  Services of employees of the eligible local education agency do not constitute qualified contributions.

To determine the present value (as of the date of issuance of the issue) of qualified contributions from private entities, the issuer must use a “reasonable” discount rate.  The credit rate is a reasonable discount rate.

I.R.C. 1397E applies to obligations issued on and before October 3, 2008.  That section provides a five-year expenditure requirement for 95 percent of the sale proceeds of the bonds.  If less than 95 percent are spent by the end of five years, the issuer must redeem nonqualified bonds.

Refundings

Can QZABs be refunded on a current refunding basis?  See Treas. Reg. 1.1397E-1(h)(9)(i).  Except in certain interim refinancing circumstances, it appears that refundings, even on a current refunding basis, are not permitted.  See also Section 6.4 of Notice 2010-35 regarding refundings of qualified tax credit bonds that are direct pay bonds.

Volume Cap

See Notice 2015-11 for a summary of volume cap amounts available for QZABs, including the new volume cap for 2014.  See Notice 2016-20 for guidance regarding volume cap for 2015 and 2016.  Volume cap may be carried forward for two years.  As described in the notice, QZABs may no longer be issued as direct pay bonds.

References

See Joint Committee on Taxation report of 2011 regarding a description of the changes from I.R.C. 1397E to I.R.C. 54A and I.R.C. 54E.

FAQ | QZAB from the Department of Education.


Qualified School Construction Bonds (I.R.C. 54F)

March 3, 2016

Volume Cap Allocations

According to statements by Aviva Roth (who, as of May 2010 is no longer at TEB) at the 2009 Bond Attorneys Workshop in Phoenix, QSCB allocations from the IRS to large local school districts cannot be carried forward by such large local school districts. The allocations must be transferred to the state. The state will then be able to carry forward the allocation.  Section 54F(e) of the Code states that an allocation to the State may be carried forward to a subsequent year if not used.  It is not sure how such allocation carryforward is put into practice.

Qualified Purposes

All QSCB expenditures after costs of issuance (not exceeding two percent) must be used for capital expenditures for construction, rehabilitation or repair of the school facility or to acquire land on which the facility is to be constructed with proceeds of the QSCBs.  In a separate publication (Notice 2009-35) and also in an IRS Q&A from 2010 (http://www.irs.gov/pub/irs-tege/tc_and_stcb_q-a._09-07-10_1.5.pdf), the IRS has indicated that QSCB proceeds can also be used for “equipment or furniture” so long as the equipment of furniture is used in the portion of the public school facility that is being constructed, rehabilitated or repaired with part of the QSCB proceeds.

Refundings

Bonds that refund QSCBs (or reissued bonds) will not retain the status as qualified tax credit bonds.  Legislation or guidance will be needed to determine whether, e.g., a current refunding bond can remain a QSCB.  The statute and notices provide that refundings are not permitted purposes for QSCBs (except in very limited cases).


Charitable, Etc., Contributions and Gifts (I.R.C. 170)

January 8, 2016

Disallowance of Deduction in Certain Cases and Special Rules

Under I.R.C. 170(f)(8), no charitable deduction is allowed for any contribution of $250 or more unless the taxpayer substantiates the contribution by a “contemporaneous written acknowledgment” (CWA) of the contribution by the donee organization.  This CWA is typically the letter provided by the entity receiving the donation.

A CWA must meet certain content requirements and be provided contemporaneously, which means on or before the earlier of (a) the date on which the taxpayer files a return for the taxable year in which the contribution was made, or (b) the due date (including extensions) for filing the return.

There is a statutory exception to the CWA rule – which means the CWA does not need to be provided if the exception is met.  The exception, however, relies on regulations to be promulgated.

Regulations were proposed (REG-138344-13) with respect to this exception, but were criticized as being too burdensome and requiring reporting that could disincentivize charitable giving.  The regulations would have permitted the donee organization to report the donation on the donee’s Form 990.  The proposed regulations were withdrawn in January 2016.  Unless other regulations are substituted, the statutory exception to CWA cannot be used.


Social Welfare Organizations (I.R.C. 501(c)(4))

January 5, 2016

Private Letter Rulings

PLR 201425013: Two exemptions revoked or denied.  A 501(c)(4) organization renting tables and chairs is not eligible for exempt status. A 501(c)(6) benefitting only one industry segment is not eligible for exempt status.

PLR 201507025 (Nov. 18, 2014):  IRS issued final adverse determination revoking Code Sec. 501(c)(4) org.’s exempt status, where org. didn’t operate exclusively for promotion of social welfare.  The activities of the organization were to research, develop and distribute, free of charge, computer software that facilitates uncensored and secure communications by human rights activists, journalists, and civil society.