The IRS Issues First Batch of Proposed Opportunity Fund Regulations

The IRS Issues First Batch of Proposed Opportunity Fund Regulations TAX

IRS PROPOSED OPPORTUNITY FUND REGULATIONS The IRS Issues First Batch of Proposed Opportunity Fund Regulations The Internal Revenue Service has issued the first batch of long-awaited proposed Treasury Regulations (the Proposed OZ Regulations) interpreting recently-enacted Sections 1400Z-1 and 1400Z-2 of the Internal Revenue Code of 1986. These provisions created a new program of tax incentives designed to encourage longterm investments in economically distressed, low-income communities designated as Opportunity Zones. The goal of the Opportunity Zone program is to free up locked-in gains held by investors and redirect those gains into specialized investment vehicles, referred to as Opportunity Funds, that in turn will make long-term capital investments in underserved communities. Created by Congress as part of the Tax Cuts and Jobs Act of 2017 (the TCJA), Opportunity Zones provide investors with significant tax benefits. Investments in Opportunity Zones also are a means for interested investors to engage in impact investing in underserved communities. From enactment of the TCJA until late June 2018, the focus of the Opportunity Zone program was on the nomination and designation of Opportunity Zones. In June 2018, the nomination and certification process was completed when the US Treasury Department issued an official list of all designated Opportunity Zones. Since then, there has been a great deal of interest in and excitement about the Opportunity Zone program, but, in the absence of guidance from the Treasury Department and IRS on key structuring issues, few Opportunity Funds of any size or scope have been formed and made available for investment. The Proposed OZ Regulations promise to change the landscape, by making it now feasible to start launching Opportunity Funds. This handbook begins with a review of the basic rules applicable to Opportunity Zones, summarizes the Proposed OZ Regulations, makes general observations on the state of play after the issuance of the Proposed OZ Regulations and highlights key issues/problems on which guidance is needed. We welcome your questions about any of the issues we cover and hope you find this information useful. Steve Sharkey Darryl Steinhause William Rudnick 2

WWW.DLAPIPER.COM Background Basics of The Opportunity Zone Program OVERVIEW OF TAX BENEFITS OF INVESTING IN AN OPPORTUNITY FUND Opportunity Zone tax incentives can only be accessed by a taxpayer (referred to herein as a QOF Investor) making a cash investment into an entity that is a qualified opportunity fund (an Opportunity Fund) in exchange for an equity interest therein (referred to herein as a QOF Interest). To qualify for these incentives, a QOF Investor must (i) first, realize capital gains from selling property to an unrelated party and (ii) then roll over those gains by making a cash equity investment into an Opportunity Fund within 180 days of the date the capital gain was realized. Potentially, a QOF Investor will derive three major tax benefits by investing in an Opportunity Fund: 1. Payment of federal income tax (and for many but not all states, corresponding state income tax) on the capital gains reinvested in an Opportunity Fund is deferred until as late as December 31, 2026. 2. The deferred capital gains taxes will be reduced by 10% if the QOF Interest is held to year 5 and an additional 5% (total of 15%) if the QOF Interest is held to year 7. 3. A QOF Investor will pay no capital gains tax on appreciation from the sale of QOF Interests if they are held for 10 years. [Note: these benefits are delivered mechanically through a series of complex adjustments to the tax basis of the QOF Interest that are too detailed for this summary.] REQUIREMENTS TO QUALIFY AS AN OPPORTUNITY FUND / 90% ASSET TEST There are three basic requirements that an entity must satisfy in order to qualify as an Opportunity Fund. First, the entity must be a corporation or partnership organized for the purpose of investing in QOZ Property (defined below). Second, the entity must be certified as an Opportunity Fund. In a list of frequently asked questions issued by the IRS in April 2018 and again in the Proposed OZ Regulations, the IRS stated that no formal approval or action by the IRS will be required, but rather an entity must self-certify by filing a form (proposed Form 8996) with its federal income tax return. The third and most substantive rule governing Opportunity Funds is the so-called 90% Asset Test. Fundamentally, the 90% Asset Test exists to ensure that cash invested into an Opportunity Fund by QOF Investors is ultimately used to make capital investments into Opportunity Zones. Under this test, 90% of the assets of an Opportunity Fund must consist of one or more of the following (collectively, QOZ Property): (i) QOZ Business Property, (ii) QOZ Stock and (iii) QOZ Partnership Interests (which are described below). The 90% Asset Test is determined annually by computing the percentage of an entity s assets that constitute QOZ Property on two dates the last day of the first six-month period of the entity s taxable year and the last day of the entity s taxable year and averaging the two percentages. The 90% Asset Test effectively distinguishes between (1) investments and activities that are held and carried on directly by an Opportunity Fund, which must be QOZ Business Property described below, versus (2) investments and activities that are held and carried on indirectly by an Opportunity Fund through a subsidiary partnership or corporation in which the Opportunity Fund acquires an equity interest (QOZ Stock or QOZ Partnership Interest). While there is significant overlap in the requirements for direct and indirect investments, there are also important differences and distinctions. Direct Investments QOZ Business Property. For an Opportunity Fund that holds its investments directly, 90% of its assets must be qualified opportunity zone business property (QOZ Business Property). QOZ Business Property is tangible property used in a trade or business of an Opportunity Fund, if (i) the Opportunity Fund acquired the property after December 31, 2017 by purchase from an unrelated party, (ii) either the original use of the property in the opportunity zone commences with the Opportunity Fund or the Opportunity Fund substantially improves the property and (iii) during substantially all of the Opportunity Fund s holding period of the property, substantially all of the use of the property is in an Opportunity Zone. 3

IRS PROPOSED OPPORTUNITY FUND REGULATIONS Property is considered substantially i. Substantially all of the tangible iv. Less than 5% of property improved by an Opportunity Fund property owned or leased by the (measured by the average if the capitalized costs of holding QOZ Portfolio Business consists unadjusted tax bases of all and improving the property that of QOZ Business Property (the property) of the QOF Portfolio are added to the property s tax same test as for directly owned Business may be nonqualified basis during any 30-month period assets of an Opportunity Fund, financial property (which after the property is acquired by but using the 70% threshold includes stock, partnership the Opportunity Fund exceed the provided by the Proposed interests, debt, options and Opportunity Fund s adjusted basis OZ Regulations) (the 70% other similar passive investment of the property at the beginning of Substantially All Test). assets). Unfortunately, cash is the selected 30-month period (the Substantial Improvement Rule). Indirect Investments QOZ Stock and QOZ Partnership Interests. For an Opportunity Fund that holds its investments indirectly through a subsidiary partnership or ii. Business Income Test). iii. A substantial portion of the corporation qualifies as QOZ Stock intellectual property, licenses if (i) the stock is acquired by the and goodwill) must be used in Opportunity Fund after December carrying on its trade or business 31, 2017, at its original issue solely in Opportunity Zones. (iii) during substantially all of the Opportunity Fund s ownership of the stock, the corporation satisfies the requirements of being a QOF Portfolio Business. Stock in corporations which undertake certain redemption transactions does not qualify as QOZ Stock. The requirements for partnership interests to qualify as QOZ Partnership Interests are substantially the same as for QOZ Stock in a corporation (but do not include the prohibition on stock redemptions). Stock does not qualify as QOZ Stock or partnership interests as QOZ Partnership Interests unless the QOZ Portfolio Business carries on a trade or business under which: 4 Business as working capital. in Opportunity Zones (the Active intangible property (eg, as a QOF Portfolio Business and of cash held a QOF Portfolio conduct of its trade or business QOF Portfolio Business), stock in a Fund, the corporation qualified except reasonable amounts must be derived from the active QOF Portfolio Business entity s stock is issued to the Opportunity nonqualified financial property, of the QOF Portfolio Business corporation (referred to herein as a for cash, (ii) as of the time the also generally considered to be At least 50% of the gross income v. The QOF Portfolio Business may not operate a golf course, country club, massage parlor, hot tub facility, suntan facility, racetrack or other gambling facility or a liquor store.

WWW.DLAPIPER.COM Summary of The Proposed Oz Regulations GENERAL OPPORTUNITY FUND GUIDANCE 1. Eligible Gains Only Capital Gains May be Reinvested. Prior to the Proposed OZ Regulations, it was unclear what types of income could be reinvested under the program. One of the most significant positive developments in the Proposed OZ Regulations is the provision of a safe harbor that permits partnerships and corporations in which an Opportunity Find invests to hold cash for designated projects for up to 31 months. The statute [IRC Section 1400Z- (a)] simply referred to gain from the sale to, or exchange with, an unrelated person of any property held by the taxpayer. The Proposed OZ Regulations clarify this in two respects. First, the unique tax benefits of investing in Opportunity Funds are only available for reinvestment of capital gains (as opposed to gains from the sale of inventory or other dealer property). Second, although the statute refers to gains from the sale or exchange of property, under the Proposed OZ Regulations eligible taxpayers generally may reinvest capital gain however realized; for example, capital gain dividends of a REIT shareholder may be reinvested. Special rules for gain from so-called section 1256 contracts are provided. Somewhat unexpectedly, the Proposed OZ Regulations expressly acknowledge that if a QOF Investor accelerates deferred gains by selling the QOF Investor s entire QOF Interest, the accelerated gain can then be rolled over again by making an new investment into the same or another Opportunity Fund. 2. Attributes of Reinvested Gains Preserved. The Proposed OZ Regulations clarify that the tax attributes of capital gain that is deferred (by virtue of being reinvested) are preserved until included in income on December 31, 2026 (or earlier by sale or exchange of the QOF Investment). This means, for example, that although short-term capital gain may be reinvested in an Opportunity Fund, it retains its character as short-term (currently subject to tax at ordinary income tax rates) even though payment of the tax liability is deferred for several years. Note that the Proposed OZ Regulations did not speak to what tax rates apply to deferred/reinvested gains; under general income tax principles, we would expect that the deferred capital gain will be taxed rates in effect when it is brought into income (ie, 2026, or earlier). 3. Eligible Taxpayers and Reinvestment by Partnerships/ Pass-Through Entities. The Proposed OZ Regulations make clear that any person that may recognize gains for purposes of federal income tax accounting is eligible for Opportunity Zone tax benefits by reinvesting in an Opportunity Fund. This includes, for example, individuals, C corporations, REITs, mutual funds (RICs), partnerships, S corporations, and trusts and estates. While not specifically stated in the Proposed OZ Regulations, foreign taxpayers would appear to be eligible for Opportunity Zone tax benefits. In the case of partnerships, the Proposed OZ Regulations provide rules that allow partners of the partnership to reinvest gain in an Opportunity Fund to the extent that the partnership does not elect deferral to do so. Under these rules, a partnership may reinvest all or part of a capital gain. To the extent that a partnership does not reinvest, the capital gain is allocated to its partners and, to the extent a partner s distributive share satisfies all of the rules for eligibility (including not arising from a sale or exchange with a person that is related either to the partnership or to the partner), then the partner may separately reinvest her or his distributive share of the gain. These rules further clarify when the applicable 180-day period begins for partners and partnerships. For a partnership, the regular 180-day investment period applies. For partners desiring to defer eligible gain allocated to them by a partnership, the Proposed OZ Regulations allow such partner or partners to choose to use either (i) the same 180-day period as the partnership or (ii) alternatively, the 180-day period that begins on the last day of the taxable year (eg, starting December 31 for calendar-year taxpayers). 5

IRS PROPOSED OPPORTUNITY FUND REGULATIONS Rules similar to the partnership rules apply to other pass-through entities (such as REITs and S corporations). 4. 90% Asset Test for First Tax Year of Opportunity Fund. As noted above, the key requirement for a partnership or corporation to qualify as an Opportunity Fund is its satisfying the 90% Asset Test. The Proposed OZ Regulations provide helpful guidance on how the 90% Asset Test will be applied in the first year of an Opportunity Fund. First, the testing period for the 90% Asset Test starts in any month selected by the Opportunity Fund even if it has been legally in existence prior to that time; however, only investments made by OZ Investors after the start date selected by the Opportunity Fund will be treated as qualifying investments. This is a reasonable rule that will help Opportunity Funds that are being formed to avoid foot-faults around whether they might fail the 90% Asset Test for activities prior to accepting investments from OZ Investors. Second, for an entity with a startdate after January 1, the 90% Asset Test is applied twice: six months after the start date and the last day of the Opportunity Fund s taxable year; if the start date is less than 6 months before the last day of the Opportunity Fund s taxable year, the 90% Asset Test is applied once, on the last day. For example, an Opportunity Fund with a start date of June 1, 2019 will have two testing dates: November 30, 2019 and December 31, 2019. Compare this to an Opportunity Fund with a start date of November 1, 2019, which will have a single test date on December 31, 2019. 5. 90% Asset Test based on Financial Statements. Prior to the Proposed OZ Regulations, it was unclear precisely what the unit of measurement was (eg, fair market value, cost, adjusted tax basis, or something else) in applying the 90% Asset Test. The statute simply states that an Opportunity Fund hold at least 90 percent of its assets in qualified opportunity zone property. Under the Proposed OZ Regulations, the 90% Asset Test will generally be based on the audited financial statements of an Opportunity Fund. If an Opportunity Fund does not have audited financial statements, then its assets are to be valued for purposes of the 90% Asset Test based on the Opportunity Fund s costs/ purchase price. 6. QOF Portfolio Businesses Only Need Satisfy 70% Substantially All Test. As mentioned above, the requirements for a QOF Portfolio Business include an analog to the 90% Asset Test substantially all of the tangible property owned or leased by a QOF Portfolio Business must meet the same requirements as business property owned directly by an Opportunity Fund as described above. The Proposed OZ Regulations set this substantially all test at 70%. (Note that this clarification does not apply to several other substantially all tests appearing in the statute, which remain to be defined.) Clearly, the 70% Substantially All Test for QOF Portfolio Businesses provides more flexibility than the 90% Asset Test applied at the Opportunity Fund level, and is another reason why Opportunity Funds may desire to acquire and hold investments in Opportunity Zones through QOF Portfolio Businesses rather than directly. 7. Treatment of Borrowing/ Indebtedness. The Proposed OZ Regulations clarified two key aspects of borrowing related to Opportunity Funds. First, QOF Portfolio Businesses only need to satisfy the 70% Substantially All Test. the Proposed OZ Regulations confirmed that a QOF Interest may be collateral for borrowing by a QOF Investor, including presumably, money borrowed to fund acquiring a QOF Interest. Second, the Proposed OZ Regulations alleviated concerns that the rules for allocating partnership debt to partners would create a new fictional investment and holding period for QOF Investors in an Opportunity Fund formed as a partnership. The concern arose because IRC Section 752(a) treats partners as making deemed (fictional) capital contributions to their partnership equal to their shares of partnership debt. The IRS quelled these concerns in the Proposed OZ Regulations by acknowledging that these deemed capital contributions would not be treated as investments under the Opportunity Fund statute. This latter clarification also implicitly addressed a nagging technical concern of the Opportunity Zone statute the zero basis issue. As a part of the statutory mechanics 6

WWW.DLAPIPER.COM implementing the Opportunity Zone tax benefits, the statute provides that a QOF Investor s basis in her or his QOF Interest is zero. Plainly, this rule is intended to apply to cash that a QOF Investor reinvests into an Opportunity Fund until the time when capital gain rolled over into the Opportunity Fund is included in income. However, some tax advisors have been concerned that the zero basis language of the statute goes farther; they would deny a QOF Investor tax basis with respect to any QOF Interest coming from other sources in particular, whether QOF Investors would be able to include in the tax basis of their QOF Interest their share of borrowing incurred by the Opportunity Fund in which they have invested. While the Proposed OZ Regulations did not expressly address the issue, the clear implication of the deemed capital contribution clarification discussed above is that the regular partnership tax accounting rules specifically, the Section 752 rules on including partnership debt in basis will apply to QOF Interests. While further clarification on this issue would certainly be welcome, the Proposed OZ Regulations appear to have provided an answer to this problem. GUIDANCE ON ISSUES OF PARTICULAR RELEVANCE TO REAL ESTATE FOCUSED FUNDS 8. 31-Month Working Capital Safe Harbor for QOF Portfolio Businesses. One of the most significant positive developments in the Proposed OZ Regulations is the provision of a safe harbor that permits partnerships and corporations in which an Opportunity Fund invests (QOF Portfolio Businesses) to hold cash for designated projects for up to 31 months. Under the statute, the rules for the amount of cash that may be held by a QOF Portfolio Business were at the same time both more restrictive and more liberal than for Opportunity Funds themselves. Consistent with the 90% Asset Test, an Opportunity Fund could hold up to 10% of its assets in cash; for a QOF Portfolio Portfolio Company Sponsor Opportunity Zone Real Estate Project Business, cash in excess of reasonable amounts of working capital generally will be treated as nonqualified financial property and cannot be more than 5% of the assets of the QOF Portfolio Business. In the Proposed QOZ Regulations, the IRS largely mitigated the issues of the Deployment Problem for Opportunity Funds (described below) that invest through QOF Portfolio Businesses that acquire, construct or rehabilitate tangible business property by providing a safe harbor for working capital. This safe harbor (the Working OPPORTUNITY FUND LP QOZ Portfolio Company Capital Safe Harbor) allows a QOF Portfolio Business to hold cash and cash equivalents ( working capital assets ) as working capital for up to 31 months if (i) there is a written plan that identifies working capital assets held for acquisition, construction or substantial improvement of tangible property in the Opportunity Zone, (ii) there is a written schedule that demonstrates that the working capital assets will be used within QOZ Investors Cash Invested Cash Invested for QOZ P/S Interest Cash Held in Working Capital Reserve for Project Costs 31 months and (iii) the working capital assets are actually used in a manner consistent with the purposes and schedule. Although the Working Capital Safe Harbor is not a panacea, it does provide a path for Opportunity Funds to deal with the problem of avoiding an issue with the 90% Asset Test caused by an Opportunity Fund holding cash received from QOF Investors before making an investment. See The Deployment Problem, below. An Opportunity Fund that has lined up specified projects whether 7

IRS PROPOSED OPPORTUNITY FUND REGULATIONS real estate development/ redevelopment or capitalintensive operating businesses can use the Working Capital Safe Harbor to receive investments from QOF Investors and downstream (contribute) the cash to a QOF Portfolio Business that can hold that cash for up to 31 months. (See the diagram of this structure on page 7.) As written, the Working Capital Safe Harbor does not solve the Deployment Problem for an Opportunity Fund that is set up to hold QOZ Business Property directly or is set up as a so-called blind pool (where the Opportunity Fund has not lined up specified projects/investments). 9. Substantial Improvements Test Excludes Land Value. As noted above, a tangible asset can satisfy the requirements of being qualified opportunity zone business property by being Substantially Improved Property. The Proposed OZ Regulations provide a favorable and unexpected clarification of the Substantial Improvement Test under which the value of the underlying land is disregarded in determining whether capitalized costs are incurred after acquisition equal to at least the acquisition basis of existing improvements. This interpretation of the Substantial Improvement Test will make it easier for Opportunity Funds to engage in redevelopment of existing real estate projects located in Opportunity Zones, in particular in cities with high land costs such as San Francisco, Los Angeles, Boston and Washington, DC. OTHER TECHNICAL CLARIFICATIONS. 10. Opportunity Zone Provisions Do Not Terminate in 2028. Under the Opportunity Zone statute (IRC Section 1400Z-1), the designation of Opportunity Zones will expire December 31, 2028. In an apparent glitch in the legislation, a literal reading of this provision seemed to potentially deny a key tax incentive of the program found in another provision tax free appreciation on Opportunity Zone investments held for 10 years (IRC Section 1400Z-2(c)). The Proposed OZ Regulations confirm that the benefit of tax free appreciation on investments in Opportunity Funds held for 10 years will be available even though the Opportunity Zone designations will expire December 31, 2028. However, the Proposed Regulations also did propose a fixed end-date of December 31, 2047 as the last date when a QOF Investor may sell her or his QOF Interest and elect to eliminate the gain. 11. Accounting for Multiple Opportunity Fund Investments. The partial gain elimination and tax-free appreciation tax incentives of the Opportunity Zone program have fixed holding period requirements (ie, 5-year, 7-year and 10-year holding periods). For situations where a QOF Investor makes multiple investments in the same Opportunity Fund and later sells/transfers some but not all of her QOF Interests, the Proposed OZ Regulations established a first in first out convention to track which QOF Interest acquired by the QOF Investor will be treated as having been sold or transferred. 12. Pre-Existing Entities. The Proposed OZ Regulations clarify that a pre-existing entity can become an Opportunity Fund or a QOF Portfolio Business, as applicable, so long as it satisfies all the requirements for being an Opportunity Fund, including that its QOZ Business Property must be acquired by purchase after December 31, 2017. 8

WWW.DLAPIPER.COM The Big Picture Where Are We After The Proposed Regulations? 1. The Treasury and IRS Are Going to Make O-Zones Work. Not to be lost in the weeds is that the Proposed OZ Regulations clearly were written with the goal of getting Opportunity Funds off the ground. By and large, the Proposed OZ Regulations reflect a taxpayer-favorable (rather than restrictive) interpretation of the Opportunity Zone legislation. Here are two examples. First, although issued in proposed form, the Proposed OZ Regulations can be relied on by taxpayers today. Typically, proposed tax regulations do not become effective until finalized. Second, many tax professionals had voiced hypertechnical concerns about how the Opportunity Zone legislation could be interpreted. The Working Capital Safe Harbor, the 70% Substantially All Test and the liberalization of the Substantially Improved Test discussed above demonstrate that the Treasury Department and IRS will take a pragmatic approach to making the Opportunity Zone program work as Congress had intended. 2. More to Come and Soon. To those who have been following the Opportunity Zone program closely, it is clear that the Proposed OZ Regulations addressed only low-hanging fruit guidance on technical, less difficult issues that would allow sponsors to launch Opportunity Funds. As outlined below, many thorny issues which will be significant in shaping the contours and success of the program remain. In the supplemental materials accompanying the Proposed OZ Regulations, the IRS indicated it will move with all due haste to provide needed guidance and went so far as to make a soft commitment (prediction?) to issue an additional batch of proposed regulations (or other guidance) this year. 3. Real Estate Opportunity Funds Start Your Engines. While many important questions remain open, the Proposed OZ Regulations provide sufficient guidance for sponsors to launch Opportunity Funds that invest in real estate development projects. Three areas of clarification/guidance in particular the Working Capital Safe Harbor, the 70% Substantially All Test and the Substantial Improvement Test make it realistic/possible to form real estate Opportunity Funds today without waiting for additional guidance from the IRS. For those considering forming a real estate Opportunity Fund, a more conservative position on various structuring considerations would seem to be advisable. In particular, until additional guidance is issued, it would seem preferable to design an Opportunity Fund to (i) have a smaller number of real estate projects, rather than an open-ended blind pool, in order to deal with uncertainties on the Deployment and Unwind Problems discussed below, (ii) carefully matching up capital raised/received from QOF Investors with specifically identified real estate projects with known funding requirements and (iii) acquiring and owning each real estate investment through a separate QOF Portfolio Business. 4. Opportunity Funds for Operating Businesses Still Face Significant Challenges. In contrast to real estate focused Opportunity Funds, the Proposed OZ Regulations did not resolve two issues that are fundamental to structuring an Opportunity Fund that will invest in operating businesses. First, what are the rules for determining whether revenue generated by an operating business is earned/ sourced inside or outside an Opportunity Zone? While this may be straightforward for some types of businesses for example, a manufacturing facility it is complicated for many other businesses, such as, for example, a service or R&D business. Second, will there be safe harbor rules provided for businesses that initially qualify but grow to the point where their activities and revenues expand outside the initial Opportunity Zone footprint? The Proposed OZ Regulations provide no guidance on these issues. Accordingly, it is extremely difficult in today s climate to entice QOF Investors to invest in an Opportunity Fund designed to invest in operating businesses except in the simplest situations and ownership structures. 9

IRS PROPOSED OPPORTUNITY FUND REGULATIONS Good Progress, But A Lot Remains To Be Done Four Hot Spots While the Proposed OZ Regulations provided much-needed guidance on the Opportunity Zone legislation, as of today many areas of uncertainty remain which make it difficult to organize and offer Opportunity Funds to QOF Investors without some degree of risk. Following are four key hot spots problems facing taxpayers looking to make use of the program. It is widely believed (hoped?) that the IRS will address these issues/ problems in future regulations or other definitive guidance. i. The Deployment Problem. There remains a great deal of uncertainty as to how long an Opportunity Fund may hold cash invested by QOF Investors before deploying the cash to purchase QOZ Property. In the absence of definitive guidance from the IRS, cash does not qualify as QOZ Property under the 90% Asset Test, and cash contributions received from QOF Investors that make up more than 10% of an Opportunity Fund s assets on a testing date could cause the Opportunity Fund to fail the 90% Asset Test. ii. While the Working Capital Safe Harbor described above mitigates this issue, the safe harbor only applies where the Opportunity Fund has committed to specified projects (with a defined budget); for an Opportunity Fund set up as a blind pool, the Working Capital Safe Harbor does not resolve the risk that the Opportunity Fund may fall afoul of the 90% Asset Test. iii. The Unwind Problem. Tax-free appreciation on QOF Interests held for 10 years or more is one of the most economically important tax incentives of the Opportunity Zone program. However, the statutory mechanism used to effect this gain elimination is a step-up in the tax basis of the QOF Interest on the date that the investment is sold or exchanged. Read literally, this would seem to deprive a QOF Investor who holds a QOF Interest for the requisite 10-year period of the intended tax benefit where (i) the Opportunity Fund owns multiple properties and (ii) the Opportunity Fund sells these assets over a period of time after the 10-year period. The result of this literal interpretation which seems contrary to the intention of the statute is that QOF Investors would be allocated gain and need to pay income tax if the Opportunity Fund liquidates from a series of property sales, whereas the same QOF Investors would pay no income tax if they had sold their QOF Interests upon satisfying the 10-year holding period. iv. The Sourcing Problem. As noted above, a QOF Portfolio Company must satisfy the Active Business Income Test, under which at least 50% of its gross income must be derived from the active conduct of its trade or business within Opportunity Zones. Of particular concern to Opportunity Funds that desire to invest in operating businesses is that there is an absence of guidance on how income of a QOF Portfolio Company will be sourced geographically (ie, inside vs. outside an Opportunity Zone) except in the simplest of situations. The Proposed OZ Regulations did not provide guidance on the active income requirement. Treasury Regulations under the New Markets Tax Credit (Code Section 45D) and Empowerment Zone (Code Section 1397C) provisions set out detailed rules to address similar requirements under those programs, and provide (i) guidance on what constitutes the conduct of an active business and the location of where gross income is deemed to be earned and (ii) helpful safe harbors and presumptions to make practicable determinations under those programs. It is hoped that the IRS will develop similar rules and safe harbors under the Opportunity Zone program. v. The Transfer Problem. It is clear under the statute that a QOF Investor who transfers QOF Interests prior to January 1, 2027 in a transaction that constitutes a sale or exchange will lose the benefit of deferring tax on the gain that were rolled over by investing in an Opportunity Fund. It is less clear whether a transferee who acquires a QOF Interest by gift or inheritance or through some form of nonrecognition transaction (such as contribution of a QOF Interest to a family limited partnership) may step into the shoes of the QOF Investor who has transferred QOF Interests for purposes of being entitled to tax-free appreciation on the transferred QOF Interests. These concerns may reduce the attractiveness to high-net-worth individuals and families of investing in Opportunity Funds and may interfere with estate planning objectives of QOF Investors. 10

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About us DLA Piper is a global law firm with lawyers located in more than 40 countries throughout the Americas, Europe, the Middle East, Africa and Asia Pacific, positioning us to help companies with their legal needs anywhere in the world. Learn more Learn more about the proposed Opportunity Fund Regulations and their implications for your business by contacting: Stephen M. Sharkey William A. Rudnick Partner Partner T +1 410 580 4257 T +1 312 368 7078 stephen.sharkey@dlapiper.com william.rudnick@dlapiper,com Darryl Steinhause Partner T +1 858 638 6702 darryl.steinhause@dlapiper.com DLA Piper is a global law firm operating through DLA Piper LLP (US) and affiliated entities. For further information please refer to www.dlapiper.com. Note past results are not guarantees of future results. Each matter is individual and will be decided on its own facts. Attorney Advertising. Copyright 2018 DLA Piper LLP (US). All rights reserved. NOV18 MRS000115931