Treasury and the IRS recently issued their second round of proposed regulations (the “Proposed Regulations”), providing needed clarity to stimulate investments in Qualified Opportunity Zones ("QOZs"). The Proposed Regulations facilitate the use of pooled qualified opportunity funds ("QOFs") and provide for greater liquidity and marketability of QOFs, among other helpful changes. This client alert provides updates to V&E’s prior client alert on selected aspects of the QOZ Proposed Regulations, including implications for investors and sponsors. For more information about Qualified Opportunity Zones, please contact one of the V&E attorneys listed at the end of this alert.


As discussed in our prior alert, the QOZ provisions provide investors with the following tax benefits:

  • Temporary Deferral: eligible gains rolled into QOFs are deferred until the earlier of December 31, 2026 or the date on which the investment in the QOF is transferred.
  • Elimination of up to 15% of deferred gain subject to tax: eligible gains invested in a QOF benefit from a basis increase of 10% of the deferred gain after 5 years and 5% of the deferred gain after 7 years, for a total potential 15% increase in basis.
  • Exclusion of gain on post-acquisition appreciation: if an investment in a QOF is held for at least 10 years, the taxpayer recognizes no gain on the post-acquisition appreciation in its QOF interest.

A. Exclusion of Gain from Post-Acquisition Appreciation on Qualifying Property Sold by Certain QOFs.

If an investment in a QOF is held for at least 10 years, the taxpayer recognizes no gain on the post-acquisition appreciation upon the sale of its QOF interest. The Proposed Regulations expand the exclusion treatment to capital gains from the sale of qualifying property by certain QOFs.

  1. Special Election by Direct Investors in QOF Partnerships. For purposes of the basis step-up election at 10 years, a partner that is a direct holder of an interest in a QOF structured as a partnership (a “QOF Partnership”) may make an election to exclude from gross income all or some of the capital gain from the disposition of QOZ property1 (“QOZ Property”) by the QOF Partnership reported on IRS Schedule K-1, provided that the QOF Partnership made the disposition after the end of the taxpayer’s 10-year period. A similar election is not available for holders of stock in a QOF structured as a C-corporation (i.e., the holder must sell its stock).
  2. Tax-Free Capital Gain Dividends from QOF REITs. QOFs structured as REITs (“QOF REITs”) may designate special capital gains dividends (not in excess of the QOF REIT’s long-term gains on sales of QOZ Property) that will be tax-free to shareholders who could have made the basis step-up election if they had sold their shares of the QOF REIT stock.
  3. Expanded Rules Apply Only to Capital Gain. The expanded rules apply only to capital gain, and therefore do not by their terms apply to ordinary income recognized upon a disposition as a result of depreciation recapture on personal property or to gain with respect to non-qualifying assets.
  4. Proposed Regulations Silent as to Tiered Arrangements. The Proposed Regulations are silent as to the treatment of gains received by a QOF from sales of QOZ Property from a lower-tier QOZ Entity, such as a QOZ partnership. Though it would appear logical that such gains would be excluded, it would be helpful if Treasury would clarify this point upon finalizing the Proposed Regulations.
  5. Reliance on Proposed Regulations. While taxpayers may generally rely on the Proposed Regulations, the portion of the Proposed Regulations relating to basis adjustments for sales of QOZ Property by a QOF held for at least 10 years may only be relied upon by taxpayers upon the finalization of the Proposed Regulations.
  6. Implications. The expansion of the exclusion in the Proposed Regulations to sales of QOZ Property by certain QOFs opens the door to diversified or pooled QOF Partnerships or QOF REITs, as well as open-ended QOF Partnerships or QOF REITs.

B. Ability to Purchase QOF Interests from Another Investor.

  1. Taxpayers May Purchase a QOF from Another Investor. The Proposed Regulations include a generous provision permitting a taxpayer to make an investment in a QOF by acquiring an existing eligible interest in a QOF from a person other than the QOF.
    • In such a case, the amount of the taxpayer’s investment for purposes of the QOZ rules is the amount paid for the interest in the QOF.
  2. Implications. The ability of taxpayers to acquire a QOF interest from a person other than the QOF will allow for greater marketability of and liquidity in QOF interests and potentially opens the door to publicly traded QOFs.

C. Carried Interest.

  1. Carried Interest Not Eligible for QOZ Tax Benefits. The Proposed Regulations specify that carried interest is not eligible for QOZ tax benefits. Specifically, the Proposed Regulations include in the rules for “mixed-funds” investments in partnerships not only investments in which cash is contributed in excess of eligible gains, but also the receipt by a partner of a carried interest in exchange for services.
    • Under the Proposed Regulations, a partner will be treated as holding a single partnership interest with a single basis for purposes of Subchapter K, but not for purposes of the QOZ rules. For purposes of the QOZ rules, the partner is generally treated as holding two separate investments based on the relative capital contributions.
    • Special rules are provided for applying Code section 704(c) principles to “mixed funds” investments in a QOF Partnership, including when an interest in a QOF Partnership is received in exchange for services. In the case of carried interests, the percentage considered attributable to the carried interest is the highest percentage interest in residual profits attributable to that carried interest.
  2. Implications: Although some practitioners and sponsors held out hope that carried interests would receive QOZ tax benefits in situations where the general partner also made a capital contribution, the Proposed Regulations make it clear that this will not be the case. However, sponsors will still receive the favorable treatment of properly structured carried interests under tax law in general (i.e., deferral and capital gain treatment).

D. Debt-Financed Distributions.

  1. The Proposed Regulations Permit Debt-Financed Distributions (with a catch). The Proposed Regulations provide that with respect to a taxpayer’s basis in a QOF Partnership, the taxpayer’s basis for purposes of the QOZ rules is zero, increased by the taxpayer’s share of liabilities under Code section 752(a).
    • It follows that a distribution of cash from a QOF Partnership to a partner does not trigger the recognition of deferred gain under the QOZ rules unless the distribution of cash is in excess of the partner’s tax basis in the QOF Partnership, determined under the Code section 752(a) rules. Examples in the Proposed Regulations illustrate this treatment.
    • Importantly, the Proposed Regulations provide that a contribution to a QOF will not be a qualifying interest and deferred gain will be triggered if a QOF Partnership makes a distribution to a partner and the distribution would be recharacterized as a disguised sale under Code section 707, determined as if (i) any cash contributed were non-cash property and (ii) in the case of a debt-financed distribution, the partner’s share of liabilities is zero. Consequently, the IRS retains the ability to recharacterize, as a disguised sale (which would trigger inclusion of deferred gain), a debt-financed distribution during the two-year disguised sale presumption period following a contribution.
  2. Implications: The Proposed Regulations will allow debt-financed distributions that are not in excess of tax basis without triggering deferred gain if such distributions occur two years or more after the date of the initial contribution to the QOF, allowing for QOF Partnerships to provide greater liquidity and increase their desirability and marketability.

E. Amount of Investment in the Case of Transfers of Property Other than Cash.

  1. Property Other Than Cash May be Invested. If an investor transfers property other than cash to a QOF in a carryover basis transaction, the amount invested is the lesser of (1) the taxpayer’s adjusted basis in the equity received and (2) the fair market value of the equity received.
    • In the case of a contribution to a QOF Partnership, the basis in the equity solely for purposes of Code section 1400Z-2(b)(2)(B)(i) is calculated without regard to any liability that is allocated to the contributor under Section 752(a).
    • A taxpayer will have a “mixed-funds” investment if (1) property contributed in a nonrecognition transaction has a fair market value in excess of its adjusted basis or (2) the amount of the investment exceeds the taxpayer’s eligible gain.
  2. Implications: Although an interesting concept in theory, the ability to contribute property other than cash may be limited in application as such property will not qualify as QOZ Property (which must be purchased to be qualifying under the QOZ rules).

F. Eligibility of 1231 Gains for QOF Investment.

  1. Section 1231 Gains Eligible Only to the Extent They Exceed 1231 Losses. The Proposed Regulations provide that Section 1231 gains are eligible gains for deferral under the QOZ program only to the extent they are in excess of Section 1231 losses for a given tax year (i.e., the taxpayer has net Section 1231 gains for the tax year).
    • The 180-day period with respect to net Section 1231 gains begins on the last day of the taxable year.
  2. Implications: The issue of whether Section 1231 gains are capital or not is determined at the partner, not the partnership level. Specifically, partners in a partnership must net, at the partner level, their distributive share of net 1231 partnership gains and losses with any other 1231 gains or losses of the partner to determine whether capital gain treatment applies. Consequently, this portion of the Proposed Regulations may have a chilling effect on partnerships reinvesting gain in a QOF. If this provision survives in the final regulations, taxpayers may wish to sell partnership interests rather than cause partnerships to sell assets to facilitate investment in QOFs on their own timetable.

G. Inclusion Events for Deferred Gain.

  1. Events that Accelerate Deferred Gain. As noted above, a taxpayer will recognize its deferred gain if it sells its QOF interest prior to December 31, 2026. In addition, other events may result in inclusion of deferred gain. An “inclusion event” generally occurs if there is a transfer of a qualifying QOZ investment to the extent the transfer reduces the taxpayer’s equity interest in the investment. The Proposed Regulations provide a substantial (but non-exclusive) list of inclusion events.
    1. Inclusion Events. Some of the listed inclusion events include:
      1. Gifts of a QOF interest.
      2. Distributions by corporations or partnerships in excess of tax basis, including dividend-equivalent redemptions of stock by corporations.
      3. Sales or taxable dispositions of QOF interests, including redemptions.
      4. Indirect transfers (e.g., transfer of a partnership interest that holds a QOF investment).
      5. Certain complete liquidations of QOFs.
    2. Non-Inclusion Events. Some of the specified non-inclusion events include:
      1. Transfers as a result of death.
      2. Transfers to a grantor trust or disregarded entity.
      3. Contribution of a QOF interest to a partnership in a Code section 721 transaction.
      4. Tax-free reorganizations (where no boot is received) involving two or more QOFs organized as corporations.

H. Timing of Basis Adjustments.

The Proposed Regulations contain timing rules for basis adjustments relating both to recognition of deferred gain and post-acquisition appreciation.

  1. Basis Adjustments for Deferred Gain Made Immediately After Inclusion Event. The basis adjustment that occurs upon the recognition of previously deferred gain upon the earlier of December 31, 2026 or an inclusion event is made immediately after the amount of deferred capital gain is taken into income by the taxpayer.
  2. Basis Adjustment For Post-Acquisition Appreciation Made Immediately Before Disposition of Interest in QOF Partnership. If the 10-year basis step-up election is made with respect to a disposition of a QOF Partnership, the basis of the partnership’s assets with respect to the transferred interest are adjusted in the same manner as if a section 754 election was in place. This basis adjustment is made immediately before the taxpayer disposes of its QOF investment.

I. Holding Period and Tacking Rules.

  1. No Tacked Holding Period for Contributed Property. A QOF investor’s holding period for property transferred to a QOF does not include the holding period of that property prior to the transfer (e.g., if an investor transfers a building owned for 10 years to a QOF in exchange for stock, its holding period for the QOF stock still begins as of the date of the transfer of the building).
  2. Reinvestment in Another QOF Restarts Holding Period. Also, if an investor disposes of an interest in a QOF (“QOF 1”) and reinvests in another QOF (“QOF 2”), the holding period does not tack and the investor has a new holding period in QOF 2.


As discussed in our prior alert, the QOZ rules provide that QOFs must hold at least 90% of their assets in QOZ Property (the “90% Asset Test”).

  • The 90% Asset Test is generally applied by measuring the average of the percentage of QOZ Property in the QOF on two testing dates, the last day of the first six-month period of the QOF’s taxable year and the last day of the QOF’s taxable year.
  • QOFs that choose to begin their QOF qualification other than on January 1 of a given year will have their first 90% Asset Test testing period 6 months after their first QOF month, and again at year end.

A. 90% Asset Test: Capital Deployment.

  1. QOF Permitted to Exclude Capital Contributions for 6 Months. The Proposed Regulations provide that a QOF is not required to consider assets received in the prior 6 months in determining its compliance with the 90% Asset Test (e.g., newly received capital), as long as those assets are held as cash, cash equivalents, or debt instruments with terms of 18 months or less.
  2. Implications. The updated rules under the Proposed Regulations will be critical in helping QOFs manage the receipt of capital without violating the 90% Asset Test, mitigating some of the tension between deadlines for taxpayers to invest their gains and the QOF’s need to satisfy the 90% Asset Test. Specifically, these rules will prevent situations in which a QOF fails the 90% Asset Test because it raised new capital on the eve of a testing date.

B. 90% Asset Test: Reinvestment Rules.

  1. QOF Permitted to Reinvest Gains within 12 Months. For purposes of the 90% Asset Test, the Proposed Regulations specify that proceeds received from the sale or disposition of (1) QOZ Business Property and (2) QOZ Entities are treated as QOZ Property so long as:
    • the QOF reinvests the proceeds during the 12-month period beginning on the date of the distribution, sale, or disposition; and
    • from the date of the distribution, sale, or disposition until the date proceeds are invested in other QOZ Property, the proceeds are continuously held in cash, cash equivalents, or debt instruments with a term of 18 months or less.
  2. Proceeds May be Reinvested in Qualifying Investments. The Proposed Regulations provide that the QOF may reinvest proceeds from the sale of an investment into another qualifying investment in QOZ Property.
  3. Relief Due to Delays in Government Action. The Proposed Regulations provide that a QOF benefits from reinvestment relief if its failure to meet the 12-month reinvestment deadline is attributable to a delay in government action – the application for which is complete (e.g., permitting delays).
  4. Impact on Holding Period and Deferred Gains. Sales or dispositions of assets by a QOF do not impact investors’ holding periods in their QOF investments or trigger the inclusion of deferred gains.
  5. Investors May Recognize Gains on Sales. IRS and Treasury did not believe that they had authority to exclude income and gains generally from the sales of QOZ Property. Consequently, even though such sales will not impact investors’ holding periods in their QOF investments or trigger inclusions of deferred gain, they may give rise to taxable income to investors.
  6. Implications. While the reinvestment rules are helpful for purposes of 90% Asset Test compliance, the fact that sales and reinvestments may not be conducted without triggering gain to QOFs and their investors may serve as a significant impediment to practical use of the reinvestment rules. On the other hand, the rules may be quite useful for recycling investments to the extent such sales do not trigger gains.

C. 90% Asset Test: Valuation.

  1. Greater Valuation Flexibility Provided. Under the prior set of proposed regulations, QOFs were required to use Generally Accepted Accounting Principles to calculate compliance with the 90% Asset Test if they had applicable financial statements. The Proposed Regulations provide greater flexibility, allowing a QOF to elect to use unadjusted cost basis for these calculations regardless of whether a QOF has applicable financial statements.

D. Updates to Working Capital Safe Harbor.

As discussed in our prior alert, a QOZ Entity may benefit from a 31-month safe harbor during which working capital will be a qualifying asset so long as certain recordkeeping requirements are met. The Proposed Regulations made several helpful changes to the working capital safe harbor.

  1. Working Capital Safe Harbor Applies Serially. The Proposed Regulations clarify that a QOZ Entity may benefit from multiple applications of the 31-month safe harbor. In other words, if a QOF raises new cash and contributes the cash to a QOZ Entity, that new cash can benefit separately from the 31-month safe harbor.
  2. Written Plan May Apply to Trade or Business. A written designation can now be a plan for the development of a trade or business (and not just a plan for the acquisition, construction and/or substantial improvement of tangible property, as was the case under the prior proposed regulations).
  3. Relief for Exceeding 31-Month Period Due to Government Action. Exceeding the 31-month period will not violate the safe harbor if the delay is attributable to waiting for governmental action on an application made within the 31-month period (e.g., permitting delays).
  4. Implications. The confirmation that the working capital safe harbor can apply serially to multiple rounds of capital raising is welcome relief to sponsors seeking to raise funds in multiple tranches. Additionally, the added flexibility in applying the working capital safe harbor will significantly help QOFs seeking to establish operating businesses. Finally, the expansion of the safe harbor to take account of government action addresses a significant concern of sponsors and advisors; namely that even 31 months may not be enough time in the face of local government permitting/licensing delays.

E. Treatment of Leased Tangible Property.

The Proposed Regulations provide clarity with respect to the treatment of leased tangible property.

  1. Leased Property May be QOZ Business Property. Leased tangible property will be treated as QOZ Business Property if (1) it was acquired under a lease entered into after December 31, 2017 and (2) substantially all (70%) of the use of the leased tangible property is in a QOZ for substantially all (90%) of the period for which the business leases the property.
  2. No Original Use/Substantial Improvement Requirement for Leased Property. There is no original use/substantial improvement requirement with respect to tangible leased property in order for it to qualify as QOZ Business Property. However, the lease must be a “market rate lease,” which will be determined under the principles of Code section 482.
  3. Related Party Issues. Tangible leased property may be leased from a lessor that is related to the QOF or QOZ Entity. However, if the parties are related, (A) the property will not qualify as QOZ Business Property if, in connection with the lease, the QOF or QOZ Business makes a prepayment to the lessor (or person related to the lessor) relating to a period of use of the leased tangible property that exceeds 12 months, and (B) if the original use of the leased property did not commence with the QOF/QOZ Entity lessee, then the lessee must purchase other tangible property that is QOZ Business Property and that has a value of not less than the value of the leased property. In the case of (B), the acquisition of such other property must occur during the period that begins on the date the lessee receives possession of the leased property and ends on the earlier of the last day of the lease or 30 months after possession.
  4. Anti-Abuse Rule. An anti-abuse rule with respect to leased real property provides that, if, at the time the lease was entered into, there was a plan, intent or expectation for the real property to be purchased by the QOF for less than fair market value, the leased property is not QOZ Business Property.
  5. Valuation Methods. Two methods – an “applicable financial statement method” and an “alternative valuation method” are provided for valuing leased property for purposes of the QOZ rules. The alternative valuation method is based on the present value of the sum of payments to be made under the lease. The method chosen must be applied consistently to all leased tangible property during the taxable year.
  6. Implications. These favorable lease rules provide substantial flexibility to a QOF to qualify as such through the lease of property as a tenant in a QOZ. Additionally, the fact that the Proposed Regulations allow for non-abusive related party leases provides an alternative path for placing QOZ Business Property owned by an affiliate in a QOF given the prohibition on related party purchases by a QOF.

F. Clarification of “Original Use”.

As discussed in our original alert, QOZ Business Property is property with respect to which either (a) the original use in the QOZ commences with the QOF or (b) “substantial improvements” are made by the QOF. The Proposed Regulations provide further clarity on the “original use” requirement with respect to the following property types.

  1. Tangible Property Generally. For such property, “original use” commences on the date when the QOF or a prior person first places the property in service in the QOZ for purposes of depreciation or amortization (or, in the case of leased property, first uses the property in the QOZ in a manner that would allow depreciation or amortization). This means that tangible property in the QOZ that was depreciated/amortized by someone other than the QOF would not satisfy the original use requirement. Conversely, used property that was placed in service outside the QOZ may qualify when it is placed in service inside the QOZ.
  2. Vacant Buildings. Where a building or other structure has been vacant for at least 5 years prior to purchase, such building or other structure will satisfy the original use requirement.
  3. Leased Property. In the case of leased property, improvements made to leased property will satisfy the original use requirement.
  4. Land. Purchased land may only be treated as QOZ Business Property if it is used in the trade or business of the QOF or QOZ Entity. The stated purpose of this rule is to prevent land speculation that might occur as a result of the original use/substantial improvement requirements not applying to land.
  5. Implications. The original use clarifications provide much needed certainty on a topic that was left unaddressed by the first set of proposed regulations. In particular, the clarity on original use should facilitate purchases of completed (but not yet placed in service) real estate projects within QOZs.

G. Real Property Straddling a QOZ.

The Proposed Regulations provide clarity in situations where parcels straddle the boundary of an opportunity zone.

  1. Entire Property Should be Deemed to be in QOZ if More Than 50% of the Property’s Unadjusted Cost Basis is Inside the QOZ. If a parcel of real property straddles multiple census tracts (QOZ and non-QOZ), the real property is considered to be in a QOZ if the amount of real property inside of the QOZ is “substantial” as compared to the amount of real property outside of the QOZ, and the real property outside of the QOZ is contiguous to the real property inside of the QOZ. Although the text of the Proposed Regulations does not define “substantial,” the preamble to the Proposed Regulations indicates that real property located within the QOZ should be considered substantial if the unadjusted cost basis of the real property inside of the QOZ is greater than the unadjusted cost basis of the real property outside of the QOZ.
  2. Implications. The favorable rules in the Proposed Regulations with respect to real property straddling a QOZ should facilitate investment by giving comfort around an issue that was causing consternation for sponsors and advisors.

H. 50% Gross Income Requirement.

The QOZ rules provide that in order to be a qualifying QOZ business, a QOZ Entity must derive a minimum of 50% of its total gross income from the active conduct of a trade or business in the QOZ. The Proposed Regulations provide three safe harbors and a facts and circumstances test for making this determination.

  1. Hours of Services Safe Harbor. At least 50% of the services performed (based on hours) for the QOZ business by its employees and independent contractors are performed within the QOZ.
  2. Cost of Services Safe Harbor. At least 50% of the services performed (based on amounts paid) with respect to the QOZ business by its employees and independent contractors are performed within the QOZ
  3. Tangible Property and Business Functions Safe Harbor. A conjunctive test requiring that (1) the tangible property of the business in the QOZ and (2) the management/operational functions performed for the business in the QOZ are each necessary to generate 50% of the gross income of the business.
  4. Facts and Circumstances Test. If none of the above safe harbors are met, the gross income test will nevertheless be satisfied if, based on all the facts and circumstances, at least 50% of the gross income of the QOZ Entity is derived from the active conduct of a trade or business in the QOZ.
  5. Implications. The establishment of the above safe harbors in the Proposed Regulations will facilitate the qualification of operating businesses as QOZ businesses. Prior to the release of the Proposed Regulations, there was a dearth of guidance as to the ability of operating businesses to qualify.

I. Active Conduct of a Trade or Business.

As noted previously, at least 50% of the gross income of a QOZ Entity must be derived from the active conduct of a trade or business within the QOZ.

  1. Active Conduct Linked to Code Section 162. The Proposed Regulations provide that the term “trade or business” has the same meaning as in Code section 162.
  2. Active Conduct with Respect to Real Estate. The Proposed Regulations provide that, solely for purposes of the QOZ rules, an active trade or business also includes the ownership and operation (including leasing) of real property.
    • The Proposed Regulations, however, exclude “mere triple net leasing“ of property from the definition of the active conduct of a trade or business.
  3. Implications. The Proposed Regulations provide needed clarity that the ownership and operation (including leasing) of real estate satisfies the active conduct of a trade or business requirement for purposes of the QOZ rules. However, the Proposed Regulations did not define “triple net lease,” leaving some uncertainty as to how much landlord activity is required to be engaged in an active trade or business under the QOZ rules.

J. Meaning of “Substantially All.”

One of the requirements for a piece of property to qualify as QOZ Business Property is that during “substantially all” of the QOF’s holding period in the QOZ Business Property, “substantially all” of the use of the QOZ Business Property is in the QOZ. The prior proposed regulations reserved on the meaning of “substantially all” in both instances.

  1. “Substantially All” means 90% as it relates to the holding period for QOZ Business Property. “Substantially all” within the context of a QOF’s holding period is deemed to mean 90% under the Proposed Regulations.
  2. “Substantially All” means 70% as it relates to the use of the QOZ Business Property within the QOZ. “Substantially all” within the context of the use of QOZ Business Property within the QOZ means 70%.

This alert is not intended to be a comprehensive summary of the 169-page regulations package.

K. “Substantial Improvement” Viewed on an Asset-by-Asset Basis.

  1. Proposed Regulations Require Asset-by-Asset Approach. The Proposed Regulations provide that in order for property that is “substantially improved” to meet the definition of QOZ Business Property, such property is evaluated for substantial improvement on an asset-by-asset basis. The Proposed Regulations also request comments as to whether an aggregate approach would be more appropriate.
  2. Implications. The application of an asset-by-asset approach could prove cumbersome. It would be helpful if the final regulations allowed an election on the part of taxpayers to utilize an aggregate approach.

L. Use of Intangibles in a QOZ.

The definition of a QOZ business includes a requirement that a “substantial portion” of any intangible property held by a QOZ Entity be used in the active conduct of a trade or business within the QOZ.

  1. Substantial Portion Means 40%. The Proposed Regulations provide that a QOZ Entity will meet the “substantial portion” requirement with respect to its intangible property if at least 40% of such property is used in the active conduct of a trade or business within the QOZ.
  2. Implications. While it is helpful that the Proposed Regulations defined the meaning of “substantial portion” in this context, many issues may arise in the practical application of this standard. For example, intangible property is not clearly defined. Additionally, the standards by which the use of intangible property inside vs. outside the QOZ is measured remain undefined. Treasury would be well-advised to provide clarity on these points in the final regulations.

M. Inventory in Transit.

The Proposed Regulations provide that inventory (including raw materials) that is in transit from a vendor to a QOZ business or from a QOZ business to a customer outside of the QOZ on a testing date will not cause a QOF to fail to satisfy the 90% Asset Test.

N. General Anti-Abuse Rule.

  1. Government Retains Ability to Recast Transactions. The Proposed Regulations give the IRS the ability to recast a transaction or series of transactions as appropriate to achieve tax results consistent with the QOZ program. Specifically, the IRS will recast a transaction if “a significant purpose” of the transaction is to achieve “a” tax result inconsistent with the purposes of the QOZ program, taking into account all the facts and circumstances.
  2. Implications. The anti-abuse rule, as written in the Proposed Regulations, is extremely broad and may, in the future, serve as an in terrorem provision, similar to the partnership anti-abuse rules under Treasury Regulations section 1.701-2.


A. Proposed Regulations May Be Relied Upon.

Although the Proposed Regulations are in proposed form only, the regulations provide that taxpayers may rely upon them currently (except as discussed in Section I.A.6. of this alert) so long as they are applied consistently and in their entirety.

B. Unclear as to Whether Additional Regulations Will be Forthcoming.

Preliminary statements from Treasury and the IRS indicate uncertainty as to whether a third round of proposed regulations will be forthcoming, and that whether another round is ultimately issued will depend on reactions to the latest round of proposed regulations from investors, sponsors, and the advisor community.

C. Open Points.

  1. Information Reporting. The Proposed Regulations left open information reporting requirements.
  2. 90% Asset Test Failures. The Proposed Regulations also left open administrative rules applying to a QOF that fails to meet the 90% Asset Test.
  3. IRS Form 8996. IRS and Treasury are expected to make further revisions to IRS Form 8996 for future tax years.