February 5, 2019

Creating and Maintaining Qualified Opportunity Funds

In order to create a Qualified Opportunity Fund (QOF), a partnership or corporation (or limited liability company taxed as a partnership or corporation) must file Form 8996 to self-certify with the IRS. Further, the entity must be set up with the sole purpose of operating as a QOF, which may be stated in the organizational documents, such as the Operating Agreement, Bylaws, etc.

Once a QOF has been formed, it must adhere to strict standards in order to maintain its status as a QOF. Most importantly, the QOF must hold at least 90% of its assets in a Qualified Opportunity Zone (QOZ). The QOF may not mix QOZ properties with other real estate located outside a QOZ. A QOF must meet this threshold at the end of 6 months of the first tax year and again at the end of the first tax year. It is presumed that a QOF’s financial statements will provide sufficient evidence.

As part of this 90% requirement, a QOF may invest in existing businesses, existing structures, vacant/abandoned land, raw land, and/or original structures located in a QOZ. If a QOF invests in an existing business within a QOZ, that QOZ business must have at least 70% of its assets located in a QOZ.

If a QOF invests in an existing structure, the QOF must “substantially improve” the property. Congress has defined this as doubling the basis/value of the existing structure, not including the land. For example, if you purchased a property for $100,000, with the land being valued at $70,000 and an existing building valued at $30,000, then the QOF must renovate and add $30,001 worth of improvements to the existing building. The QOF is allowed 30 months to increase the value of the existing structure.

If a QOF invests in vacant/abandoned land or raw land, or if the original use of the property is intended for a QOF, the requirement to “substantially improve” the property does not apply. However, regardless of the type of property in which a QOF invests, the QOF is required to generate at least 50% of its total gross income from “active business conduct”, meaning the funds may not be sitting in a bank unused.

Also, there is a safe harbor for QOFs of 31 months to include working capital toward the 90% threshold, if the QOF has a written business plan, including a schedule, and can show that it is substantially complying with the schedule.

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