Lawmakers Ask Mnuchin for Opportunity Zones Regs Clarification

1. Treasury exercised its broad statutory authority to provide market clarity and encourage broad uptake of the Opportunity Zones incentive. We were pleased that the proposed rules address the amount of Opportunity Zone Business Property a business must have in order to become a Qualified Opportunity Zone Business eligible for investment from an Opportunity Fund. Treasury's proposed 70 percent threshold to meet the “substantially all” test ensures both a high standard and basic practical flexibility for local businesses and prospective investors, and should be included in the final rulemaking. The proposed regulations also provide valuable clarity on a range of issues for those looking to form or invest in Opportunity Funds, including the types of gains that are eligible for the tax benefit; partnership rules for the deferral of capital gains; the ability for Opportunity Funds to be formed as LLCs that are taxed as partnerships or corporations; and, the amount of time investors may hold their interests in Opportunity Funds.

2. We are concerned with the proposed rule requiring an Opportunity Zone business to derive 50 percent of its gross income from the active conduct of a trade or business “in the qualified opportunity zone.” Since many businesses derive income from the sale of goods and services outside of a single census tract, this would significantly limit the ability for local operating businesses to qualify for Opportunity Fund investment, contrary to congressional intent. Even for those businesses who might qualify under this rule, it would impose immense new administrative burdens to track and report the location of each source of business income. As noted above, the statute already provides a tangible property test to ensure qualifying businesses are predominantly located within a designated community. Thus, Treasury should remove this added locational requirement and hew closely to the language in Code section 1397C(b)(2), as cross-referenced by Code section 1400Z-2(d)(3)(A)(ii), which simply requires that a qualifying business to derive at least 50 percent of its total gross income from the active conduct of its trade or business.

3. Opportunity Funds need rules that ensure adequate time to make qualifying investments after receiving capital from their investors or from the disposition of a portfolio holding. Timing flexibility is particularly needed around initial investment and reinvestment periods, which fundamentally impact the ability to form and maintain multi-asset Funds that spread risks and costs across a portfolio of investments as Congress intended. The proposed regulations provide a working capital safe harbor period for businesses that receive Opportunity Fund investment, demonstrating Treasury's ability to address necessary timing issues. However, similar flexibility is needed for Opportunity Funds themselves — particularly for those looking to invest in a portfolio of Qualified Opportunity Zone Businesses. Congress gave Treasury explicit authority to write regulations to carry out the purposes of this provision, and we hope future regulations will further Congressional intent by addressing the basic timing flexibility needed for Opportunity Funds to provide capital to businesses in designated communities.

4. Congress tied the tax incentive to the longevity of an investor's stake in an Opportunity Fund, not to an Opportunity Fund's stake in any specific portfolio investment. This is a critical distinction, because Congress recognized that many Opportunity Funds — particularly those investing in operating businesses — would experience “churn” in their investments, as some portfolio businesses grow and seek new investment, while others are liquidated, within the lifespan of the fund. This is why we specifically directed Treasury to provide adequate time for Opportunity Funds to reinvest capital that has been returned to the fund from an underlying portfolio investment. Such fund-level activity should in no way disallow the tax benefit to the Opportunity Fund's investors, provided they do not take distributions from the fund or sell their fund interest prior to meeting the 10-year holding period. Clarifying this in the final regulations would eliminate a significant roadblock for investors, and open the door for catalytic investments in operating businesses.

5. The Investing in Opportunity Act included basic transparency measures and directed Treasury to produce reports on the incentive and its impacts on communities, but the provision was dropped from the TCJA for procedural reasons. Consistent with your statutorily-granted authority, we urge Treasury to include in its final regulations reasonable reporting requirements, including of Fund- and transaction-level information, in order to prevent against waste, fraud, and abuse, and to ensure that the incentive is delivering impact for communities. Further, making this data available will move capital off the sidelines by connecting investors to funds and allowing community stakeholders to align local strategies and additional investments with Opportunity Fund capital.