Opportunity Zone Regs Lack Essential Guidance, Individual Says

ISSUE RELATED TO ELECTION BY A PARTNERSHIP TO DEFER
PARTNERSHIP LEVEL GAIN AND EFFECT ON PARTNERS

QUALIFIED OPPORTUNITY ZONES

REVISED

Monte A. Jackel

October 29, 2018

This issue relates to a partnership level election to defer gain by investing in a QOZ and thereafter one or more partners dispose of their partnership interests before the end of 2026 before the partnership disposes of its interest in the fund. There is no rule in the proposed QOZ regulations addressing or discussing this. There is only a part of a single sentence in the preamble asking for comments on what type of dispositions by a taxpayer accelerates deferred gain under section 1400Z-2.

1. The first choice is whether to accelerate a partner's share of the deferred partnership level gain or not and which dispositions (just taxable or tax-free too) trigger that share of gain. See below.

2. Next, you need to decide whether the accelerated partner level gain is treated like a section 704(c)/743(b) item to the purchasing partner. Since there will be an inside-outside basis difference at inception (partnership has outside basis for the deferred gain as cash proceeds but partners do not have basis at that time for the deferred gain), it most likely should be treated in a similar manner. Does that mean that if a partnership that has deferred gain distributes money to its partners that triggers section 731 gain that there is no basis offset for the as yet unrecognized deferred gain at the partnership level? This would argue that redemptions by a partnership should be treated as a partner disposition under these rules.

3. Next, if you have a partner level accelerated gain, you will need to trace if the partnership then disposes of all or part of the fund investment at the partnership level.

4. Tracing becomes difficult if you have a large number of partners but it is still possible unless . . .

5. The partnership is publicly traded, in which case tracing to the disposing/ purchasing partner is impossible.

6. The only way to make PTP interests fungible if partnership elections to defer gain is allowed is as follows. It seems you would need to spread the basis step up of the purchaser partner on partner accelerated gain to all PTP partners, if you can even find the seller and purchaser partner. And doing this would be distortive because one partner paid tax on accelerated gain but all PTP partners would share when PTP disposes of all or part of the fund investment.

7. Section 1400Z-2 strongly implies that the “taxpayer” is the one who defers the gain. If so and the partnership elects, is there even authority to tax partner disposition of his interest to accelerate part of the deferred gain of partnership? The theory of a partnership level election would seem to not allow taxation of partner level dispositions but is this really the right result?

8. What if partner sells only part of his partnership interest — is all or only part of that partner's share of deferred gain accelerated? See RR 84-53.

9. Do special partnership basis adjustments under sections 743(b) or 734(b) eliminate part of the deferred gain when partnership disposes of its fund investment? It seems like the rules in section 1400Z-2 should not allow it because it arguably would distort the results in the statute as to the amount of gain recognized and when but what do you do with special basis adjustments that would otherwise attach?

10. Tax free disposition of partnership interest raises assignment of income issues under Revenue Rulings 84-115 and 80-198. The partnership interest of a partner seems to carry with it a share of deferred gain. Does a business purpose allow sections 351 and 721 to otherwise apply to a disposition of a partnership interest by a partner?

11. Incorporating section 1092(d)(4)(C) into the straddle rule of the proposed regulations raises a lot of complexity as you need to look through partnerships to find positions to see if you have a straddle. This could involve putting together a position from many different partnerships with different kinds and types of partnership allocations. Further, positions flow downward only and do not flow upward to the partnership from its partners. Thus, partner dispositions could be treated differently than partnership dispositions. For example, if one partner in a partnership would be in a straddle position because of positions he has in other partnerships, can the partnership still elect to defer all of its eligible gain? How will the electing partnership know?

12. Some partnerships cannot apply section 1092(d)(4)(C) because they are securities partnerships that aggregate tax gain and loss under regulation section 1.704-3(e). There are no regulations or other guidance on this issue.

13. Exclusion of gain under section 1400Z-2 can conflict with other gain inclusion rules under statutes such as 897 which affects withholding. Also. . . . Technically, any capital gain from any type of transaction including partial boot transactions under statutes like sections 1031 and 356 qualify for deferral including a transaction which includes recapture which cannot be deferred. Section 1231 gain would be capital gain and be eligible gain if realized at the partnership level but how do you elect at the partnership level if one or more partners would have lots of section 1231 losses, making that partner's share of section 1231 gains and losses ordinary?

14. No discussion of tiered partnerships in the proposed regulations. Thus, the above issues can become increasingly complex. Dispositions of interests in the next higher tier or at the highest tier could trigger gain acceleration.