Coming soon to an Opportunity Zone investment near you: information reporting, and possibly much more of it. Two Democratic lawmakers released their visions for what investors and qualified opportunity funds should report to the IRS on November 6. QOFs and their investors should pay attention.
The Opportunity Zone regime, which was established by new sections 1400Z-1 and -2, is one of the breakout stars of the Tax Cuts and Jobs Act. That’s in part because of the regime's novelty and the well-known names behind the idea, which largely originated with the Economic Innovation Group, a think tank founded by former Facebook President Sean Parker. The principal legislative proponents of the regime were Senate Finance Committee member Tim Scott, R-S.C., and Sen. Cory A. Booker, D-N.J.
In brief, section 1400Z-2 allows taxpayers with capital gains to reinvest them in QOFs and, if the investment in the QOF is held for at least 10 years, to have the post-acquisition gain from the investment excluded from income. Section 1400Z-1(a) defines Opportunity Zones as census tracts that are low-income communities and that were designated as Opportunity Zones by state governors.
The frequently stated rationale for the tax benefit was that encouraging taxpayers with capital gains to reinvest them in distressed communities would facilitate economic growth in the areas that need it most. The hitch is that the statutory text doesn't include that purpose of benefiting the local community.
Treasury was given authority to issue regulations to implement the statutory regime, including making rules for the certification of QOFs “for the purposes of this section” and rules to prevent abuse. Congress didn’t tell Treasury and the IRS to collect information that would help evaluate how much the tax benefit improved economic opportunities for the residents of Opportunity Zones, and that has been a major sticking point for economists and community groups that want to be able to measure the incentive's impact. The Joint Committee on Taxation estimated that the forgone revenue from the addition of the Opportunity Zone regime between 2018 and 2027 would be $1.6 billion (JCX-63-17).
There are compelling reasons for Congress to require Treasury to report annually on the changes that occur in Opportunity Zones. The introduction of draft legislative language by Finance Committee ranking member Ron Wyden, D-Ore., and House Ways and Means Committee member Ron Kind, D-Wis., indicates support for making more rigorous reporting happen soon. The proposals overlap, but they aren’t entirely on the same page on the degree of reporting that should be required of QOFs and their investors. There’s bipartisan support for increased reporting, but probably not to the extent those bills would require.
An information collection bill introduced earlier this year doesn’t go quite as far as the new ones. Ways and Means Committee members Kind and Mike Kelly, R-Pa., introduced H.R. 2593 in May, and Scott and Booker introduced a companion bill in the Senate (S. 1344). Under that proposal, Treasury must collect information on investments held by QOFs, including the number of QOFs; the amount of assets held in QOFs; the composition of QOF investments by asset class; the percentage of qualified Opportunity Zone census tracts that have received QOF investments; and the impacts and outcomes of zone designation in those areas on economic indicators, including job creation, poverty reduction, new business starts, and other metrics. The bill requires public disclosure of the total investment, type of investment, type of activity supported by the investment, full-time employees, and square footage of real property for investments held by QOFs.
Wyden Proposal
Wyden’s bill (S. 2787) would require QOFs and individual investors in QOFs to give the IRS added information with their tax returns. The required information would include:
the name, address, taxpayer identification number, and URL of the website of the fund;
the value of all property held by the fund on the last day of the sixth month of the fund’s tax year and the last day of the tax year;
the value of qualified Opportunity Zone stock, partnership interests, and business property, as well as tangible and intangible property held by the fund;
the name and address of each corporation or partnership in which the fund owns stock or a capital or profits interest, respectively;
the identity of the entity conducting the qualified Opportunity Zone business, and the North American Industry Classification System code that applies to the trade or business for each qualified Opportunity Zone business conducted by the fund, a corporation in which the fund owns stock, or a partnership in which the fund owns a capital or profits interest;
the value of the tangible and intangible property (including cash and cash equivalents) of each qualified Opportunity Zone business, and the average monthly number of full-time equivalent employees of the business for each qualified Opportunity Zone business conducted by the fund or by a corporation or partnership controlled by the fund;
for each qualified Opportunity Zone business property held by the fund or by a corporation or partnership controlled by the fund, the qualified Opportunity Zone of the property; the date it was acquired; and for real property, the square footage, number of residential units, and aggregate costs incurred for land acquisition, new construction, and rehabilitation; and
for investors in the fund during the reporting period, each of their names and TINs, the date or dates of their investments, and the total amount of their investments.
Treasury can add other information reporting requirements as it chooses.
Taxpayers who invest in QOFs must file annual statements with basic identifying information for themselves and their investments in funds, as well as the amount of the investments and the date of their disposition.
Publicity is a substantial aspect of Wyden’s proposal. The bill would require QOFs to publish on their websites for three years all the information required on the return, except TINs and the names of each investor in the fund and the dates and amounts of their investments. Treasury is permitted to exclude other information, as long as the exclusion “is consistent with the purposes of this section.”
Treasury would publish a list of all qualified Opportunity Zones and the name, address, and website address for each fund, and the Government Accountability Office would be responsible for five- and 10-year reports analyzing the distribution of investments of funds among Opportunity Zones, industries, and investment purposes; the impact of Opportunity Zone designation on economic indicators, housing costs, and income distribution among residents of the zones; the impact on low-income communities that aren't Opportunity Zones; and a cost-benefit analysis.
Wyden’s bill supports the reporting requirements with a $10,000 penalty for failure to file the return or statement, or for submitting incomplete or incorrect information. There's an exception for de minimis errors of $25 or less, but for cases of intentional disregard of the filing requirement or the correct information reporting requirement, the penalty is doubled. The penalty is also adjusted for inflation.
In addition to beefing up the reporting requirements, the bill makes various changes to the regime, including disqualifying census tracts with a median family income above 120 percent of the national median family income from being Opportunity Zones, and excluding self-storage properties, sports stadiums, and some residential rental properties from the definition of qualified Opportunity Zone business property. The bill answers the question that Treasury is exploring regarding what the phrase “substantially all” means in the context of section 1400Z-2 by defining it as “not less than 90 percent.” That largely follows the proposed regulations, but it's a slightly less favorable rule than that in the proposed regulations for determining whether a business owns or leases sufficient amounts of qualified Opportunity Zone business property.
Kind's Bill
Kind’s bill would require less information from QOFs on their annual returns. The bill includes self-certification and less granular details about the funds’ investments and activities. The bill requires:
the name, address, and TIN of the fund;
whether the fund is a partnership, C corporation, S corporation, or real estate investment trust;
certification that the purpose of the fund is investing in qualified Opportunity Zone property;
the total assets held by the fund;
the aggregate amount of qualified Opportunity Zone stock, partnership interests, and business property held in the fund; and
the aggregate amount of investments from mixed funds in the fund, and the ratio of those investments to all investments in the fund.
Funds must also report information about the corporations and partnerships whose qualified Opportunity Zone stock or partnership interest they hold, as well as information about the qualified Opportunity Zone businesses carried on by those corporations and partnerships. Kind’s bill requires some publicity for funds’ returns, but instead of requiring the funds to publish the information on their own websites, the bill requires Treasury to make the returns available “as soon as practicable in a machine readable format,” minus any individual TINs.
Penalties under the bill would be charged to any fund that failed to file a complete and correct form, unless the fund showed reasonable cause and the error wasn't attributable to willful neglect. The amount of the penalty is $500 per day while the failure continues, and the maximum penalty for any return is $200,000.
Treasury would be responsible for collecting and compiling statistical information on Opportunity Zones, including the number of QOFs that invested in each zone; the aggregate amount of investment in each zone by funds; and metrics about job creation, poverty reduction, and community and economic development. That information would be made public yearly.
The proposed changes to the reporting requirements are likely to cause some consternation among QOFs and investors, but the bills indicate that Congress is starting to try to strike a balance between providing the tax benefits of the Opportunity Zone regime and taking some steps to measure how much benefits also flow to the local residents in Opportunity Zones.