State Development Execs Look for Changes to Proposed O-Zone Regs

December 28, 2018

CC:PA:LPD:PR (REG-115420-18)
Room 5203
Internal Revenue Service
P.O. Box 7604, Ben Franklin Station
Washington, D.C. 20044

Re: Internal Revenue Service's Proposed Rules for Investing in Qualified Opportunity Funds

To whom it may concern:

The undersigned state economic development officials write to provide comments on IRS's recently proposed regulations under the Opportunity Zone incentive. This is a follow up to an earlier set of comments dated September 24, 2018 that a similar group sent to the Office of Information and Regulatory Affairs. This second set of comments is primarily focused on the proposed rules that were published in the Federal Register on October 29, 2018, and that are open to public comment until December 28, 2018. The issues we would like to focus on include amending certain requirements that businesses must meet in order to meet the definition of Qualified Opportunity Zone Businesses; clarifying the tax treatment of rolled-over Opportunity Fund capital among Qualified Stock and Partnership Interests; allowing for an additional flexibility for the 90-Percent Asset Test for new Opportunity Funds; and, adding simple reporting requirements for Opportunity Funds. This letter details these issues and recommends that the IRS consider them during the regulatory review process. Finally, we acknowledge that there are a number of other technical points in the proposed regulations that would benefit from clarification — we are not attempting to address these items in this letter. We note that individual states and the undersigned officials may have further, individual comments and that this letter does not prevent them from sending separate comments.

The requirements that businesses must meet to be considered Qualified Opportunity Zone Businesses should be clarified and adjusted in order to better facilitate investment by Opportunity Funds in operating businesses.

The proposed regulations released in October 2018 helped clarify some of the requirements for a business to be considered a Qualified Opportunity Zone Business. The 70-percent threshold used for defining the term “substantially all” with respect to the tangible property requirement set forth in section 1400Z-2(d)(3)(A)(i) of the Internal Revenue Code of 1986, as amended, was a positive clarification that sets a reasonable standard for the amount of tangible business property that a Qualified Opportunity Zone Business must hold within the Opportunity Zone.

However, we are concerned about the newly proposed criterion for a Qualified Opportunity Zone Business that stipulates “at least 50 percent of the gross income of a qualified opportunity zone business is derived from the active conduct of a trade or business in the qualified opportunity zone.” It is currently unclear how this criterion should be interpreted. Under a strict interpretation, this requirement could effectively restrict the growth of a business by limiting the business's ability to generate potential sales outside of the Opportunity Zone in which it is located. This seems contrary to the overall aspiration of the law to promote entrepreneurship and business growth. For example, an advanced manufacturing company with a factory located in an Opportunity Zone should not be penalized for generating more than 50% of its sales revenue globally from the manufacturing of goods from such factory. Ironically, a business that derived the majority of its income from activity within an Opportunity Zone would have significantly less impact on its local (and possibly distressed) economy than if it were able to receive additional significant revenue from outside the Opportunity Zone and use that revenue to hire and create local jobs. The proposed criterion needs significant clarification (or perhaps better, explicit revision) to ensure that the incentive does not impose overly restrictive requirements that reduce the growth potential and positive economic impact of businesses that could attract capital through Opportunity Funds but still provides the intended impact for the local community.

The rules should provide sufficient flexibility for Opportunity Funds to reinvest interim gains in Qualified Opportunity Zone Property in a timely manner without incurring a penalty or triggering a taxable event.

The proposed regulations suggest that additional guidance will be offered regarding an Opportunity Fund's reinvestment of proceeds from the sale or disposition of Qualified Opportunity Zone Property. Specifically, the IRS indicated proposed rulemaking would be forthcoming regarding the length of a “reasonable period of time to reinvest” as well as the Federal income tax treatment of any gains that an Opportunity Fund reinvests during such a period. We consider guidance on this issue to be of high importance and we encourage the IRS to be as flexible, as permissible within the bounds of the law, in allowing Opportunity Funds to reinvest sale proceeds in Qualified Opportunity Zone Property within a certain period of time without incurring penalty and without triggering a taxable event.

As indicated in our previous letter in September 2018, we remain concerned that a lack of provisions ensuring the ability of Opportunity Funds to reinvest capital proceeds from the sale of Qualified Stock and Partnership Interests without triggering a taxable event would reduce the incentive for Opportunity Funds to invest in operating businesses. While we acknowledge the intent of the law to encourage long-term investment, requiring a 10-year hold on an investment in a new business could present substantial investment uncertainty for Opportunity Funds and could work to reduce the willingness of Opportunity Funds to enter into these investments in operating businesses. The IRS could consider establishing a minimum length of time that an Opportunity Fund would be required to hold Qualified Opportunity Zone Property such that the Opportunity Fund could, thereafter, sell such Qualified Opportunity Zone Property and reinvest the sales proceeds without triggering a taxable event.

The rules should provide sufficient flexibility for new Opportunity Funds to meet the requirements of the 90-Percent Asset Test.

Although the clarity that the proposed rules provided regarding the first date of the 90-Percent Asset Test following the inception of an Opportunity Fund was positive, we continue to recommend the regulations include a provision that provides Opportunity Funds with additional flexibility in meeting the requirements of the 90-Percent Asset Test following the inception of a qualifying entity being treated as an Opportunity Fund.

In typical investment timelines, it takes a fund a minimum of 18 to 30 months to raise capital from investors and appropriately deploy it across a balanced portfolio. Under the proposed rules, a Qualified Opportunity Fund has at most six months to deploy its capital that it has raised before being subjected to a possible penalty under the 90-Percent Asset Test. The short timeline can be highly demanding for a newly-formed Opportunity Fund and could delay or discourage the formation of potential Opportunity Funds.

While the proposed rules did provide a 31-month period safe harbor for treating cash as reasonable working capital for Opportunity Zone Businesses, Opportunity Funds were not granted similar flexibility. The IRS could consider including a provision such that for the first 12-months following the receipt of cash by an Opportunity Fund, the Opportunity Fund would be able to treat such cash as Qualified Opportunity Zone Property for purposes of the 90-Percent Asset Test, conditional on that cash being deployed into actual Qualified Opportunity Zone Property within one year of the Opportunity Fund's receipt of that cash. Such a provision would provide more flexibility for an Opportunity Fund to thoughtfully establish an investment portfolio that meets the intent of the law.

The rules should encourage simple, unobtrusive public reporting requirements for Qualified Opportunity Zone Funds.

We are encouraged by the IRS's commitment to avoiding onerous requirements for the Opportunity Zone incentive and encouraging investments to move at market speed. However, we believe that in order to track the efficacy of the program and identify areas of improvement and modification for the future, Opportunity Funds should be required to publicly provide a simple set of information. We propose that Opportunity Funds be required to report, at a minimum, on the specific Opportunity Zones in which they have capital deployed, the amount of capital deployed, and the eventual appreciation of that capital.

We hope the IRS strongly considers our comments and suggestions as it continues to promulgate regulations under Investing in Qualified Opportunity Funds. If the IRS would like to better understand or clarify our comments, we would gladly welcome the opportunity for an extended discussion. Thank you for your consideration.

Sincerely,

Stephanie Copeland
Executive Director
Colorado Office of Economic Development and International Trade

Stefan Pryor
Secretary of Commerce
State of Rhode Island

Donald M. Pierson Jr.
Secretary of Louisiana Economic Development
State of Louisiana

Joan Goldstein
Commissioner
Vermont Department of Economic Development

W. Kurt Foreman
President & CEO
Delaware Prosperity Partnership

Dennis M. Davin
Secretary
Pennsylvania Department of Community and Economic Development

Deby Snodgrass
Secretary of Commerce & Tourism
State of Oklahoma

Catherine H. Smith
Commissioner
Connecticut Dept. of Economic and Community Development

Matthew B. Geisel
Cabinet Secretary
Economic Development Department
State of New Mexico

Q. Val Hale
Executive Director
Utah Governor's Office of Economic Development

Manuel A. Laboy Rivera, P.E.
Secretary
Puerto Rico Department Economic Development and Commerce

Brian Bonlender
Director
Washington State Department of Commerce

CC:
Scott Dinwiddie, Associate Chief Counsel, Income Tax & Accounting, IRS
David Kautter, Assistant Secretary for Tax Policy, US Department of the Treasury
Daniel Kowalski, Counselor to the Secretary, US Department of the Treasury
Erika C. Reigle, Office of Associate Chief Counsel (Income Tax & Accounting), IRS
Kyle C. Griffin, Office of Associate Chief Counsel (Income Tax & Accounting), IRS