Christmas arrived early for brownfield developers when the United States Treasury Department (“Treasury”) and the Internal Revenue Service (IRS) released the final set of Opportunity Zone (OZ) regulations on December 19th . The final rules confirm that developers of brownfield sites will be eligible for the favorable tax treatment available under the OZ program. The final OZ rules were published in the federal register earlier this week.
The final OZ rule amends the Income Tax Regulations (26 CFR part 1) by adding final regulations under section 1400Z-2 of the IRS Code. Section 1400Z-2 provides two main federal income tax benefits to eligible taxpayers that make longer-term investments of new capital in one or more designated qualified opportunity zones (QOZs) through qualified opportunity fund (QOF) and qualified opportunity zone businesses.
The first main Federal income tax benefit is the ability of eligible taxpayers to defer certain capital gains until as late as December 31, 2026. Moreover, eligible taxpayers may potentially exclude 10% of such deferred gain from gross income if the eligible taxpayer holds the qualifying investment in the QOF for at least five years. In addition, taxpayers may exclude an additional 5% of such gain if the eligible taxpayer holds that qualifying investment for at least seven years.
The second main Federal income tax benefit is that eligible taxpayers may exclude appreciation on the eligible taxpayer’s qualifying investment in the QOF if the eligible taxpayer holds the qualifying investment for at least 10 years.
Section 1400Z2-2(d)(2)(D) requires either that the original use of qualified opportunity zone business property in the QOZ commences with the QOF or qualified opportunity zone business or that the QOF or qualified opportunity zone business substantially improve the property. After Treasury and the IRS proposed rules in October 2018, developers and the EPA Office of Brownfields and Land Revitalization filed comments requesting clarification on how the “substantial improvement” and the “original use” tests applied to brownfield sites. See our blog post discussing the issues in more detail.
Treasury and IRS issued a second notice of proposed rulemaking in May 2019 (84 FR 18652) responding to the initial comments. The revised proposed rules did not fully address the comments submitted by EPA and the brownfield community.
The third time proved a charm for brownfield developers as the final rule unequivocally and clearly addresses EPA and brownfield developer concerns raised in the two preceding rounds of rulemaking.
Vacancy Period to Qualify for Original Use.
The proposed regulations provided that a building or other structure must be vacant for at least five years prior to being purchased by a QOF or qualified opportunity zone business to satisfy the “original use” requirement. Some commenters suggested the five-year period was too long while others were concerned a shorter period would incentivize developers to warehouse properties.
As a result, the final rule modifies the vacancy period. There is now a special one-year vacancy requirement for property that was vacant prior immediately to the date of publication of a QOZ containing the property is located.. For property that was not vacant at the time of such QOZ designation notice but becomes vacant later, the final regulations require the property to be vacant continuously for at least three years.
Clarification of the Term “Vacant” for Purposes of Applying the Vacant Property Rules
Commenters also asked Treasury and IRS to clarify the meaning of “vacant”. The agencies were told that local governments often hold inventories of brownfield sites and other blighted properties through tax delinquency, abandonment, bankruptcy, with varying historic uses and that there were differing regulatory definitions under state and federal programs of what constituted a vacant site.
The final QZ regulations provide that real property (including land and buildings) is considered to be in a state of vacancy if the property is “significantly unused.” A building or land is considered “significantly unused” under the final regulations if more than 80% of the building or land is not used, as measured by the square footage of useable space.
Buildings Located on Brownfield Sites Qualify as “Original Use” Property
The final regulations make clear that “all real property composing a brownfield site, including land and structures located thereon,” will be treated by the IRS as satisfying the “original use” test requirement of section 1400Z-2(d)(2)(D)(i)(II). In making this decision, Treasury wrote :
“Cleaning up and reinvesting in these properties increases local tax bases, facilitates job growth, utilizes existing infrastructure, takes development pressures off of undeveloped, open land, and both improves and protects the environment”
Clarification of Activities and Expenses That Count as “Substantial Improvements” Test
The final rule provides that the costs of brownfield site assessment and remediation are eligible as cost of “substantial improvement” where:
“ the land has been more than minimally improved, and that the QOF or qualified OZ business must make investments into the brownfield site to improve its safety and environmental standards.”
Requests for Extensions and Safe Harbors Regarding 30-Month Substantial Improvement Period
The proposed rule required substantial improvements had to be completed within 30 months. Treasury received comments requesting an extension of the 30-month period for brownfield sites because of the delays associated with regulatory approvals.
The final regulations provide that if a governmental permitting delay has caused the delay of a project covered by the 30-month working capital safe harbor, and no other action could be taken to improve the tangible property or complete the project during the permitting process, then the 30-month working capital safe harbor will be tolled for a duration equal to the permitting delay.