[Federal Register Volume 83, Number 209 (Monday, October 29, 2018)]
[Proposed Rules]
[Pages 54279-54296]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2018-23382]


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DEPARTMENT OF TREASURY

Internal Revenue Service

26 CFR Part I

[REG-115420-18]
RIN 1545-BP03


Investing in Qualified Opportunity Funds

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Notice of proposed rulemaking and notice of public hearing.

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SUMMARY: This document contains proposed regulations that provide 
guidance under new section 1400Z-2 of the Internal Revenue Code (Code) 
relating to gains that may be deferred as a result of a taxpayer's 
investment in a qualified opportunity fund (QOF). Specifically, the 
proposed regulations address the type of gains that may be deferred by 
investors, the time by which corresponding amounts must be invested in 
QOFs, and the manner in which investors may elect to defer specified 
gains. This document also contains proposed regulations applicable to 
QOFs, including rules for self-certification, valuation of QOF assets, 
and guidance on qualified opportunity zone businesses. The proposed 
regulations affect QOFs and their investors. This document also 
provides notice of a public hearing on these proposed regulations.

DATES: Written (including electronic) comments must be received by 
December 28, 2018. Outlines of topics to be discussed at the public 
hearing scheduled for January 10, 2019 at 10 a.m. must be received by 
December 28, 2018.

ADDRESSES: Send submissions to: CC:PA:LPD:PR (REG-115420-18), Room 
5203, Internal Revenue Service, P.O. Box 7604, Ben Franklin Station, 
Washington, DC 20044. Submissions may be hand delivered Monday through 
Friday between the hours of 8 a.m. and 4 p.m. to CC:PA:LPD:PR (REG-
115420-18), Courier's Desk, Internal Revenue Service, 1111 Constitution 
Avenue NW, Washington, DC 20224. Alternatively, taxpayers may submit 
comments electronically via the Federal Rulemaking Portal at 
www.regulations.gov (IRS REG-115420-18). The public hearing will be 
held in the IRS auditorium, Internal Revenue Building, 1111 
Constitution Avenue NW, Washington, DC.

FOR FURTHER INFORMATION CONTACT: Concerning the proposed regulations, 
Erika C. Reigle of the Office of Associate Chief Counsel (Income Tax 
and Accounting), (202) 317-7006 and Kyle C. Griffin of the Office of 
Associate Chief Counsel (Income Tax and Accounting), (202) 317-4718; 
concerning the submission of comments, the hearing, or to be placed on 
the building access list to attend the hearing, Regina L. Johnson, 
(202) 317-6901 (not toll-free numbers).

SUPPLEMENTARY INFORMATION:

Background

    This document contains proposed regulations under section 1400Z-2 
of the Code that amend the Income Tax Regulations (26 CFR part 1). 
Section 13823 of the Tax Cuts and Jobs Act, Public Law 115-97, 131 
Stat. 2054, 2184 (2017) (TCJA), amended the Code to add sections 1400Z-
1 and 1400Z-2. Section 1400Z-1 provides procedural rules for 
designating qualified opportunity zones and related definitions. 
Section 1400Z-2 allows a taxpayer to elect to defer certain gains to 
the extent that corresponding amounts are timely invested in a QOF.
    Section 1400Z-2, in conjunction with section 1400Z-1, seeks to 
encourage economic growth and investment in designated distressed 
communities (qualified opportunity zones) by providing Federal income 
tax benefits to taxpayers who invest in businesses located within these 
zones. Section 1400Z-2 provides two main tax incentives to encourage 
investment in qualified opportunity zones. First, it allows for the 
deferral of inclusion in gross income for certain gains to the extent 
that corresponding amounts are reinvested in a QOF. Second, it excludes 
from gross income the post-acquisition gains on investments in QOFs 
that are held for at least 10 years.
    As is more fully explained in the Explanation of Provisions, these 
proposed regulations describe and clarify the requirements that must be 
met by a taxpayer in order properly to defer the recognition of gains 
by investing in a QOF. In addition, the proposed regulations provide 
rules permitting a corporation or partnership to self-certify as a QOF. 
Finally, the proposed regulations provide initial proposed rules 
regarding some of the requirements that must be met by a corporation or 
partnership in order to qualify as a QOF.
    Contemporaneous with the issuance of these proposed regulations, 
the IRS is releasing a revenue ruling addressing the application to 
real property of the ``original use'' requirement in section 1400Z-
2(d)(2)(D)(i)(II) and the ``substantial improvement'' requirement in 
section 1400Z-2(d)(2)(D)(i)(II) and 1400Z-2(d)(2)(D)(ii).
    In addition, these proposed regulations address the substantial-
improvement requirement with respect to a purchased building located in 
a qualified opportunity zone. They provide that for purposes of this 
requirement, the basis attributable to land on which such a building 
sits is not taken into account in determining whether the building has 
been substantially improved. Excluding the basis of land from the 
amount that needs to be doubled under section 1400Z-2(d)(2)(D)(ii) for 
a building to be substantially improved facilitates repurposing vacant 
buildings in qualified opportunity zones. Similarly, an absence of a 
requirement to increase the basis of land itself would address many of 
the comments that taxpayers have made regarding the need to facilitate 
repurposing vacant or otherwise unutilized land.
    In connection with soliciting comments on these proposed 
regulations the Department of the Treasury (Treasury Department) and 
the IRS are soliciting comments on all aspects of the definition of 
``original use'' and ``substantial improvement.'' In particular, they 
are seeking comments on possible approaches to defining the ``original 
use'' requirement, for both real property and other tangible property. 
For example, what metrics would be appropriate for determining whether

[[Page 54280]]

tangible property has ``original use'' in an opportunity zone? Should 
the use of tangible property be determined based on its physical 
presence within an opportunity zone, or based on some other measure? 
What if the tested tangible property is a vehicle or other movable 
tangible property that was previously used within the opportunity zone 
but acquired from a person outside the opportunity zone? Should some 
period of abandonment or under-utilization of tangible property erase 
the property's history of prior use in the opportunity zone? If so, 
should such a fallow period enable subsequent productive utilization of 
the tangible property to qualify as ``original use''? Should the rules 
appropriate for abandonment and underutilization of personal tangible 
property also apply to vacant real property that is productively 
utilized after some period? If so, what period of abandonment, 
underutilization, or vacancy would be consistent with the statute? In 
addition, comments are requested on whether any additional rules 
regarding the ``substantial improvement'' requirement for tangible 
property are warranted or would be useful.
    The Treasury Department and the IRS are working on additional 
published guidance, including additional proposed regulations expected 
to be published in the near future. The Treasury Department and the IRS 
expect the forthcoming proposed regulations to incorporate the guidance 
contained in the revenue ruling to facilitate additional public 
comment. The forthcoming proposed regulations are expected to address 
other issues under section 1400Z-2 that are not addressed in these 
proposed regulations. Issues expected to be addressed include: The 
meaning of ``substantially all'' in each of the various places where it 
appears in section 1400Z-2; the transactions that may trigger the 
inclusion of gain that has been deferred under a section 1400Z-2(a) 
election; the ``reasonable period'' (see section 1400Z-2(e)(4)(B)) for 
a QOF to reinvest proceeds from the sale of qualifying assets without 
paying a penalty; administrative rules applicable under section 1400Z-
2(f) when a QOF fails to maintain the required 90 percent investment 
standard; and information-reporting requirements under section 1400Z-2.
    The Treasury Department and the IRS welcome comments on what other 
additional issues should be addressed in forthcoming proposed 
regulations or guidance.

Explanation of Provisions

I. Deferring Tax on Capital Gains by Investing in Opportunity Zones

A. Gains Eligible for Deferral

    The proposed regulations clarify that only capital gains are 
eligible for deferral under section 1400Z-2(a)(1). In setting forth the 
gains that are subject to deferral, the text of section 1400Z-2(a)(1) 
specifies ``gain from the sale to, or exchange with, an unrelated 
person of any property held by the taxpayer,'' to the extent that such 
gain does not exceed the aggregate amount invested by the taxpayer in a 
QOF during the 180-day period beginning on the date of the sale or 
exchange (emphasis added). The statutory text is silent as to whether 
Congress intended both ordinary and capital gains to be eligible for 
deferral under section 1400Z-2. (Sections 1221 and 1222 define these 
two kinds of gains.) However, the statute's legislative history 
explicitly identifies ``capital gains'' as the gains that are eligible 
for deferral. The Treasury Department and the IRS believe, based on the 
legislative history as well as the text and structure of the statute, 
that section 1400Z-2 is best interpreted as making deferral available 
only for capital gains. The proposed regulations provide that a gain is 
eligible for deferral if it is treated as a capital gain for Federal 
income tax purposes. Eligible gains, therefore, generally include 
capital gain from an actual, or deemed, sale or exchange, or any other 
gain that is required to be included in a taxpayer's computation of 
capital gain.
    The proposed regulations address two additional gain deferral 
requirements. First, the gain to be deferred must be gain that would be 
recognized, if deferral under section 1400Z-2(a)(1) were not permitted, 
not later than December 31, 2026, the final date under section 1400Z-
2(a)(2)(B) for the deferral of gain. Second, the gain must not arise 
from a sale or exchange with a related person as defined in section 
1400Z-2(e)(2). Section 1400Z-2(e)(2) incorporates the related person 
definition in sections 267(b) and 707(b)(1) but substitutes ``20 
percent'' in place of ``50 percent'' each place it occurs in section 
267(b) or section 707(b)(1).

B. Types of Taxpayers Eligible To Elect Gain Deferral

    The proposed regulations clarify that taxpayers eligible to elect 
deferral under section 1400Z-2 are those that recognize capital gain 
for Federal income tax purposes. These taxpayers include individuals, C 
corporations (including regulated investment companies (RICs) and real 
estate investment trusts (REITs)), partnerships, and certain other 
pass-through entities, including common trust funds described in 
section 584, as well as, qualified settlement funds, disputed ownership 
funds, and other entities taxable under Sec.  1.468B of the Income Tax 
Regulations.
    In order to address the numerous issues raised by new section 
1400Z-2 for pass-through entities, the proposed regulations include 
special rules for partnerships and other pass-through entities, and for 
taxpayers to whom these entities pass through income and other tax 
items. Under these rules, the entities and taxpayers can invest in a 
QOF and thus defer recognition of eligible gain. The Treasury 
Department and the IRS request comments on whether the rules are 
sufficient and whether more detailed rules are required to provide 
additional certainty for investors in pass-through entities that are 
not partnerships.

C. Investments in a QOF

    The proposed regulations clarify that, to qualify under section 
1400Z-2(a)(1)(A), (that is, to be an eligible interest in a QOF), an 
investment in the QOF must be an equity interest in the QOF, including 
preferred stock or a partnership interest with special allocations. 
Thus, an eligible interest cannot be a debt instrument within the 
meaning of section 1275(a)(1) and Sec.  1.1275-1(d). Provided that the 
eligible taxpayer is the owner of the equity interest for Federal 
income tax purposes, status as an eligible interest is not impaired by 
the taxpayer's use of the interest as collateral for a loan, whether a 
purchase-money borrowing or otherwise. The proposed regulations also 
clarify that deemed contributions of money under section 752(a) do not 
result in the creation of an investment in a QOF.

D. 180-Day Rule for Deferring Gain by Investing in a QOF

    Under section 1400Z-2(a)(1)(A), to be able to elect to defer gain, 
a taxpayer must generally invest in a QOF during the 180-day period 
beginning on the date of the sale or exchange giving rise to the gain. 
Some capital gains, however, are the result of Federal tax rules 
deeming an amount to be a gain from the sale or exchange of a capital 
asset, and, in many cases, the statutory language providing capital 
gain treatment does not provide a specific date for the deemed sale. 
The proposed regulations address this issue by providing that, except 
as specifically provided in the proposed regulations,

[[Page 54281]]

the first day of the 180-day period is the date on which the gain would 
be recognized for Federal income tax purposes, without regard to the 
deferral available under section 1400Z-2. The proposed regulations 
include examples that illustrate the general rule by applying it to 
capital gains in a variety of situations (including, for example, gains 
from the sale of exchange-traded stock and capital gain dividend 
distributions).
    If a taxpayer acquires an original interest in a QOF in connection 
with a gain-deferral election under section 1400Z-2(a)(1)(A), if a 
later sale or exchange of that interest triggers an inclusion of the 
deferred gain, and if the taxpayer makes a qualifying new investment in 
a QOF, then the proposed regulations provide that the taxpayer is 
eligible to make a section 1400Z-2(a)(2) election to defer the 
inclusion of the previously deferred gain. Deferring an inclusion 
otherwise mandated by section 1400Z-2(a)(1)(B) in this situation is 
permitted only if the taxpayer has disposed of the entire initial 
investment without which the taxpayer could not have made the previous 
deferral election under section 1400Z-2. The complete disposition is 
necessary because section 1400Z-2(a)(2)(A) expressly prohibits the 
making of a deferral election under section 1400Z-2(a)(1) with respect 
to a sale or exchange if an election previously made with respect to 
the same sale or exchange remains in effect. The general 180-day rule 
described above determines when this second investment must be made to 
support the second deferral election. Under that rule, the first day of 
the 180-day period for the new investment in a QOF is the date that 
section 1400Z-2(b)(1) provides for inclusion of the previously deferred 
gain .
    Comments are requested as to whether the final regulations should 
contain exceptions to the general 180-day rule and whether it would be 
helpful for either the final regulations or other guidance to 
illustrate the application of the general 180-day rule to additional 
circumstances, and what those circumstances are.

E. Attributes of Included Income When Gain Deferral Ends

    Section 1400Z-2(a)(1)(B) and (b) require taxpayers to include in 
income previously deferred gains. The proposed regulations provide that 
all of the deferred gain's tax attributes are preserved through the 
deferral period and are taken into account when the gain is included. 
The preserved tax attributes include those taken into account under 
sections 1(h), 1222, 1256, and any other applicable provisions of the 
Code. Furthermore, the proposed regulations address situations in which 
separate investments providing indistinguishable property rights (such 
as serial purchases of common stock in a corporation that is a QOF) are 
made at different times or are made at the same time with separate 
gains possessing different attributes (such as different holding 
periods). If a taxpayer disposes of less than all of its fungible 
interests in a QOF, the proposed regulations provide that the QOF 
interests disposed of must be identified using a first-in, first-out 
(FIFO) method. Where the FIFO method does not provide a complete 
answer, such as where gains with different attributes are invested in 
indistinguishable interests at the same time, the proposed regulations 
provide that a pro-rata method must be used to determine the character, 
and any other attributes, of the gain recognized. Examples in the 
proposed regulations illustrate this rule.
    Comments are requested as to whether different methods should be 
used. Any such alternative methods must both provide certainty as to 
which fungible interest a taxpayer disposes of and allow taxpayers to 
comply easily with the requirements of section 1400Z-2(a)(1)(B) and 
(b),which require that certain dispositions of an interest in a QOF 
cause deferred gain be included in a taxpayer's income.

II. Special Rules

A. Gain Not Already Subject to an Election

    Under section 1400Z-2(a)(2)(A), no election may be made under 
section 1400Z-2(a)(1) with respect to a sale or exchange if an election 
previously made with respect to that sale or exchange is in effect. 
There has been some confusion as to whether this language bars a 
taxpayer from making multiple elections within 180-days for various 
parts of the gain from a single sale or exchange of property held by 
the taxpayer. This rule in section 1400Z-2(a)(2)(A) is meant to exclude 
from the section 1400Z-2(a)(1) election multiple purported elections 
with respect to the same gain. (Although the gain itself can be 
deferred only once, a taxpayer might be seeking to multiply the 
investments eligible for various increases in basis.) Thus, the 
proposed regulations clarify that in the case of a taxpayer who has 
made an election under section 1400Z-2(a) with respect to some but not 
all of an eligible gain, the term ``eligible gain'' includes the 
portion of that eligible gain as to which no election has been made. 
(All elections with respect to portions of the same gain would, of 
course, be subject to the same 180-day period.)

B. Section 1256 Contracts

    The proposed regulations provide rules for capital gains arising 
from section 1256 contracts. Under section 1256, a taxpayer generally 
``marks to market'' each section 1256 contract at the termination or 
transfer of the taxpayer's position in the contract or on the last 
business day of the taxable year if the contract is still held by the 
taxpayer at that time. The mark causes the taxpayer to take into 
account in the taxable year any not-yet recognized appreciation or 
depreciation in the position. This gain or loss, if capital, is treated 
as 60 percent long-term capital gain or loss and 40 percent short-term 
capital gain or loss. Currently, for federal income tax purposes, the 
only relevant information required to be reported by a broker to the 
IRS and to individuals and certain other taxpayers holding section 1256 
contracts, is the taxpayer's net recognized gain or loss from all of 
the taxpayer's section 1256 contracts held during the taxable year. 
Some taxpayers holding section 1256 contracts, however, report the gain 
or loss from section 1256 contracts to the IRS on a per contract basis 
rather than on an aggregate basis. To minimize the burdens on 
taxpayers, brokers, and the IRS from tax compliance and tax 
administration, the proposed regulations allow deferral under section 
1400Z-2(a)(1) only for a taxpayer's capital gain net income from 
section 1256 contracts for a taxable year. In addition, because the 
capital gain net income from section 1256 contracts for a taxable year 
is determinable only as of the last day of the taxable year, the 
proposed regulations provide that the 180-day period for investing 
capital gain net income from section 1256 contracts in a QOF begins on 
the last day of the taxable year.
    Finally, the proposed regulations do not allow any deferral of gain 
from a section 1256 contract in a taxable year if, at any time during 
the taxable year, one of the taxpayer's section 1256 contracts was part 
of an offsetting-positions transaction (as defined later in the 
proposed regulations and described later in this preamble) in which any 
of the other positions was not also a section 1256 contract.
    Comments are requested on this limitation and on whether capital 
gain from a section 1256 contract should be eligible for deferral under 
section 1400Z-2 on a per contract basis rather than on an aggregate net 
basis. Reporting on a per contract basis might

[[Page 54282]]

require a significant increase in the number of information returns 
that taxpayers would need to file with the IRS as compared to the 
number of information returns that are currently filed on an aggregate 
net basis. Comments are requested on how to minimize the burdens and 
complexity that may be associated with reporting on a per contract 
basis for section 1256 contracts.

C. Offsetting-Positions Transactions, Including Straddles

    The Treasury Department and the IRS considered allowing deferral 
under section 1400Z-2(a)(1) for a net amount of capital gain related to 
a straddle (as defined in section 1092(c)(1)) after the disposition of 
all positions in the straddle. However, such a rule would pose 
significant administrative challenges. For example, additional rules 
would be needed for a taxpayer to defer such a net amount of capital 
gain when positions are disposed of in different taxable years (and 
likely would require affected taxpayers to file amended tax returns). 
Further, additional rules might be needed to take into account the 
netting requirements for identified mixed straddles described in Sec.  
1.1092(b)-3T or 1.1092(b)-6 and for mixed straddle accounts described 
in Sec.  1.1092(b)-4T. Accordingly, in the interest of sound tax 
administration and to provide consistent treatment for transactions 
involving offsetting positions in personal property, the proposed 
regulations provide that any capital gain from a position that is or 
has been part of an offsetting-positions transaction (other than an 
offsetting-positions transaction in which all of the positions are 
section 1256 contracts) is not eligible for deferral under section 
1400Z-2.
    An offsetting-positions transaction is defined in the proposed 
regulations as a transaction in which a taxpayer has substantially 
diminished the taxpayer's risk of loss from holding one position with 
respect to personal property by holding one or more other positions 
with respect to personal property (whether or not of the same kind). It 
does not matter whether either of the positions is with respect to 
actively traded personal property. An offsetting-positions transaction 
includes a straddle as defined in section 1092 and the regulations 
thereunder, including section 1092(d)(4), which provides rules for 
positions held by related persons and certain flow-through entities 
(for example, a partnership). An offsetting-positions transaction also 
includes a transaction that would be a straddle (taking into account 
the principles referred to in the preceding sentence) if the straddle 
definition did not contain the active trading requirement in section 
1092(d)(1).

III. Gains of Partnerships and Other Pass-Through Entities

    Commenters have requested clarification regarding whether deferral 
is possible under section 1400Z-2 any time a partnership would 
otherwise recognize capital gain. The proposed regulations provide 
rules that permit a partnership to elect deferral under section 1400Z-2 
and, to the extent that the partnership does not elect deferral, 
provide rules that allow a partner to do so. These rules both clarify 
the circumstances under which each can elect and clarify when the 
applicable 180-day period begins.
    Proposed Sec.  1.1400Z2(a)-1(c)(1) provides that a partnership may 
elect to defer all or part of a capital gain to the extent that it 
makes an eligible investment in a QOF. Because the election provides 
for deferral, if the election is made, no part of the deferred gain is 
required to be included in the distributive shares of the partners 
under section 702, and the gain is not subject to section 705(a)(1). 
Proposed Sec.  1.1400Z2(a)-1(c)(2) provides that, to the extent that a 
partnership does not elect to defer capital gain, the capital gain is 
included in the distributive shares of the partners under section 702 
and is subject to section 705(a)(1). If all or any portion of a 
partner's distributive share satisfies all of the rules for eligibility 
under section 1400Z-2(a)(1) (including not arising from a sale or 
exchange with a person that is related either to the partnership or to 
the partner), then the partner generally may elect its own deferral 
with respect to the partner's distributive share. The partner's 
deferral is potentially available to the extent that the partner makes 
an eligible investment in a QOF.
    Consistent with the general rule for the beginning of the 180-day 
period, the partner's 180-day period generally begins on the last day 
of the partnership's taxable year, because that is the day on which the 
partner would be required to recognize the gain if the gain is not 
deferred. The proposed regulations, however, provide an alternative for 
situations in which the partner knows (or receives information) 
regarding both the date of the partnership's gain and the partnership's 
decision not to elect deferral under section 1400Z-2. In that case, the 
partner may choose to begin its own 180-day period on the same date as 
the start of the partnership's 180-day period.
    The proposed regulations state that rules analogous to the rules 
provided for partnerships and partners apply to other pass-through 
entities (including S corporations, decedents' estates, and trusts) and 
to their shareholders and beneficiaries. Comments are requested 
regarding whether taxpayers need additional details regarding analogous 
treatment for pass-through entities that are not partnerships.

IV. How To Elect Deferral

    These proposed regulations require deferral elections to be made at 
the time and in the manner provided by the Commissioner of Internal 
Revenue (Commissioner). The Commissioner may prescribe in regulations, 
revenue procedures, notices, or other guidance published in the 
Internal Revenue Bulletin or in forms and instructions the time, form, 
and manner in which an eligible taxpayer may elect to defer eligible 
gains under section 1400Z-2(a). It is currently anticipated that 
taxpayers will make deferral elections on Form 8949, which will be 
attached to their Federal income tax returns for the taxable year in 
which the gain would have been recognized if it had not been deferred. 
Form instructions to this effect are expected to be released very 
shortly after these proposed regulations are published. Comments are 
requested whether additional proposed regulations or other guidance are 
needed to clarify the required procedures. In addition IRS releases 
draft forms for public review and comments. These drafts are posted to 
www.IRS.gov/DraftForms and include a cover sheet that indicates how to 
submit comments.

V. Section 1400Z-2(c) Election for Investments Held at Least 10 Years

A. In General

    Under section 1400Z-2(c), a taxpayer that holds a QOF investment 
for at least ten years may elect to increase the basis of the 
investment to the fair market value of the investment on the date that 
the investment is sold or exchanged.
    The basis step-up election under section 1400Z-2(c) is available 
only for gains realized upon investments that were made in connection 
with a proper deferral election under section 1400Z-2(a). It is 
possible for a taxpayer to invest in a QOF in part with gains for which 
a deferral election under section 1400Z-2(a) is made and in part with 
other funds (for which no section 1400Z-2(a) deferral election is made 
or for which no such election is available). Section 1400Z-2(e) 
requires that these two types of QOF investments be treated

[[Page 54283]]

as separate investments, which receive different treatment for Federal 
income tax purposes. Pursuant to section 1400Z-2(e)(1)(B), the proposed 
regulations reiterate that a taxpayer may make the election to step-up 
basis in an investment in a QOF that was held for 10 years or more only 
if a proper deferral election under section 1400Z-2(a) was made for the 
investment.

B. QOF Investments and the 10-Year Zone Designation Period

    Section 1400Z-2(c), as stated above, permits a taxpayer to elect to 
increase the basis in its investment in a QOF if the investment is held 
for at least ten years from the date of the original investment in the 
QOF. However, under section 1400Z-1(f), the designations of all 
qualified opportunity zones now in existence will expire on December 
31, 2028. The loss of qualified opportunity zone designation raises 
numerous issues regarding gain deferral elections that are still in 
effect when the designation expires. Among the issues that the zone 
expiration date raises is whether, after the relevant qualified 
opportunity zone loses its designation, investors may still make basis 
step-up elections for QOF investments from 2019 and later.
    Section 1400Z-2 does not contain specific statutory language like 
that in some other provisions, such as the DC enterprise zones 
provision in section 1400B(b)(5), that expressly permits a taxpayer to 
satisfy the requisite holding period after the termination of the 
designation of a zone. Commenters have raised the question described in 
the preceding paragraph--whether a taxpayer whose investment in a QOF 
has its 10-year anniversary after the 2028 calendar year will be able 
to take advantage of the basis step-up election provided in section 
1400Z-2(c). The incentive provided by this benefit is integral to the 
primary purpose of the provision (see H.R. Rept. 115-466, 537, which 
describes the intent to attract an influx of capital to designated low 
income communities). For this reason, the proposed regulations permit 
taxpayers to make the basis step-up election under section 1400Z-2(c) 
after a qualified opportunity zone designation expires.
    The ability to make this election is preserved under these proposed 
regulations until December 31, 2047, 20\1/2\ years after the latest 
date that an eligible taxpayer may properly make an investment that is 
part of an election to defer gain under section 1400Z-2(a). Because the 
latest gain subject to deferral would be at the end of 2026, the last 
day of the 180-day period for that gain would be in late June 2027. A 
taxpayer deferring such a gain would achieve a 10-year holding period 
in a QOF investment only in late June 2037. Thus, this proposed rule 
would permit an investor in a QOF that makes an investment as late as 
the end of June 2027 to hold the investment in the QOF for the entire 
10-year holding period described in section 1400Z-2(c), plus another 10 
years.
    The additional ten year period is provided to avoid situations in 
which, in order to enjoy the benefits provided by section 1400Z-2(c), a 
taxpayer would need to dispose of an investment in a QOF shortly after 
completion of the required 10-year holding period. There may be cases 
in which disposal shortly after the 10-year holding period would 
diverge from otherwise desirable business conduct, and, absent the 
additional time, some taxpayers may lose the statutory benefit.
    The Treasury Department and the IRS request comments on this 
proposed fixed 20\1/2\-year end date for the section 1400Z-2(c) basis 
step-up election. In particular, whether some other time period would 
better align with taxpayers' economic interests and the purposes of the 
statute. Comments may also include an alternative to incentivizing 
investors to disinvest shortly before any such a fixed end date for the 
section 1400Z-2(c) basis step-up election. For example, should the 
regulations provide for a presumed basis step-up election immediately 
before the ability to elect a step-up upon disposition expires? If such 
a basis step-up without disposition is allowed, how should a QOF 
investment be properly valued at the time of the step-up?

VI. Rules for a Qualified Opportunity Fund

A. Certification of an Entity as a QOF

    Section 1400Z-2(e)(4) allows the Secretary of the Treasury to 
prescribe regulations for the certification of QOFs for purposes of 
section 1400Z-2. In order to facilitate the certification process and 
minimize the information collection burden placed on taxpayers, the 
proposed regulations generally permit any taxpayer that is a 
corporation or partnership for tax purposes to self-certify as a QOF, 
provided that the entity self-certifying is statutorily eligible to do 
so. The proposed regulations permit the Commissioner to determine the 
time, form, and manner of the self-certification in IRS forms and 
instructions or in guidance published in the Internal Revenue Bulletin. 
It is expected that taxpayers will use Form 8996, Qualified Opportunity 
Fund, both for initial self-certification and for annual reporting of 
compliance with the 90-Percent Asset Test in section 1400Z-2(d)(1). It 
is expected that the Form 8996 would be attached to the taxpayer's 
Federal income tax return for the relevant tax years. The IRS expects 
to release this form contemporaneous with the release of these proposed 
regulations.

B. Designating When a QOF Begins

    The proposed regulations allow a QOF both to identify the taxable 
year in which the entity becomes a QOF and to choose the first month in 
that year to be treated as a QOF. If an eligible entity fails to 
specify the first month it is a QOF, then the first month of its 
initial taxable year as a QOF is treated as the first month that the 
eligible entity is a QOF. A deferral election under section 1400Z-2(a) 
may only be made for investments in a QOF. Therefore, a proper deferral 
election under section 1400Z-2(a) may not be made for an otherwise 
qualifying investment that is made before an eligible entity is a QOF.

C. Becoming a QOF in a Month Other Than the First Month of the Taxable 
Year

    The proposed regulations provide guidance regarding application of 
the 90-Percent Asset Test in section 1400Z-2(d)(1) with respect to an 
entity's first year as a QOF, if the entity chooses to become a QOF 
beginning with a month other than the first month of its first taxable 
year. The phrase ``first 6-month period of the taxable year of the 
fund'' means the first 6-month period composed entirely of months which 
are within the taxable year and during which the entity is a QOF. For 
example, if a calendar-year entity that was created in February chooses 
April as its first month as a QOF, then the 90-Percent-Asset-Test 
testing dates for the QOF are the end of September and the end of 
December. Moreover, if the calendar-year QOF chooses a month after June 
as its first month as a QOF, then the only testing date for the taxable 
year is the last day of the QOF's taxable year. Regardless of when an 
entity becomes a QOF, the last day of the taxable year is a testing 
date.
    The proposed regulations clarify that the penalty in section 1400Z-
2(f)(1) does not apply before the first month in which the entity 
qualifies as a QOF. The Treasury Department and the IRS intend to 
publish additional proposed regulations that will address, among other 
issues, the applicability of the section 1400Z-2(f)(1) penalty and 
conduct that may lead to potential decertification of a QOF.

[[Page 54284]]

    Section 1400Z-2(e)(4)(B) authorizes regulations to ensure that a 
QOF has ``a reasonable period of time to reinvest the return of capital 
from investments in qualified opportunity zone stock and qualified 
opportunity zone partnership interests, and to reinvest proceeds 
received from the sale or disposition of qualified opportunity zone 
business property.'' For example, if a QOF shortly before a testing 
date sells qualified opportunity zone property, that QOF should have a 
reasonable amount of time in which to bring itself into compliance with 
the 90-Percent Asset Test. Soon-to-be-released proposed regulations 
will provide guidance on these reinvestments by QOFs. Many stakeholders 
have requested guidance not only on the length of a ``reasonable period 
of time to reinvest'' but also on the Federal income tax treatment of 
any gains that the QOF reinvests during such a period. In the 
forthcoming notice of proposed rulemaking, the Treasury Department and 
the IRS will invite additional public comment on the scope of 
statutorily permissible policy alternatives. The Treasury Department 
and the IRS will carefully consider those comments in evaluating the 
widest range of statutorily permissible possibilities.

D. Pre-Existing Entities

    Commenters have inquired whether a pre-existing entity may qualify 
as a QOF or as the issuer of qualified opportunity zone stock or of a 
qualified opportunity zone partnership. For example, commenters have 
asked whether a pre-existing entity may self-certify as a QOF or 
whether, after 2017, a QOF may acquire an equity interest in a pre-
existing operating partnership or corporation. The proposed regulations 
clarify that there is no prohibition to using a pre-existing entity as 
a QOF or as a subsidiary entity operating a qualified opportunity 
business, provided that the pre-existing entity satisfies the 
requirements under section 1400Z-2(d).
    As previously discussed, section 1400Z-2(d)(1) requires that a QOF 
must undergo semi-annual tests to determine whether its assets consist 
on average of at least 90 percent qualified opportunity zone property. 
For purposes of these semi-annual tests, section 1400Z-2(d)(2) requires 
that a tangible asset can be qualified opportunity zone business 
property by an entity that has self-certified as a QOF or an operating 
subsidiary entity only if it acquired the asset after 2017 by purchase. 
The Treasury Department and the IRS request comments on whether there 
is a statutory basis for additional flexibilities that might facilitate 
qualification of a greater number of pre-existing entities across broad 
categories of industries.

E. Valuation Method for Applying the 90-Percent Asset Test

    For purposes of the calculation of the 90-Percent Asset Test in 
section 1400Z-2(d)(1) by the QOF, the proposed regulations require the 
QOF to use the asset values that are reported on the QOF's applicable 
financial statement for the taxable year, as defined in Sec.  1.475(a)-
4(h) of the Income Tax Regulations. If a QOF does not have an 
applicable financial statement, the proposed regulations require the 
QOF to use the cost of its assets. The Treasury Department and the IRS 
request comments on the suitability of both of these valuation methods, 
and whether another method, such as tax adjusted basis, would be better 
for purposes of assurance and administration.

F. Nonqualified Financial Property

    Commenters have recommended that the Treasury Department and the 
IRS adopt a rule that provides that cash be an appropriate QOF property 
for purposes of the 90-Percent Asset Test, if the cash is held with the 
intent of investing in qualified opportunity zone property. 
Specifically, commenters indicated that, because developing a new 
business or the construction or rehabilitation of real estate may take 
longer than six months, QOFs should be given longer than the six months 
provided under section 1400Z-2(d)(1) to invest in qualifying assets.
    In response to these comments, the proposed regulations provide a 
working capital safe harbor for QOF investments in qualified 
opportunity zone businesses that acquire, construct, or rehabilitate 
tangible business property, which includes both real property and other 
tangible property used in a business operating in an opportunity zone. 
The safe harbor allows qualified opportunity zone businesses to apply 
the definition of working capital provided in section 1397C(e)(1) to 
property held by the business for a period of up to 31 months, if there 
is a written plan that identifies the financial property as property 
held for the acquisition, construction, or substantial improvement of 
tangible property in the opportunity zone, there is written schedule 
consistent with the ordinary business operations of the business that 
the property will be used within 31-months, and the business 
substantially complies with the schedule. Taxpayers would be required 
to retain any written plan in their records.
    This expansion of the term ``working capital'' reflects the fact 
that section 1400Z-2(d)(iii) anticipates situations in which a QOF or 
operating subsidiary may need up to 30 months after acquiring a 
tangible asset in which to improve the asset substantially. In seeking 
relief, some commenters based their requests on administrative 
practices that have developed under other sections of the Code that 
these commenters believe are analogous. The Treasury Department and the 
IRS request comments on the adequacy of the working-capital safe harbor 
and of ancillary safe harbors that protect a business during the 
working capital period, and on whether there is a statutory basis for 
any additional relief. Comments are also requested about the 
appropriateness of any further expansion of the ``working capital'' 
concept beyond the acquisition, construction, or rehabilitation of 
tangible business property to the development of business operations in 
the opportunity zone.

G. Qualified Opportunity Zone Business

    Under section 1400Z-2(d)(1), a QOF is any investment vehicle 
organized as a corporation or partnership for the purpose of investing 
in qualified opportunity zone property (other than another QOF). A QOF 
must hold at least 90 percent of its assets in qualified opportunity 
zone property. Compliance with the 90 Percent Asset Test is determined 
by the average of the percentage of the qualified opportunity zone 
property held in the QOF as measured on the last day of the first 6-
month period of the taxable year of the QOF and on the last day of the 
taxable year of the QOF.
    Under section 1400Z-2(d)(2)(A), the term qualified opportunity zone 
property includes qualified opportunity zone business property. 
Qualified opportunity zone property may also include certain equity 
interests in an operating subsidiary entity (either a corporation or a 
partnership) that qualifies as a qualified opportunity zone business by 
satisfying certain requirements pursuant to section 1400Z-2(d)(2)(B) 
and (C).
    Consequently, if a QOF operates a trade or business directly and 
does not hold any equity in a qualified opportunity zone business, at 
least 90 percent of the QOF's assets must be qualified opportunity zone 
property.
    The definition of qualified opportunity zone business property 
requires property to be used in a QOZ and also requires new capital to 
be employed in a QOZ. Under section 1400Z-2(d)(2)(D)(i), qualified

[[Page 54285]]

opportunity zone business property means tangible property used in a 
trade or business of a QOF, but only if (1) the property was acquired 
by purchase after December 31, 2017; (2) the original use of the 
property in the QOZ commences with the QOF, or the QOF substantially 
improves the property; and (3) during substantially all of the QOF's 
holding period for the property, substantially all of the use of the 
property was in a QOZ.
    Under section 1400Z-2(d)(2)(B)(i) and (C), to qualify as a 
qualified opportunity zone business, an entity must be a qualified 
opportunity zone business both (a) when the QOF acquires its equity 
interest in the entity and (b) during substantially all of the QOF's 
holding period for that interest. The manner of the QOF's acquisition 
of the equity interest must comply with certain additional 
requirements.
    Under section 1400Z-2(d)(3)(A), for a trade or business to qualify 
as a qualified opportunity zone business, it must (among other 
requirements) be one in which substantially all of the tangible 
property owned or leased by the taxpayer is qualified opportunity zone 
business property.
    If an entity qualifies as a qualified opportunity zone business, 
the value of the QOF's entire interest in the entity counts toward the 
QOF's satisfaction of the 90 Percent Asset Test. Thus, if a QOF 
operates a trade or business (or multiple trades or businesses) through 
one or more entities, then the QOF can satisfy the 90 Percent Asset 
Test if each of the entities qualifies as a qualified opportunity zone 
business. The minimum amount of qualified opportunity zone business 
property owned or leased by a business for it to qualify as a qualified 
opportunity zone business is controlled by the meaning of the phrase 
substantially all in section 1400Z-2(d)(3)(A)(i).
    In determining whether an entity is a qualified opportunity zone 
business, these proposed regulations propose a threshold to determine 
whether a trade or business satisfies the substantially all requirement 
in section 1400Z-2(d)(3)(A)(i).
    If at least 70 percent of the tangible property owned or leased by 
a trade or business is qualified opportunity zone business property (as 
defined section 1400Z-2(d)(3)(A)(i)), the trade or business is treated 
as satisfying the substantially all requirement in section 1400Z-
2(d)(3)(A)(i). The 70 percent threshold provided in these proposed 
regulations is intended to apply only to the term ``substantially all'' 
as it is used in section 1400Z-2(d)(3)(A)(i).
    The phrase substantially all is also used in several other places 
in section 1400Z-2. That phrase appears in section 1400Z-2(d)(3)(A)(i), 
in which a qualified opportunity zone business is generally defined as 
a trade or business ``in which substantially all of the tangible 
property owned or leased by the taxpayer is qualified opportunity zone 
business property (determined by substituting `qualified opportunity 
zone business' for `qualified opportunity fund' each place it appears 
in section 1400Z-2(d)](2)(D)).'' In addition, substantially all appears 
in section 1400Z-2(d)(2)(D)(i)(III), which establishes the conditions 
for qualifying as an opportunity zone business property ``during 
substantially all of the qualified opportunity fund's holding period 
for such property, substantially all of the use of such property was in 
a qualified opportunity zone'' and section 1400Z-2(d)(2)(B)(ii)(III).
    Several requirements of section 1400Z-2(d) use substantially all 
multiple times in a row (that is, ``substantially all of . . . 
substantially all of . . . substantially all of . . .''). This 
compounded use of substantially all must be interpreted in a manner 
that does not result in a fraction that is too small to implement the 
intent of Congress.
    The Treasury Department and the IRS request comments regarding the 
proposed meaning of the phrase substantially all in section 1400Z-
2(d)(3)(A)(i) as well as in the various other locations in section 
1400Z-2(d) where that phrase is used.

H. Eligible Entities

    The proposed regulations clarify that a QOF must be an entity 
classified as a corporation or partnership for Federal income tax 
purposes. In addition, it must be created or organized in one of the 50 
States, the District of Columbia, or a U.S. possession. In addition, if 
an entity is organized in a U.S. possession but not in one of the 50 
States or in the District of Columbia, then it may be a QOF only if it 
is organized for the purpose of investing in qualified opportunity zone 
property that relates to a trade or business operated in the possession 
in which the entity is organized.
    The proposed regulations further clarify that qualified opportunity 
zone property may include stock or a partnership interest in an entity 
classified as a corporation or partnership for Federal income tax 
purposes. In addition, it must be a corporation or partnership created 
or organized in, or under the laws of, one of the 50 States, the 
District of Columbia, or a U.S. possession. Specifically, if an entity 
is organized in a U.S. possession but not in one of the 50 States or 
the District of Columbia, an equity interest in the entity may be 
qualified opportunity zone stock or a qualified opportunity zone 
partnership interest, as the case may be, only if the entity conducts a 
qualified opportunity zone business in the U.S. possession in which the 
entity is organized.
    The proposed regulations further define a U.S. possession to mean 
any jurisdiction outside of the 50 States and the District of Columbia 
in which a designated qualified opportunity zone exists under section 
1400Z-1. This definition may include the following U.S. territories: 
American Samoa, Guam, the Commonwealth of the Northern Mariana Islands, 
Puerto Rico, and the U.S. Virgin Islands. A complete list of designated 
qualified opportunity zones is found in Notice 2018-48, 2018-28 I.R.B. 
9.

VII. Section 1400Z-2(e) Investments From Mixed Funds

    If only a portion of a taxpayer's investment in a QOF is subject to 
the deferral election under section 1400Z-2(a), then section 1400Z-2(e) 
requires the investment to be treated as two separate investments, 
which receive different treatment for Federal income tax purposes. 
Pursuant to section 1400Z-2(e)(1)(B), the proposed regulations 
reiterate that a taxpayer may make the election to step-up basis in an 
investment in a QOF that was held for 10 years or more only if a proper 
deferral election under section 1400Z-2(a) was made for the investment.
    Commenters have questioned whether section 752(a) could result in 
investments with mixed funds under section 1400Z-2(e)(1). Section 
1400Z-2(e)(1) requires a taxpayer to treat as two separate investments 
the combination of an investment to which a section 1400Z-2(a) gain-
deferral election applies and an investment of any amount to which such 
an election does not apply. As previously noted, these proposed 
regulations clarify that deemed contributions of money under section 
752(a) do not constitute an investment in a QOF; therefore, such a 
deemed contribution does not result in the partner having a separate 
investment under section 1400Z-2(e)(1). Thus, a partner's increase in 
outside basis is not taken into account in determining what portion of 
the partner's interest is subject to the deferral election under 
section 1400Z-2(a) or what portion is not subject to the deferral 
election under section 1400Z-2(a). Comments are requested on whether 
other pass-through entities require similar treatment. Comments are 
also requested

[[Page 54286]]

on whether there may be certain circumstances in which not treating the 
deemed contribution under section 752(a) as creating a separate 
investment for purposes of section 1400Z-2(e)(1) may be considered 
abusive or otherwise problematic.

Proposed Effective Date

    These regulations generally are proposed to be effective on or 
after the date of publication in the Federal Register of a Treasury 
decision adopting these proposed rules as final regulations (final 
regulations publication date). However--
     An eligible taxpayer may rely on the rules of proposed 
Sec.  1.1400Z2(a)-1 with respect to eligible gains that would be 
recognized before the final regulations' date of applicability, but 
only if the taxpayer applies the rules in their entirety and in a 
consistent manner.
     A taxpayer may rely on the rules in proposed Sec.  
1.1400Z2(c)-1 with respect to dispositions of investment interests in 
QOFs in situations where the investment was made in connection with an 
election under section 1400Z-2(a) that relates to the deferral of a 
gain such that the first day of 180-day period for the gain was before 
the final regulations' date of applicability. This reliance is 
dependent on the taxpayer's applying the rules of Sec.  1.1400Z2(c)-1 
in their entirety and in a consistent manner.
     A QOF may rely on the rules in proposed Sec.  1.1400Z2(d)-
1 with respect to taxable years that begin before the final 
regulations' date of applicability, but only if the QOF applies the 
rules in their entirety and in a consistent manner.
     A taxpayer may rely on the rules in proposed Sec.  
1.1400Z2(e)-1 with respect to investments and deemed contributions of 
money that occur before the final regulations' date of applicability, 
but only if the taxpayer applies the rules in their entirety and in a 
consistent manner.

Special Analyses

I. Regulatory Planning and Review

    Executive Orders 13771, 13563, and 12866 direct agencies to assess 
costs and benefits of available regulatory alternatives and, if 
regulation is necessary, to select regulatory approaches that maximize 
net benefits (including potential economic, environmental, public 
health and safety effects, distributive impacts, and equity). Executive 
Order 13563 emphasizes the importance of quantifying both costs and 
benefits, reducing costs, harmonizing rules, and promoting flexibility.
    These proposed regulations have been designated by the Office of 
Management and Budget's Office of Information and Regulatory Affairs 
(OIRA) as subject to review under Executive Order 12866 pursuant to the 
Memorandum of Agreement (April 11, 2018) between the Treasury 
Department and the Office of Management and Budget regarding review of 
tax regulations. OIRA has determined that the proposed rulemaking is 
economically significant and subject to review under E.O. 12866 and 
section 1(c) of the Memorandum of Agreement. The Treasury Department 
and the IRS believe that significant investment will flow into 
qualified opportunity zones as a result of the TCJA legislation and 
proposed regulation. This investment is likely to be primarily from 
other areas of the United States. Accordingly, the proposed regulations 
have been reviewed by the Office of Management and Budget. In addition, 
the Treasury Department and the IRS expect the proposed regulation, 
when final, to be an Executive Order 13771 deregulatory action and 
request comment on this designation. Details on the costs of the 
proposed regulations can be found in this economic analysis.

A. Background and Overview

    Congress enacted section 1400Z-2, in conjunction with section 
1400Z-1, as a temporary provision to encourage private sector 
investment in certain lower-income communities designated as qualified 
opportunity zones (see Senate Committee on Finance, Explanation of the 
Bill, at 313 (November 22, 2017)). Taxpayers may elect to defer the 
recognition of capital gain to the extent of amounts invested in a QOF, 
provided that the corresponding amounts are invested during the 180-day 
period beginning on the date such capital gain would have been 
recognized by the taxpayer. Inclusion of the deferred capital gain in 
income occurs on the date the investment in the QOF is sold or 
exchanged, or on December 31, 2026, whichever comes first. For 
investments in a QOF held longer than five years, taxpayers may exclude 
10 percent of the deferred gain from inclusion in income, and for 
investment held longer than seven years, taxpayers may exclude a total 
of 15 percent of the deferred gain from inclusion in income. In 
addition, for investments held longer than 10 years, the post-
acquisition gain on the qualifying investment in the QOF may also be 
excluded from income. In turn, a QOF must hold at least 90 percent of 
its assets in qualified opportunity zone property, as measured by the 
average percentage held at the last day of the first 6-month period of 
the taxable year of the fund and the last day of the taxable year. The 
statute requires a QOF that fails this 90 percent test to pay a penalty 
for each month it fails to maintain the 90-percent asset requirement.
    The proposed regulations clarify several terms used in the statute, 
such as what type of gains are eligible for this preferential 
treatment, what type of taxpayers are eligible, the timing of 
transactions necessary for satisfying the requirements of the statute, 
including the time period for which the exclusion on gains for 
investments held longer than 10 years applies, and certain rules 
related to the creation and continued qualification of a fund as a QOF.

B. Need for the Proposed Regulations

    Taxpayers may be unwilling to make investments in QOFs without 
first having additional clarity on which investments in a QOF would 
qualify to receive the preferential tax treatment specified by the 
TCJA. This uncertainty could reduce the amount of investment flowing 
into lower-income communities designated as qualified opportunity zones 
below the congressionally intended effect. The lack of additional 
clarity could also lead to different taxpayers interpreting, and 
therefore applying, the same statute differently, which could distort 
the allocation of investment across the qualifying opportunity zones.

C. Economic Analysis

1. Baseline
    The Treasury Department and the IRS have assessed the benefits and 
costs of the proposed regulations relative to a no-action baseline 
reflecting anticipated Federal income tax-related behavior in the 
absence of these proposed regulations.
2. Anticipated Benefits
a. In General
    The Treasury Department and the IRS expect that the certainty and 
clarity provided by these proposed regulations, relative to the 
baseline, will enhance U.S. economic performance under the statute. 
Under the proposed regulations, taxpayers are provided clarity on the 
type and timing of transactions that would qualify for the beneficial 
tax treatment provided for investments in QOFs. As a primary benefit, 
the clarity provided by these proposed regulations would reduce 
planning costs for taxpayers and make it easier for

[[Page 54287]]

taxpayers to make investment decisions that more precisely conform to 
the statutory requirements for QOFs. In addition, the reduction in 
uncertainty should encourage investment to flow into qualified 
opportunity zones, consistent with the intent of the TCJA.
    The Treasury Department and the IRS considered various alternatives 
in the promulgation of the proposed regulations, with the major ones 
described in the following paragraphs. These alternatives included not 
issuing the proposed regulations under section 1400Z-2. This path was 
not chosen for several reasons. The TCJA provides both a reward in 
terms preferential tax treatment of deferred gains, but also a penalty 
if a QOF does not maintain compliance with the 90-percent asset test. 
Without the proposed regulations, some taxpayers may have foregone 
making promising investments within a qualifying opportunity zone out 
of concern that the investment may later be determined to not be a 
qualifying investment. As described in the following paragraphs, the 
proposed regulations help clarify several areas in which the statutory 
language was either ambiguous or not very specific. Overall, the 
clarity provided by the proposed regulations should reduce planning 
costs by taxpayers and enable taxpayers to make economically efficient 
decisions given the context of the whole Code.
b. Clarity Regarding Eligible Gains
    The proposed regulations specify that only capital gains are 
eligible for deferral and potential exclusion under section 1400Z-2. As 
discussed in section I.A of the Explanation of Provisions, there is 
ambiguity that results from the variation between the operative 
statutory text and the section heading in the statute regarding what 
type of gains would be eligible for deferral. The Treasury Department 
and the IRS determined that Congress intended deferral only to be 
available to capital gains. This clarity provided in the proposed 
regulations would reduce uncertainty for taxpayers regarding what 
transactions would qualify for the preferential tax treatment and also 
reduce administrative and compliance costs.
c. Clarity Regarding Application to Eligible Taxpayers
    The proposed regulations also clarify which taxpayers are eligible 
to defer the recognition of capital gain through investing in a QOF and 
describe how different types of taxpayers may satisfy the requirements 
for electing to defer capital gain consistent with the rules of section 
1400Z-2 and the overall Code. In particular, the proposed regulations 
describe rules for how partnerships and partners in a partnership may 
invest in a QOF and elect to defer recognition of capital gains. 
Partnerships are expected to be a significant source of funds invested 
in QOFs. Without these proposed rules clarifying how partnerships and 
partners may satisfy the requirements for the preferential treatment of 
capital gains, partners may be less willing to invest in a QOF. The 
proposed regulations help provide a uniform signal to different types 
of taxpayers of the availability of this preferential treatment of 
capital gains and provide the mechanics of how these different 
taxpayers may satisfy the requirements imposed by the statute. Thus 
these different types of taxpayers may make decisions that are more 
economically efficient contingent on the overall Code.
d. Clarity Regarding Electing Post-10-Year Gain Exclusion if Zone 
Designation Expires
    Proposed Sec.  1.1400Z2(c)-1 specifies that expiration of a zone 
designation would not impair the ability of a taxpayer to elect the 
exclusion from gains for investments held for at least 10 years, 
provided the disposition of the investment occurs prior to January 1, 
2048. The Treasury Department and the IRS considered four alternatives 
regarding the interaction between the expiration of the designated 
zones and the election to exclude gain for investments held more than 
10 years. A discussion of the economic costs and benefits of the four 
options follows.
i. Remaining Silent on Electing Post-10-Year Gain Exclusion
    The first alternative would be for the proposed regulations to 
remain silent on this issue. Section 1400Z-2(c) permits a taxpayer to 
increase the basis in the property held in a QOF longer than 10 years 
to be equal to the fair market value of that property on the date that 
the investment is sold or exchanged, thus excluding post-acquisition 
capital gain on the investment from tax. However, the statutory 
expiration of the designation of qualified opportunity zones on 
December 31, 2028, makes it unclear to what extent investments in a QOF 
made after 2018 would qualify for this exclusion.
    Some taxpayers may believe that only investments in a QOF made 
prior to January 1, 2019, would be eligible for the exclusion from gain 
if held greater than 10 years. Such taxpayers may rush to complete 
transactions within 2018, while others may choose to hold off 
indefinitely from investing in a QOF until they received clarity on the 
availability of the 10-year exclusion from gain for investments made 
later than 2018. Other taxpayers may plan to invest in a QOF after 2018 
with the expectation that future regulations would be provided or the 
statute would be amended to make it clear that dispositions of assets 
within a QOF after 2028 would be eligible for exclusion if held longer 
than 10 years. The ambiguity of the statute is likely to lead to uneven 
response by different taxpayers, dependent on the taxpayer's 
interpretation of the statute, which may lead to an inefficient 
allocation of investment across qualified opportunity zones.
ii. Providing a Clear Deadline for Electing Post-10-Year Gain Exclusion
    The alternative adopted by the proposed regulations clarifies that 
as long as the investment in the QOF was made with funds subject to a 
proper deferral election under section 1400Z-2(a), which requires the 
investment to be made prior to June 29, 2027, then the 10-year gain 
exclusion election is allowed as long as the disposition of the 
investment occurs before January 1, 2048. This proposed rule would 
provide certainty to taxpayers regarding the timing of investments 
eligible for the 10-year gain exclusion. Taxpayers would have a more 
uniform understanding of what transactions would be eligible for the 
favorable treatment on capital gains. This would help taxpayers 
determine which investments provide a sufficient return to compensate 
for the extra costs and risks of investing in a QOF. This proposed rule 
would likely lead to an increase in investment within QOFs compared the 
proposed regulations remaining silent on this issue.
    However, setting a fixed date for the disposition of eligible QOFs 
investments could introduce economic inefficiencies. Some taxpayers may 
dispose of their investment in a QOF by the deadline in the proposed 
regulation primarily in order to receive the benefit of the gain 
exclusion, but that selling date may not be optimal for the taxpayer in 
terms of the portfolio of assets that the taxpayer could have chosen to 
invest in were there no deadline. Setting a fixed deadline may also 
generate an overall decline in asset values in some qualified 
opportunity zones if many investors in QOFs seek to sell their portion 
of the fund within the same time period. This decline in asset values 
may affect the broader level of economic activity within some qualified 
opportunity zones or affect other investors in such zones that did not

[[Page 54288]]

invest through a QOF. In anticipation of this fixed deadline, some 
taxpayers may choose to dispose of QOF assets earlier than the deadline 
to avoid an anticipated ``rush to the exits,'' but this would seem to 
conflict with the purpose of the incentives in the statute to encourage 
``patient'' capital investment within qualified opportunity zones. 
While the proposed regulations may produce these inefficiencies, by 
providing a long time period for which taxpayers may dispose of their 
investment within a QOF and still qualify for the exclusion the 
proposed regulations will lead any such inefficiencies to be minor.
iii. Providing No Deadline for Electing Gain Exclusion
    As an alternative, the proposed regulations could have provided no 
deadline for electing the 10-year gain exclusion for investments in a 
QOF, while still stating that the ability to make the election is not 
impaired solely because the designation of one or more qualified 
opportunity zones ceases to be in effect. While this alternative would 
eliminate the economic inefficiencies associated with a fixed deadline 
and would likely lead to greater investment in QOFs, it could introduce 
substantial additional administrative and compliance costs. Taxpayers 
would also need to maintain records and make efforts to maintain 
compliance with the rules of section 1400Z-2 on an indefinite basis.
iv. Providing Fair Market Value Basis Without Disposition of Investment
    Another alternative considered would allow taxpayers to elect to 
increase the basis in their investment in the QOF if held at least 10 
years to the fair market value of the investment without disposing of 
the property, as long as the election was made prior to January 1, 
2048. (Analogously, the proposed regulations could have provided that, 
at the close of business of the day on which a taxpayer first has the 
ability to make the 10-year gain exclusion election, the basis in the 
investment automatically sets to the greater of current basis or the 
fair market value of the investment.) This alternative would minimize 
the economic inefficiencies of the proposed regulations resulting from 
taxpayers needing to dispose of their investment in the opportunity 
zone at a fixed date not related to any factor other than the lapse of 
time. However, this approach would require a method of valuing assets 
that could raise administrative and compliance costs. It may also 
require the maintenance of records and trained compliance personnel for 
over two decades.
v. Summary
    As discussed in section V.B of the Explanation of Provisions, the 
Treasury Department and the IRS have determined the ability to exclude 
gains for investment held at least 10 years in a QOF is integral to the 
TCJA's purpose of creating qualified opportunity zones. The proposed 
regulations provide a uniform signal to all taxpayers on the 
availability of this tax incentive, which should encourage greater 
investment, and a more efficient distribution of investment, in QOFs 
than in the absence of these proposed regulations. The relative costs 
and benefits of the various alternatives are difficult to measure and 
compare. The proposed regulations would likely produce the lowest 
compliance and administrative costs among the alternatives and any 
associated economic inefficiencies are likely to be small.
e. Safe Harbors for Statutory Qualifying Property Tests
    Section 1400Z-2 contains several rules limiting taxpayers from 
benefitting from the deferral and exclusion of capital gains from 
income offered by that section without also locating investment within 
a qualifying opportunity zone. The proposed regulations clarify the 
rules related to nonqualified financial property and what amounts can 
be held in cash and cash equivalents as working capital. The statute 
requires that a QOF must hold 90 percent of its assets in qualified 
opportunity zone property, such as owning stock or a partnership 
interest in a qualified opportunity zone business. A qualifying 
opportunity zone business is subject to the requirements of section 
1397C(b)(8), that less than 5 percent of the aggregate adjusted basis 
of the entity is attributable to nonqualified financial property. The 
proposed regulations establish a working capital safe harbor consistent 
with section 1397C(e)(1), under which a qualified opportunity zone 
business may hold cash or cash equivalents for a period not longer than 
31 months and not violate section 1397C(b)(8).
    The Treasury Department and the IRS expect that the establishment 
of safe harbors under these parameters will provide net economic 
benefits. Without specification of the working capital safe harbor, 
some taxpayers would not invest in a QOF for fear that the QOF would 
not be able to deploy the funds soon enough to satisfy the 90-percent 
asset test. Thus, this part of the proposed regulations would generally 
encourage investment in QOFs by providing greater specificity to how an 
entity may consistently satisfy the statutory requirements for 
maintaining a QOF without penalty. In addition, this part of the 
proposed regulations minimizes the distortion that may arise between 
purchasing existing property and sufficiently rehabilitating that 
property versus constructing new property, as the time frame specified 
under the statute and proposed regulations are similar (30 months after 
acquisition for rehabilitating existing property versus 31 months for 
acquiring and rehabilitating existing property or for constructing new 
property).
    A longer or a shorter period could have been chosen for the working 
capital safe harbor. A shorter time period would minimize the ability 
of taxpayers to use the investment in a QOF as a way to lower taxes 
without actually investing in tangible assets within a qualified 
opportunity zone, but taxpayers may also forego legitimate investments 
within an opportunity zone out of concern of not being able to deploy 
the working capital fast enough to meet the requirements. A longer 
period would have the opposite effects. Taxpayers could potentially 
invest in a QOF and receive the benefits of the tax incentive for 
multiple years before the money is invested into a qualified 
opportunity zone.
f. Definition of Substantially All
    The proposed regulations specify that if at least 70 percent of the 
tangible property owned or leased by a trade or business is qualified 
opportunity zone business property, then the trade or business is 
treated as satisfying the substantially all requirement of section 
1400Z-2(d)(3)(A)(i). This clarity would provide taxpayers greater 
certainty when evaluating potential investment opportunities as to 
whether the potential investment would satisfy the statutory 
requirements.
    However, the 70 percent requirement for a trade or business will 
give QOFs an incentive to invest in a qualified opportunity zone 
business rather than owning qualified opportunity zone business 
property directly. For example, consider a QOF with $10 million in 
assets that plans to invest 100 percent of its assets in real property. 
If it held the real property directly, then at least $9 million (90 
percent) of the property must be located within an opportunity zone to 
satisfy the 90 percent asset test for the QOF. If instead, it invests 
in a subsidiary that then holds real property, then only $7 million (70 
percent) of the property must be located within an opportunity zone. In 
addition, if the

[[Page 54289]]

QOF only invested $9 million into the subsidiary, which then held 70 
percent of its property within an opportunity zone, the investors in 
the QOF could receive the statutory tax benefits while investing only 
$6.3 million (63 percent) of its assets within a qualified opportunity 
zone.
    The Treasury Department and the IRS also considered setting this 
``substantially all'' threshold at 90 percent. This would reduce, but 
not eliminate, the incentive the QOF has to invest in a qualified 
opportunity zone business rather than directly owning qualified 
opportunity zone business property compared to the 70 percent 
threshold. Please see earlier discussion and request for comment 
regarding this definition for additional detail.
3. Anticipated Impacts on Administrative and Compliance Costs
    The Treasury Department and the IRS anticipate decreased taxpayer 
compliance costs resulting from the proposed regulations due to the 
greater taxpayer certainty regarding how to comply with the 
requirements set forth in the statute. The Treasury Department also 
anticipates decreased administrative and enforcement costs for the IRS.

D. Paperwork Reduction Act

    The collection of information in these proposed regulations with 
respect to QOFs is in proposed Sec.  1.1400Z2(d)-1. The collection of 
information in proposed Sec.  1.1400Z2(d)-1 is satisfied by submitting 
a new reporting form, Form 8996, Qualified Opportunity Fund, with an 
income tax return. For purposes of the Paperwork Reduction Act of 1995 
(44 U.S.C. 3507(d)) (PRA), the reporting burden associated with 
proposed Sec.  1.1400Z2(d)-1 will be reflected in the Paperwork 
Reduction Act submission associated with new Form 8996 (OMB control 
number 1545-0123). Notice of the availability of the draft Form 8996 
and request for comment will be available at IRS.gov/DraftForms. In 
addition, the Treasury Department and the IRS request comments on any 
aspect of this collection in this proposed rulemaking.
    The collection of information in proposed Sec.  1.1400Z2(d)-1 
requires each QOF, be it a corporation or partnership, to file a Form 
8996 to certify that it is organized to invest in qualified opportunity 
zone property. In addition, a QOF files Form 8996 annually to certify 
that the qualified opportunity fund meets the investment standards of 
section 1400Z-2 or to figure the penalty if it fails to meet the 
investment standards.

II. Regulatory Flexibility Act

    Under the Regulatory Flexibility Act (RFA) (5 U.S.C. chapter 6), it 
is hereby certified that these proposed regulations, if adopted, would 
not have a significant economic impact on a substantial number of small 
entities that are directly affected by the proposed regulations. 
Therefore, a regulatory flexibility analysis under the Regulatory 
Flexibility Act (5 U.S.C. chapter 6) is not required. Although there is 
a lack of available data regarding the extent to which small entities 
invest in QOFs, this certification is based on the belief of the 
Treasury Department and the IRS that these funds will generally involve 
investments made by larger entities and investments are entirely 
voluntary. The Treasury Department and the IRS specifically solicit 
comment from any party, particularly affected small entities, on the 
accuracy of this certification.
    Pursuant to section 7805(f), this notice of proposed rulemaking has 
been submitted to the Chief Counsel for Advocacy of the Small Business 
Administration for comment on its impact on small business.

III. Unfunded Mandates Reform Act

    Section 202 of the Unfunded Mandates Reform Act of 1995 (UMRA) 
requires that agencies assess anticipated costs and benefits and take 
certain other actions before issuing a final rule that includes any 
Federal mandate that may result in expenditures in any one year by a 
state, local, or tribal government, in the aggregate, or by the private 
sector, of $100 million in 1995 dollars, updated annually for 
inflation. In 2018, that threshold is approximately $150 million. This 
rule does not include any Federal mandate that may result in 
expenditures by state, local, or tribal governments, or by the private 
sector in excess of that threshold.

IV. Executive Order 13132: Federalism

    Executive Order 13132 (entitled ``Federalism'') prohibits an agency 
from publishing any rule that has federalism implications if the rule 
either imposes substantial, direct compliance costs on state and local 
governments, and is not required by statute, or preempts state law, 
unless the agency meets the consultation and funding requirements of 
section 6 of the Executive Order. This proposed rule does not have 
federalism implications and does not impose substantial direct 
compliance costs on state and local governments or preempt state law 
within the meaning of the Executive Order.

Statement of Availability of IRS Documents

    IRS Revenue Procedures, Revenue Rulings, and Notices cited in this 
preamble are published in the Internal Revenue Bulletin (or Cumulative 
Bulletin) and are available from the Superintendent of Documents, U.S. 
Government Publishing Office, Washington, DC 20402, or by visiting the 
IRS website at http://www.irs.gov.

Comments

    Before these proposed regulations are adopted as final regulations, 
consideration will be given to any electronic and written comments that 
are submitted timely to the IRS as prescribed in this preamble under 
the ADDRESSES heading. The Treasury Department and the IRS request 
comments on all aspects of the proposed rules. All comments will be 
available at http://www.regulations.gov or upon request.

Drafting Information

    The principal author of these proposed regulations is Erika C. 
Reigle, Office of Associate Chief Counsel (Income Tax & Accounting). 
However, other personnel from the Treasury Department and the IRS 
participated in their development.

List of Subjects in 26 CFR Part 1

    Income taxes, Reporting and recordkeeping requirements.

Proposed Amendments to the Regulations

    Accordingly, 26 CFR part 1 is proposed to be amended as follows:

PART 1--INCOME TAX

0
Paragraph 1. The authority citation for part 1 is amended by adding 
entries in numerical order to read in part as follows:

    Authority: 26 U.S.C. 7805 * * *
    Section 1.1400Z2(a)-1 also issued under 26 U.S.C. 1400Z-2(e)(4).
    Section 1.1400Z2(c)-1 also issued under 26 U.S.C. 1400Z-2(e)(4).
    Section 1.1400Z2(d)-1 also issued under 26 U.S.C. 1400Z-2(e)(4).
    Section 1.1400Z2(e)-1 also issued under 26 U.S.C. 1400Z-2(e)(4).
* * * * *
0
Par. 2. Section 1.1400Z2(a)-1 is added to read as follows:


Sec.  1.1400Z2(a)-1  Deferring tax on capital gains by investing in 
opportunity zones.

    (a) In general. Under section 1400Z-2(a) of the Internal Revenue 
Code (Code) and this section, an eligible taxpayer may elect to defer 
recognition of some or all of its eligible gains to the extent

[[Page 54290]]

that the taxpayer timely invests (as provided for by section 1400Z-
2(a)(1)(A)) in eligible interests of a qualified opportunity fund 
(QOF), as defined in section 1400Z-2(d)(1). Paragraph (b) of this 
section defines eligible taxpayers, eligible gains, and eligible 
interests and contains related operational rules. Paragraph (c) of this 
section provides rules for applying section 1400Z-2 to a partnership, S 
corporation, trust, or estate that recognizes an eligible gain or would 
recognize such a gain if it did not elect to defer the gain under 
section 1400Z-2(a).
    (b) Definitions and related operating rules. The following 
definitions and rules apply for purposes of section 1400Z-2:
    (1) Eligible taxpayer. An eligible taxpayer is a person that may 
recognize gains for purposes of Federal income tax accounting. Thus, 
eligible taxpayers include individuals; C corporations, including 
regulated investment companies (RICs) and real estate investment trusts 
(REITs); partnerships; S corporations; trusts and estates. An eligible 
taxpayer may elect to defer recognition of one or more eligible gains 
in accordance with the requirements of section 1400Z-2.
    (2) Eligible gain--(i) In general. An amount of gain is an eligible 
gain, and thus is eligible for deferral under section 1400Z-2(a), if 
the gain--
    (A) Is treated as a capital gain for Federal income tax purposes;
    (B) Would be recognized for Federal income tax purposes before 
January 1, 2027, if section 1400Z-2(a)(1) did not apply to defer 
recognition of the gain; and
    (C) Does not arise from a sale or exchange with a person that, 
within the meaning of section 1400Z-2(e)(2), is related to the taxpayer 
that recognizes the gain or that would recognize the gain if section 
1400Z-2(a)(1) did not apply to defer recognition of the gain.
    (ii) Gain not already subject to an election. In the case of a 
taxpayer who has made an election under section 1400Z-2(a) with respect 
to some but not all of an eligible gain, the term ``eligible gain'' 
includes the portion of that eligible gain with respect to which no 
election has yet been made.
    (iii) Gains under section 1256 contracts--(A) General rule. The 
only gain arising from section 1256 contracts that is eligible for 
deferral under section 1400Z-2(a)(1) is capital gain net income for a 
taxable year. This net amount is determined by taking into account the 
capital gains and losses for a taxable year on all of a taxpayer's 
section 1256 contracts, including all amounts determined under section 
1256(a), both those determined on the last business day of a taxable 
year and those that section 1256(c) requires to be determined under 
section 1256(a) because of the termination or transfer during the 
taxable year of the taxpayer's position with respect to a contract. The 
180-day period with respect to any capital gain net income from section 
1256 contracts for a taxable year begins on the last day of the taxable 
year, and the character of that gain when it is later included under 
section 1400Z-2(a)(1)(B) and (b) is determined under the general rule 
in paragraph (b)(5) of this section. See paragraph (b)(2)(iii)(B) of 
this section for limitations on the capital gains eligible for deferral 
under this paragraph (b)(2)(iii)(A).
    (B) Limitation on deferral for gain from 1256 contracts. If, at any 
time during the taxable year, any of the taxpayer's section 1256 
contracts was part of an offsetting positions transaction (as defined 
in paragraph (b)(2)(iv) of this section) and any other position in that 
transaction was not a section 1256 contract, then no gain from any 
section 1256 contract is an eligible gain with respect to that taxpayer 
in that taxable year.
    (iv) No deferral for gain from a position that is or has been part 
of an offsetting-positions transaction. If a capital gain is from a 
position that is or has been part of an offsetting-positions 
transaction, the gain is not eligible for deferral under section 1400Z-
2(a)(1). For purposes of this paragraph (b)(2)(iv), an offsetting-
positions transaction is a transaction in which a taxpayer has 
substantially diminished the taxpayer's risk of loss from holding one 
position with respect to personal property by holding one or more other 
positions with respect to personal property (whether or not of the same 
kind). It does not matter whether either of the positions is with 
respect to actively traded personal property. An offsetting-positions 
transaction includes a straddle within the meaning of section 1092 and 
the regulations under section 1092, including section 1092(d)(4), which 
provides rules for positions held by related persons and certain flow-
through entities (for example, a partnership). An offsetting-positions 
transaction also includes a transaction that would be a straddle 
(taking into account the principles referred to in the preceding 
sentence) if the straddle definition did not contain the active trading 
requirement in section 1092(d)(1). For example, an offsetting-positions 
transaction includes positions in closely held stock or other non-
traded personal property and substantially offsetting derivatives.
    (3) Eligible interest--(i) In general. For purposes of section 
1400Z-2, an eligible interest in a QOF is an equity interest issued by 
the QOF, including preferred stock or a partnership interest with 
special allocations. Thus, the term eligible interest excludes any debt 
instrument within the meaning of section 1275(a)(1) and Sec.  1.1275-
1(d).
    (ii) Use as collateral permitted. Provided that the eligible 
taxpayer is the owner of the equity interest for Federal income tax 
purposes, status as an eligible interest is not impaired by using the 
interest as collateral for a loan, whether as part of a purchase-money 
borrowing or otherwise.
    (iii) Deemed contributions not constituting investment. See Sec.  
1.1400Z2(e)-1(a)(2) for rules regarding deemed contributions of money 
to a partnership pursuant to section 752(a).
    (4) 180-day period--(i) In general. Except as otherwise provided 
elsewhere in this section, the 180-day period referred to in section 
1400Z-2(a)(1)(A) with respect to any eligible gain (180-day period) 
begins on the day on which the gain would be recognized for Federal 
income tax purposes if the taxpayer did not elect under section 1400Z-2 
to defer recognition of that gain.
    (ii) Examples. The following examples illustrate the principles of 
paragraph (b)(4)(i) of this section.

    (A) Example 1.  Regular-way trades of stock. If stock is sold at 
a gain in a regular-way trade on an exchange, the 180-day period 
with respect to the gain on the stock begins on the trade date.
    (B) Example 2.  Capital gain dividends received by RIC and REIT 
shareholders. If an individual RIC or REIT shareholder receives a 
capital gain dividend (as described in section 852(b)(3) or section 
857(b)(3)), the shareholder's 180-day period with respect to that 
gain begins on the day on which the dividend is paid.
    (C) Example 3. Undistributed capital gains received by RIC and 
REIT shareholders. If section 852(b)(3)(D) or section 857(b)(3)(D) 
(concerning undistributed capital gains) requires the holder of 
shares in a RIC or REIT to include an amount in the shareholder's 
long-term capital gains, the shareholder's 180-day period with 
respect to that gain begins on the last day of the RIC or REIT's 
taxable year.
    (D) Example 4.  Additional deferral of previously deferred 
gains--(1) Facts. Taxpayer A invested in a QOF and properly elected 
to defer realized gain. During 2025, taxpayer A disposes of its 
entire investment in the QOF in a transaction that, under section 
1400Z-2(a)(1)(B) and (b), triggers an inclusion of gain in A's gross 
income. Section 1400Z-2(b) determines the date and amount of the 
gain included in A's income. That date is the date on which A 
disposed of its entire

[[Page 54291]]

interest in the QOF. A wants to elect under section 1400Z-2 to defer 
the amount that is required to be included in income.
    (2) Analysis. Under paragraph (b)(4)(i) of this section, the 
180-day period for making another investment in a QOF begins on the 
day on which section 1400Z-2(b) requires the prior gain to be 
included. As prescribed by section 1400Z-2(b)(1)(A), that is the 
date of the inclusion-triggering disposition. Thus, in order to make 
a deferral election under section 1400Z-2, A must invest the amount 
of the inclusion in the original QOF or in another QOF during the 
180-day period beginning on the date when A disposed of its entire 
investment in the QOF.

    (5) Attributes of gains that section 1400Z-2(a)(1)(B) includes in 
income. If section 1400Z-2(a)(1)(B) and (b) require a taxpayer to 
include in income some or all of a previously deferred gain, the gain 
so included has the same attributes in the taxable year of inclusion 
that it would have had if tax on the gain had not been deferred. These 
attributes include those taken into account by sections 1(h), 1222, 
1256, and any other applicable provisions of the Code.
    (6) First-In, First-Out (FIFO) method to identify which interest in 
a QOF has been disposed of--(i) FIFO requirement. If a taxpayer holds 
investment interests with identical rights (fungible interests) in a 
QOF that were acquired on different days and if, on a single day, the 
taxpayer disposes of less than all of these interests, then the first-
in-first-out (FIFO) method must be used to identify which interests 
were disposed of. Fungible interests may be equivalent shares of stock 
in a corporation or partnership interests with identical rights.
    (ii) Consequences of identification. The FIFO method determines--
    (A) Whether an investment is described in section 1400Z-
2(e)(1)(A)(i) (an investment to which a gain deferral election under 
section 1400Z-2(a) applies) or section 1400Z-2(e)(1)(A)(ii) (an 
investment which was not part of a gain deferral election under section 
1400Z-2(a));
    (B) In the case of investments described in section 1400Z-
2(e)(1)(A)(i), the attributes of the gain subject to a deferral 
election under section 1400Z-2(a), at the time the gain is included in 
income (the attributes addressed in paragraph (b)(5) of this section); 
and
    (C) The extent, if any, of an increase under section 1400Z-
2(b)(2)(B) in the basis of an investment interest that is disposed of.
    (7) Pro-rata method. If, after application of the FIFO method, a 
taxpayer is treated as having disposed of less than all of the 
investment interests that the taxpayer acquired on one day and if the 
interests acquired on that day vary with respect to the characteristics 
described in paragraph (b)(6)(ii) of this section, then a proportionate 
allocation must be made to determine which interests were disposed of 
(pro-rata method).
    (8) Examples. The following examples illustrate the rules of 
paragraph (b)(5) through (7) of this section.

    (i) Example 1.  Short-term gain. For 2018, taxpayer B properly 
made an election under section 1400Z-2 to defer $100 of gain that, 
if not deferred, would have been recognized as short-term capital 
gain, as defined in section 1222(1). In 2022, section 1400Z-
2(a)(1)(B) and (b) requires taxpayer B to include the gain in gross 
income. Under paragraph (b)(5) of this section, the gain included is 
short-term capital gain.
    (ii) Example 2. Collectibles gain. For 2018, taxpayer C properly 
made an election under section 1400Z-2 to defer a gain that, if not 
deferred, would have been collectibles gain as defined in IRC 
section 1(h)(5). In a later taxable year, section 1400Z-2(a)(1)(B) 
and (b) requires some or all of that deferred gain to be included in 
gross income. The gain included is collectibles gain.
    (iii) Example 3. Net gains from section 1256 contracts. For 
2019, taxpayer D had $100 of capital gain net income from section 
1256 contracts. D timely invested $100 in a QOF and properly made an 
election under section 1400Z-2 to defer that $100 of gain. In 2023, 
section 1400Z-2(a)(1)(B) and (b) requires taxpayer D to include that 
deferred gain in gross income. Under paragraph (b)(5) of this 
section, the character of the inclusion is governed by section 
1256(a)(3) (which requires a 40:60 split between short-term and 
long-term capital gain). Accordingly, $40 of the inclusion is short-
term capital gain and $60 of the inclusion is long-term capital 
gain.
    (iv) Example 4.  FIFO method. For 2018, taxpayer E properly made 
an election under section 1400Z-2 to defer $300 of short-term 
capital gain. For 2020, E properly made a second election under 
section 1400Z-2 to defer $200 of long-term capital gain. In both 
cases, E properly invested in QOF Q the amount of the gain to be 
deferred. The two investments are fungible interests and the price 
of the interests was the same at the time of the two investments. E 
did not purchase any additional interest in QOF Q or sell any of its 
interest in QOF Q until 2024, when E sold for a gain 60 percent of 
its interest in QOF Q. Under paragraph (b)(6)(i) of this section, E 
must apply the FIFO method to identify which investments in QOF Q 
that E disposed of. As determined by this identification, E sold the 
entire 2018 initial investment in QOF Q. Under section 1400Z-
2(a)(1)(B) and (b), the sale triggered an inclusion of deferred 
gain. Because the inclusion has the same character as the gain that 
had been deferred, the inclusion is short-term capital gain.
    (v) Example 5.  FIFO method. In 2018, before Corporation R 
became a QOF, Taxpayer F invested $100 cash to R in exchange for 100 
R common shares. Later in 2018, after R was a QOF, F invested $500 
cash to R in exchange for 400 R common shares and properly elected 
under section 1400Z-2 to defer $500 of independently realized short-
term capital gain. Even later in 2018, on different days, F realized 
$300 of short-term capital gain and $700 of long-term capital gain. 
On a single day that fell during the 180-day period for both of 
those gains, F invested $1,000 cash in R in exchange for 800 R 
common shares and properly elected under section 1400Z-2 to defer 
the two gains. In 2020, F sold 100 R common shares. Under paragraph 
(b)(6)(i) of this section, F must apply the FIFO method to identify 
which investments in R F disposed of. As determined by that 
identification, F sold the initially acquired 100 R common shares, 
which were not part of a deferral election under section 1400Z-2. R 
must recognize gain or loss on the sale of its R shares under the 
generally applicable Federal income tax rules, but the sale does not 
trigger an inclusion of any deferred gain.
    (vi) Example 6.  FIFO method. The facts are the same as example 
5, except that, in addition, during 2021 F sold an additional 400 R 
common shares. Under paragraph (b)(6)(i) of this section, F must 
apply the FIFO method to identify which investments in R were 
disposed of. As determined by this identification, F sold the 400 
common shares which were associated with the deferral of $500 of 
short-term capital gain. Thus, the deferred gain that must be 
included upon sale of the 400 R common shares is short-term capital 
gain.
    (vii) Example 7. Pro-rata method. The facts are the same as in 
examples 5 and 6, except that, in addition, during 2022 F sold an 
additional 400 R common shares. Under paragraph (b)(6)(i) of this 
section, F must apply the FIFO method to identify which investments 
in R were disposed of. In 2022, F is treated as holding only the 800 
R common shares purchased on a single day, and the section 1400Z-2 
deferral election associated with these shares applies to gain with 
different characteristics (described in paragraph (b)(6)(ii) of this 
section). Under paragraph (b)(7) of this section, therefore, R must 
use the pro-rata method to determine which of the characteristics 
pertain to the deferred gain required to be included as a result of 
the sale of the 400 R common shares. Under the pro-rata method, $150 
of the inclusion is short-term capital gain ($300 x 400/800) and 
$350 is long-term capital gain ($700 x 400/800).

    (c) Special rules for pass-through entities--(1) Eligible gains 
that a partnership elects to defer. A partnership is an eligible 
taxpayer under paragraph (b)(1) of this section and may elect to defer 
recognition of some or all of its eligible gains under section 1400Z-
2(a)(2).
    (i) Partnership election. If a partnership properly makes an 
election under section 1400Z-2(a)(2), then--
    (A) The partnership defers recognition of the gain under the rules 
of section 1400Z-2 (that is, the partnership does not recognize gain at 
the time it otherwise would have in the absence of the election to 
defer gain recognition);

[[Page 54292]]

    (B) The deferred gain is not included in the distributive shares of 
the partners under section 702 and is not subject to section 705(a)(1); 
and
    (ii) Subsequent recognition. Absent any additional deferral under 
section 1400Z-2(a)(1)(A), any amount of deferred gain that an electing 
partnership subsequently must include in income under sections 1400Z-
2(a)(1)(B) and (b) is recognized by the electing partnership at the 
time of inclusion and is subject to sections 702 and 705(a)(1) in a 
manner consistent with recognition at that time.
    (2) Eligible gains that the partnership does not defer--(i) Tax 
treatment of the partnership. If a partnership does not elect to defer 
some, or all, of the gains for which it could make a deferral election 
under section 1400Z-2, the partnership's treatment of any such amounts 
is unaffected by the fact that the eligible gain could have been 
deferred under section 1400Z-2.
    (ii) Tax treatment by the partners. If a partnership does not elect 
to defer some, or all, of the gains for which it could make a deferral 
election under section 1400Z-2--
    (A) The gains for which a deferral election are not made are 
included in the partners' distributive shares under section 702 and are 
subject to section 705(a)(1);
    (B) If a partner's distributive share includes one or more gains 
that are eligible gains with respect to the partner, the partner may 
elect under section 1400Z-2(a)(1)(A) to defer some or all of its 
eligible gains; and
    (C) A gain in a partner's distributive share is an eligible gain 
with respect to the partner only if it is an eligible gain with respect 
to the partnership and it did not arise from a sale or exchange with a 
person that, within the meaning of section 1400Z-2(e)(2), is related to 
the partner.
    (iii) 180-day period for a partner electing deferral--(A) General 
rule. If a partner's distributive share includes a gain that is 
described in paragraph (c)(2)(ii)(C) of this section (gains that are 
eligible gains with respect to the partner), the 180-day period with 
respect to the partner's eligible gains in the partner's distributive 
share generally begins on the last day of the partnership taxable year 
in which the partner's allocable share of the partnership's eligible 
gain is taken into account under section 706(a).
    (B) Elective rule. Notwithstanding the general rule in paragraph 
(c)(2)(iii)(A) of this section, if a partnership does not elect to 
defer all of its eligible gain, the partner may elect to treat the 
partner's own 180-day period with respect to the partner's distributive 
share of that gain as being the same as the partnership's 180-day 
period.
    (C) The following example illustrates the principles of this 
paragraph (c)(2)(iii).

    (1) Example.  Five individuals have identical interests in 
partnership P, there are no other partners, and P's taxable year is 
the calendar year. On January 17, 2019, P realizes a capital gain of 
$1000x that it decides not to elect to defer. Two of the partners, 
however, want to defer their allocable portions of that gain. One of 
these two partners invests $200x in a QOF during February 2020. 
Under the general rule in paragraph (c)(2)(iii)(A) of this section, 
this investment is within the 180-day period for that partner (which 
begins on December 31, 2019). The fifth partner, on the other hand, 
decides to make the election provided in paragraph (c)(2)(iii)(B) of 
this section and invests $200x in a QOF during February 2019. Under 
that elective rule, this investment is within the 180-day period for 
that partner (which begins on January 17, 2019).

    (2) [Reserved]
    (3) Pass-through entities other than partnerships. If an S 
corporation; a trust; or a decedent's estate recognizes an eligible 
gain, or would recognize an eligible gain if it did not elect to defer 
recognition of the gain under section 1400Z-2(a), then rules analogous 
to the rules of paragraph (c)(1) and (2) of this section apply to that 
entity and to its shareholders or beneficiaries, as the case may be.
    (d) Elections. The Commissioner may prescribe in guidance published 
in the Internal Revenue Bulletin or in forms and instructions (see 
Sec. Sec.  601.601(d)(2) and 601.602 of this chapter), both the time, 
form, and manner in which an eligible taxpayer may elect to defer 
eligible gains under section 1400Z-2(a) and also the time, form, and 
manner in which a partner may elect to apply the elective 180-day 
period provided in paragraph (c)(2)(iii)(B) of this section.
    (e) Applicability date. This section applies to eligible gains that 
would be recognized in the absence of deferral on or after the date of 
publication in the Federal Register of a Treasury decision adopting 
these proposed rules as final regulations. An eligible taxpayer, 
however, may rely on the proposed rules in this section with respect to 
eligible gains that would be recognized before that date, but only if 
the taxpayer applies the rules in their entirety and in a consistent 
manner.
0
Par. 3. Section 1.1400Z2(c)-1 is added to read as follows:


Sec.  1.1400Z2(c)-1  Investments held for at least 10 years.

    (a) Limitation on the 10-year rule. As required by section 1400Z-
2(e)(1)(B) (treatment of investments with mixed funds), section 1400Z-
2(c) (special rule for investments held for at least 10 years) applies 
only to the portion of an investment in a QOF with respect to which a 
proper election to defer gain under section 1400Z-2(a)(1) is in effect.
    (b) Extension of availability of the election described in section 
1400Z-2(c). The ability to make an election under section 1400Z-2(c) 
for investments held for at least 10 years is not impaired solely 
because, under section 1400Z-1(f), the designation of one or more 
qualified opportunity zones ceases to be in effect. The preceding 
sentence does not apply to elections under section 1400Z-2(c) that are 
related to dispositions occurring after December 31, 2047.
    (c) Examples. The following examples illustrate the principles of 
paragraphs (a) and (b) of this section.

    (1) Example 1.  (i) Facts. In 2020, taxpayer G invests $100 in 
QOF S in exchange for 100 common shares of QOF S and properly makes 
an election under section 1400Z-2(a) to defer $100 of gain. G also 
acquires 200 additional common shares in QOF in exchange for $z. G 
does not make a section 1400Z-2(a) deferral election with respect to 
any of the $z investments. At the end of 2028, the qualified 
opportunity zone designation expires for the population census tract 
in which QOF S primarily conducts its trade or business. In 2031, G 
sells all of its 300 QOF S shares, realizes gain, and makes an 
election to increase the qualifying basis in G's QOF S shares to 
fair market value. But for the expiration of the designated zones in 
section 1400Z-1(f), QOF S and G's conduct is consistent with 
continued eligibility to make the election under section 1400Z-2(c).
    (ii) Analysis. Under paragraph (b) of this section, although the 
designation expired on December 31, 2028, the expiration of the 
zone's designation does not, without more, invalidate G's ability to 
make an election under section 1400Z-2(c). Accordingly, pursuant to 
that election, G's basis is increased in the one-third portion of 
G's investment in QOF S with respect to which G made a proper 
deferral election under section 1400Z-2(a)(2) (100 common shares/300 
common shares). Under section 1400Z-2(e)(1) and paragraph (a) of 
this section, however, the election under section 1400Z-2(c) is 
unavailable for the remaining two-thirds portion of G's investment 
in QOF S because G did not make a deferral election under section 
1400Z-2(a)(2) for this portion of its investment in QOF S (200 
common shares/300 common shares).

    (2) [Reserved]
    (d) Applicability date. This section applies to an election under 
section 1400Z-2(c) related to dispositions made after the date of 
publication in the Federal Register of a Treasury decision adopting 
these proposed rules as final regulations. A taxpayer, however, may 
rely on the proposed rules in this

[[Page 54293]]

section with respect to dispositions of investment interests in QOFs in 
situations where the investment was made in connection with an election 
under section 1400Z-2(a) that relates to the deferral of a gain such 
that the first day of 180-day period for the gain was before the date 
of applicability of that section. The preceding sentence applies only 
if the taxpayer applies the rules of this section in their entirety and 
in a consistent manner.
0
Par. 4. Section 1.1400Z2(d)-1 is added to read as follows:


Sec.  1.1400Z2(d)-1  Qualified Opportunity Funds.

    (a) Becoming a Qualified Opportunity Fund (QOF)-(1) Self-
certification. Except as provided in paragraph (e)(1) of this section, 
if a taxpayer that is classified as a corporation or partnership for 
Federal tax purposes is eligible to be a QOF, the taxpayer may self-
certify that it is QOF. This section refers to such a taxpayer as an 
eligible entity. The following rules apply to the self-certification:
    (i) Time, form, and manner. The self-certification must be effected 
at such time and in such form and manner as may be prescribed by the 
Commissioner in IRS forms or instructions or in publications or 
guidance published in the Internal Revenue Bulletin (see Sec. Sec.  
601.601(d)(2) and 601.602 of this chapter).
    (ii) First taxable year. The self-certification must identify the 
first taxable year that the eligible entity wants to be a QOF.
    (iii) First month. The self-certification may identify the first 
month (in that initial taxable year) in which the eligible entity wants 
to be a QOF.
    (A) Failure to specify first month. If the self-certification fails 
to specify the month in the initial taxable year that the eligible 
entity first wants to be a QOF, then the first month of the eligible 
entity's initial taxable year as a QOF is the first month that the 
eligible entity is a QOF.
    (B) Investments before first month not eligible for deferral. If an 
investment in eligible interests of an eligible entity occurs prior to 
the eligible entity's first month as a QOF, any election under section 
1400Z-2(a)(1) made for that investment is invalid.
    (2) Becoming a QOF in a month that is not the first month of the 
taxable year. If an eligible entity's self-certification as a QOF is 
first effective for a month that is not the first month of that 
entity's taxable year--
    (i) For purposes of section 1400Z-2(d)(1)(A) and (B) in the first 
year of the QOF's existence, the phrase first 6-month period of the 
taxable year of the fund means the first 6 months each of which is in 
the taxable year and in each of which the entity is a QOF. Thus, if an 
eligible entity becomes a QOF in the seventh or later month of a 12-
month taxable year, the 90-percent test in section 1400Z-2(d)(1) takes 
into account only the QOF's assets on the last day of the taxable year.
    (ii) The computation of any penalty under section 1400Z-2(f)(1) 
does not take into account any months before the first month in which 
an eligible entity is a QOF.
    (3) Pre-existing entities. There is no legal barrier to a pre-
existing eligible entity becoming a QOF, but the eligible entity must 
satisfy all of the requirements of section 1400Z-2, including the 
requirements regarding qualified opportunity zone property, as defined 
in section 1400Z-2(d)(2). In particular, that property must be acquired 
after December 31, 2017.
    (b) Valuation of assets for purposes of the 90-percent asset test--
(1) In general. For a taxable year, if a QOF has an applicable 
financial statement within the meaning of Sec.  1.475(a)-4(h), then the 
value of each asset of the QOF for purposes of the 90-percent asset 
test in section 1400Z-2(d)(1) is the value of that asset as reported on 
the QOF's applicable financial statement for the relevant reporting 
period.
    (2) QOF without an applicable financial statement. If paragraph 
(b)(1) of this section does not apply to a QOF, then the value of each 
asset of the QOF for purposes of the 90-percent asset test in section 
1400Z-2(d)(1) is the QOF's cost of the asset.
    (c) Qualified opportunity zone property--(1) In general. Pursuant 
to section 1400Z-2(d)(2)(A), the following property is qualified 
opportunity zone property:
    (i) Qualified opportunity zone stock as defined in paragraph (c)(2) 
of this section,
    (ii) Qualified opportunity zone partnership interest as defined in 
paragraph (c)(3) of this section, and
    (iii) Qualified opportunity zone business property as defined in 
paragraph (c)(4) of this section.
    (2) Qualified opportunity zone stock--(i) In general. Except as 
provided in paragraphs (c)(2)(ii) and (e)(2) of this section, if an 
entity is classified as a corporation for Federal tax purposes 
(corporation), then an equity interest (stock) in the entity is 
qualified opportunity zone stock if--
    (A) The stock is acquired by a QOF after December 31, 2017, at its 
original issue (directly or through an underwriter) from the 
corporation solely in exchange for cash,
    (B) As of the time the stock was issued, the corporation was a 
qualified opportunity zone business as defined in section 1400Z-2(d)(3) 
and paragraph (d) of this section (or, in the case of a new 
corporation, the corporation was being organized for purposes of being 
such a qualified opportunity zone business), and
    (C) During substantially all of the QOF's holding period for the 
stock, the corporation qualified as a qualified opportunity zone 
business as defined in section 1400Z-2(d)(3) and paragraph (d) of this 
section.
    (ii) Redemptions of stock. Pursuant to section 1400Z-
2(d)(2)(B)(ii), rules similar to the rules of section 1202(c)(3) apply 
for purposes of determining whether stock in a corporation qualifies as 
qualified opportunity zone stock.
    (A) Redemptions from taxpayer or related person. Stock acquired by 
a QOF is not treated as qualified opportunity zone stock if, at any 
time during the 4-year period beginning on the date 2 years before the 
issuance of the stock, the corporation issuing the stock purchased 
(directly or indirectly) any of its stock from the QOF or from a person 
related (within the meaning of section 267(b) or 707(b)) to the QOF. 
Even if the purchase occurs after the issuance, the stock was never 
qualified opportunity zone stock.
    (B) Significant redemptions. Stock issued by a corporation is not 
treated as qualified opportunity zone stock if, at any time during the 
2-year period beginning on the date 1 year before the issuance of the 
stock, the corporation made 1 or more purchases of its stock with an 
aggregate value (as of the time of the respective purchases) exceeding 
5 percent of the aggregate value of all of its stock as of the 
beginning of the 2-year period. Even if one or more of the 
disqualifying purchases occurs after the issuance, the stock was never 
qualified opportunity zone stock.
    (C) Treatment of certain transactions. If any transaction is 
treated under section 304(a) as a distribution in redemption of the 
stock of any corporation, for purposes of paragraphs (c)(2)(ii)(A) and 
(B) of this section, that corporation is treated as purchasing an 
amount of its stock equal to the amount that is treated as such a 
distribution under section 304(a).
    (3) Qualified opportunity zone partnership interest. Except as 
provided in paragraph (e)(2) of this section, if an entity is 
classified as a partnership for Federal tax purposes (partnership), any 
capital or profits interest (partnership interest) in the entity is a 
qualified

[[Page 54294]]

opportunity zone partnership interest if--
    (i) The partnership interest is acquired by a QOF after December 
31, 2017, from the partnership solely in exchange for cash,
    (ii) As of the time the partnership interest was acquired, the 
partnership was a qualified opportunity zone business as defined in 
section 1400Z-2(d)(3) and paragraph (d) of this section (or, in the 
case of a new partnership, the partnership was being organized for 
purposes of being a qualified opportunity zone business), and
    (iii) During substantially all of the QOF's holding period for the 
partnership interest, the partnership qualified as a qualified 
opportunity zone business as defined in section 1400Z-2(d)(3) and 
paragraph (d) of this section.
    (4) Qualified opportunity zone business property of a QOF. Tangible 
property used in a trade or business of a QOF is qualified opportunity 
zone business property for purposes of paragraph (c)(1)(iii) of this 
section if--
    (i) The tangible property satisfies section 1400Z-2(d)(2)(D)(i)(I);
    (ii) The original use of the tangible property in the qualified 
opportunity zone, within the meaning of paragraph (c)(7) of this 
section, commences with the QOF, or the QOF substantially improves the 
tangible property within the meaning of paragraph (c)(8) of this 
section (which defines substantial improvement in this context); and
    (iii) During substantially all of the QOF's holding period for the 
tangible property, substantially all of the use of the tangible 
property was in a qualified opportunity zone.
    (5) Substantially all of a QOF's holding period for property 
described in paragraphs (c)(2), (3), and (4) of this section. 
[Reserved]
    (6) Substantially all of the usage of tangible property by a QOF in 
a qualified opportunity zone. [Reserved]
    (7) Original use of tangible property. [Reserved]
    (8) Substantial improvement of tangible property--(i) In general. 
Except as provided in paragraph (c)(8)(ii) of this section, for 
purposes of paragraph (c)(4)(ii) of this section, tangible property is 
treated as substantially improved by a QOF only if, during any 30-month 
period beginning after the date of acquisition of the property, 
additions to the basis of the property in the hands of the QOF exceed 
an amount equal to the adjusted basis of the property at the beginning 
of the 30-month period in the hands of the QOF.
    (ii) Special rules for land and improvements on land--(A) Buildings 
located in the zone. If a QOF purchases a building located on land 
wholly within a QOZ, under section 1400Z-2(d)(2)(D)(ii) a substantial 
improvement to the purchased tangible property is measured by the QOF's 
additions to the adjusted basis of the building. Under section 1400Z-
2(d), measuring a substantial improvement to the building by additions 
to the QOF's adjusted basis of the building does not require the QOF to 
separately substantially improve the land upon which the building is 
located.
    (B) [Reserved]
    (d) Qualified opportunity zone business--(1) In general. A trade or 
business is a qualified opportunity zone business if--
    (i) Substantially all of the tangible property owned or leased by 
the trade or business is qualified opportunity zone business property 
as defined in paragraph (d)(2) of this section,
    (ii) Pursuant to section 1400Z-2(d)(3)(A)(iii), the trade or 
business satisfies the requirements of section 1397C(b)(2), (4), and 
(8) as defined in paragraph (d)(5) of this section, and
    (iii) Pursuant to section 1400Z-2(d)(3)(A)(iii), the trade or 
business is not described in section 144(c)(6)(B) as defined in 
paragraph (d)(6) of this section.
    (2) Qualified opportunity zone business property of the qualified 
opportunity zone business for purposes of paragraph (d)(1)(i) of this 
section--(i) In general. The tangible property used in a trade or 
business of an entity is qualified opportunity zone business property 
for purposes of paragraph (d)(1)(i) of this section if--
    (A) The tangible property satisfies section 1400Z-2(d)(2)(D)(i)(l);
    (B) The original use of the tangible property in the qualified 
opportunity zone commences with the entity or the entity substantially 
improves the tangible property within the meaning of paragraph (d)(4) 
of this section (which defines substantial improvement in this 
context); and
    (C) During substantially all of the entity's holding period for the 
tangible property, substantially all of the use of the tangible 
property was in a qualified opportunity zone.
    (ii) Substantially all of a qualified opportunity zone business's 
holding period for property described in paragraph (d)(2)(i)(C) of this 
section. [Reserved]
    (iii) Substantially all of the usage of tangible property by a 
qualified opportunity zone business in a qualified opportunity zone. 
[Reserved]
    (3) Substantially all requirement of paragraph (d)(1)(i) of this 
section--(i) In general. A trade or business of an entity is treated as 
satisfying the substantially all requirement of paragraph (d)(1)(i) of 
this section if at least 70 percent of the tangible property owned or 
leased by the trade or business is qualified opportunity zone business 
property as defined in paragraph (d)(2) of this section.
    (ii) Calculating percent of tangible property owned or leased in a 
trade or business--(A) In general. If an entity has an applicable 
financial statement within the meaning of Sec.  1.475(a)-4(h), then the 
value of each asset of the entity as reported on the entity's 
applicable financial statement for the relevant reporting period is 
used for determining whether a trade or business of the entity 
satisfies the first sentence of paragraph (d)(3)(i) of this section 
(concerning whether the trade or business is a qualified opportunity 
zone business).
    (B) Entity without an applicable financial statement. If paragraph 
(d)(3)(ii)(A) of this section does not apply to an entity and a 
taxpayer both holds an equity interest in the entity and has self-
certified as a QOF, then that taxpayer may value the entity's assets 
using the same methodology under paragraph (b) of this section that the 
taxpayer uses for determining its own compliance with the 90-percent 
asset requirement of section 1400Z-2(d)(1) (Compliance Methodology), 
provided that no other equity holder in the entity is a Five-Percent 
Zone Taxpayer. If paragraph (d)(3)(ii)(A) of this section does not 
apply to an entity and if two or more taxpayers that have self-
certified as QOFs hold equity interests in the entity and at least one 
of them is a Five-Percent Zone Taxpayer, then the values of the 
entity's assets may be calculated using the Compliance Methodology that 
both is used by a Five-Percent Zone Taxpayer and that produces the 
highest percentage of qualified opportunity zone business property for 
the entity.
    (C) Five Percent Zone Taxpayer. A Five-Percent Zone Taxpayer is a 
taxpayer that has self-certified as a QOF and that holds stock in the 
entity (if it is a corporation) representing at least 5 percent in 
voting rights and value or holds an interest of at least 5 percent in 
the profits and capital of the entity (if it is a partnership).
    (iii) Example. The following example illustrates the principles of 
paragraph (d)(3)(ii) of this section.

    (A) Example.  Entity ZS is a corporation that has issued only 
one class of stock and that conducts a trade or business. Taxpayer X 
holds 94% of the ZS stock, and Taxpayer Y holds the remaining 6% of 
that stock. (Thus, both X and Y are Five Percent Zone

[[Page 54295]]

Taxpayers within the meaning of paragraph (d)(3)(ii)(C) of this 
section.) ZS does not have an applicable financial statement, and, 
for that reason, a determination of whether ZS is conducting a 
qualified opportunity zone business may employ the Compliance 
Methodology of X or Y. X and Y use different Compliance 
Methodologies permitted under paragraph (d)(3)(ii)(B) of this 
section for purposes of satisfying the 90-percent asset test of 
section 1400Z-2(d)(1). Under X's Compliance Methodology (which is 
based on X's applicable financial statement), 65% of the tangible 
property owned or leased by ZS's trade or business is qualified 
opportunity zone business property. Under Y's Compliance Methodology 
(which is based on Y's cost), 73% of the tangible property owned or 
leased by ZS's trade or business is qualified opportunity zone 
business property. Because Y's Compliance Methodology would produce 
the higher percentage of qualified opportunity zone business 
property for ZS (73%), both X and Y may use Y's Compliance 
Methodology to value ZS's owned or leased tangible property. If ZS's 
trade or business satisfies all additional requirements in section 
1400Z-2(d)(3), the trade or business is a qualified opportunity zone 
business. Thus, if all of the additional requirements in section 
1400Z-2(d)(2)(B) are satisfied, stock in ZS is qualified opportunity 
zone stock in the hands of a taxpayer that has self-certified as a 
QOF.

    (B) [Reserved]
    (4) Substantial improvement of tangible property for purposes of 
paragraph (d)(2)(i)(B) of this section--(i) In general. Except as 
provided in paragraph (d)(4)(ii) of this section, for purposes of 
paragraph (d)(2)(i)(B) of this section, tangible property is treated as 
substantially improved by a qualified opportunity zone business only 
if, during any 30-month period beginning after the date of acquisition 
of such tangible property, additions to the basis of such tangible 
property in the hands of the qualified opportunity zone business exceed 
an amount equal to the adjusted basis of such tangible property at the 
beginning of such 30-month period in the hands of the qualified 
opportunity zone business.
    (ii) Special rules for land and improvements on land--(A) Buildings 
located in the zone. If a QOF purchases a building located on land 
wholly within a QOZ, under section 1400Z-2(d)(2)(D)(ii) a substantial 
improvement to the purchased tangible property is measured by the QOF's 
additions to the adjusted basis of the building. Under section 1400Z-
2(d), measuring a substantial improvement to the building by additions 
to the QOF's adjusted basis of the building does not require the QOF to 
separately substantially improve the land upon which the building is 
located.
    (B) [Reserved]
    (5) Operation of section 1397C requirements incorporated by 
reference--(i) Gross income requirement. Section 1400Z-2(d)(3)(A)(iii) 
incorporates section 1397C(b)(2), requiring that for each taxable year 
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.
    (ii) Use of intangible property requirement--(A) In general. 
Section 1400Z-2(d)(3) incorporates section 1397C(b)(4), requiring that, 
with respect to any taxable year, a substantial portion of the 
intangible property of an opportunity zone business is used in the 
active conduct of a trade or business in the qualified opportunity 
zone.
    (B) Active conduct of a trade or business. [Reserved]
    (iii) Nonqualified financial property limitation. Section 1400Z-
2(d)(3) incorporates section 1397C(b)(8), limiting in each taxable year 
the average of the aggregate unadjusted bases of the property of a 
qualified opportunity zone business that may be attributable to 
nonqualified financial property. Section 1397C(e)(1), which defines the 
term nonqualified financial property for purposes of section 
1397C(b)(8), excludes from that term reasonable amounts of working 
capital held in cash, cash equivalents, or debt instruments with a term 
of 18 months or less (working capital assets).
    (iv) Safe harbor for reasonable amount of working capital. Solely 
for purposes of applying section 1397C(e)(1) to the definition of a 
qualified opportunity zone business under section 1400Z-2(d)(3), 
working capital assets are treated as reasonable in amount for purposes 
of sections 1397C(b)(2) and 1400Z-2(d)(3)(A)(ii), if all of the 
following three requirements are satisfied:
    (A) Designated in writing. These amounts are designated in writing 
for the acquisition, construction, and/or substantial improvement of 
tangible property in a qualified opportunity zone, as defined in 
section 1400Z-1(a).
    (B) Reasonable written schedule. There is a written schedule 
consistent with the ordinary start-up of a trade or business for the 
expenditure of the working capital assets. Under the schedule, the 
working capital assets must be spent within 31 months of the receipt by 
the business of the assets.
    (C) Property consumption consistent. The working capital assets are 
actually used in a manner that is substantially consistent with 
paragraph (d)(5)(iv)(A) and (B) of this section.
    (v) Safe harbor for gross income derived from the active conduct of 
business. Solely for purposes of applying the 50-percent test in 
section 1397C(b)(2) to the definition of a qualified opportunity zone 
business in section 1400Z-2(d)(3), if any gross income is derived from 
property that paragraph (d)(5)(iv) of this section treats as a 
reasonable amount of working capital, then that gross income is counted 
toward satisfaction of the 50-percent test.
    (vi) Safe harbor for use of intangible property. Solely for 
purposes of applying the use requirement in section 1397C(b)(4) to the 
definition of a qualified opportunity zone business under section 
1400Z-2(d)(3), the use requirement is treated as being satisfied during 
any period in which the business is proceeding in a manner that is 
substantially consistent with paragraphs (d)(5)(iv)(A) through (C) of 
this section.
    (vii) Safe harbor for property on which working capital is being 
expended. If paragraph (d)(5)(iv) of this section treats some financial 
property as being a reasonable amount of working capital because of 
compliance with the three requirements of paragraph (d)(5)(iv)(A)-(C) 
and if the tangible property referred to in paragraph (d)(5)(iv)(A) is 
expected to satisfy the requirements of section 1400Z-2(d)(2)(D)(1) as 
a result of the planned expenditure of those working capital assets, 
then that tangible property is not treated as failing to satisfy those 
requirements solely because the scheduled consumption of the working 
capital is not yet complete.
    (viii) Example. The following example illustrates the rules of this 
paragraph (d)(5):

    (A) Facts.  In 2019, Taxpayer H realized $w million of capital 
gains and within the 180-day period invested $w million in QOF T, a 
qualified opportunity fund. QOF T immediately acquired from 
partnership P a partnership interest in P, solely in exchange for $w 
million of cash. P immediately placed the $w million in working 
capital assets, which remained in working capital assets until used. 
P had written plans to acquire land in a qualified opportunity zone 
on which it planned to construct a commercial building. Of the $w 
million, $x million was dedicated to the land purchase, $y million 
to the construction of the building, and $z million to ancillary but 
necessary expenditures for the project. The written plans provided 
for purchase of the land within a month of receipt of the cash from 
QOF T and for the remaining $y and $z million to be spent within the 
next 30 months on construction of the building and on the ancillary 
expenditures. All expenditures were made on schedule, consuming the 
$w million. During the taxable years that overlap with the first 31-

[[Page 54296]]

month period, P had no gross income other than that derived from the 
amounts held in those working capital assets. Prior to completion of 
the building, P's only assets were the land it purchased, the 
unspent amounts in the working capital assets, and P's work in 
process as the building was constructed.
    (B) Analysis of construction--(1) P met the three requirements 
of the safe harbor provided in paragraph (d)(5)(iv) of this section. 
P had a written plan to spend the $w received from QOF T for the 
acquisition, construction, and/or substantial improvement of 
tangible property in a qualified opportunity zone, as defined in 
section 1400Z-1(a). P had a written schedule consistent with the 
ordinary start-up for a business for the expenditure of the working 
capital assets. And, finally, P's working capital assets were 
actually used in a manner that was substantially consistent with its 
written plan and the ordinary start-up of a business. Therefore, the 
$x million, the $y million, and the $z million are treated as 
reasonable in amount for purposes of sections 1397C(b)(2) and 1400Z-
2(d)(3)(A)(ii).
    (2) Because P had no other gross income during the 31 months at 
issue, 100 percent of P's gross income during that time is treated 
as derived from an active trade or business in the qualified 
opportunity zone for purposes of satisfying the 50-percent test of 
section 1397C(b)(2).
    (3) For purposes of satisfying the requirement of section 
1397C(b)(4), during the period of land acquisition and building 
construction a substantial portion of P's intangible property is 
treated as being used in the active conduct of a trade or business 
in the qualified opportunity zone.
    (4) All of the facts described are consistent with QOF T's 
interest in P being a qualified opportunity zone partnership 
interest for purposes of satisfying the 90-percent test in section 
1400Z-2(d)(1).
    (C) Analysis of substantial improvement. The above conclusions 
would also apply if P's plans had been to buy and substantially 
improve a pre-existing commercial building. In addition, the fact 
that P's basis in the building has not yet doubled does not cause 
the building to fail to satisfy section 1400Z-2(d)(2)(D)1)(III).

    (6) Trade or businesses described in section 144(c)(6)(B) not 
eligible. Pursuant to section 1400Z-2(d)(3)(A)(iii), the following 
trades or businesses described in section 144(c)(6)(B) cannot qualify 
as a qualified opportunity zone business:
    (i) Any private or commercial golf course,
    (ii) Country club,
    (iii) Massage parlor,
    (iv) Hot tub facility,
    (v) Suntan facility,
    (vi) Racetrack or other facility used for gambling, or
    (vii) Any store the principal business of which is the sale of 
alcoholic beverages for consumption off premises.
    (e) Exceptions based on where an entity is created, formed, or 
organized--(1) QOFs. If a partnership or corporation (an entity) is not 
organized in one of the 50 states, the District of Columbia, or the 
U.S. possessions, it is ineligible to be a QOF. If an entity is 
organized in a U.S. possession but not in one of the 50 States or the 
District of Columbia, it may be a QOF only if it is organized for the 
purpose of investing in qualified opportunity zone property that 
relates to a trade or business operated in the U.S. possession in which 
the entity is organized.
    (2) Entities that can issue qualified opportunity zone stock or 
qualified opportunity zone partnership interests. If an entity is not 
organized in one of the 50 states, the District of Columbia, or the 
U.S. possessions, an equity interest in the entity is neither qualified 
opportunity zone stock nor a qualified opportunity zone partnership 
interest. If an entity is organized in a U.S. possession but not in one 
of the 50 States or the District of Columbia, an equity interest in the 
entity may be qualified opportunity zone stock or a qualified 
opportunity zone partnership interest, as the case may be, only if the 
entity conducts a qualified opportunity zone business in the U.S. 
possession in which the entity is organized. An entity described in the 
preceding sentence is treated as satisfying the ``domestic'' 
requirement in section 1400Z-2(d)(2)(B)(i) or section 1400Z-2(C)(i).
    (3) U.S. possession defined. For purposes of this paragraph (e), a 
U.S. possession means any jurisdiction other than the 50 States and the 
District of Columbia where a designated qualified opportunity zone 
exists under section 1400Z-1.
    (f) Applicability date. This section applies for QOF taxable years 
that begin on or after the date of publication in the Federal Register 
of a Treasury decision adopting these proposed rules as final 
regulations. A QOF, however, may rely on the proposed rules in this 
section with respect to taxable years that begin before the date of 
applicability of this section, but only if the QOF applies the rules in 
their entirety and in a consistent manner.
0
Par. 5. Section 1.1400Z2(e)-1 is added to read as follows:


Sec.  1.1400Z2(e)-1  Applicable rules.

    (a) Treatment of investments with mixed funds--(1) Investments to 
which no election under section 1400Z-2(a) applies. If a taxpayer 
invests money in a QOF and does not make an election under section 
1400Z-2(a) with respect to that investment, the investment is one 
described in section 1400Z-2(e)(1)(A)(ii) (a separate investment to 
which section 1400Z-2(a), (b), and (c) do not apply).
    (2) Treatment of deemed contributions of money under 752(a). In the 
case of a QOF classified as a partnership for Federal income tax 
purposes, the deemed contribution of money described in section 752(a) 
does not create or increase an investment in the fund described in 
section 1400Z-2(e)(1)(A)(ii). Thus, any basis increase resulting from a 
deemed section 752(a) contribution is not taken into account in 
determining the portion of a partner's investment subject to section 
1400Z-2(e)(1)(A)(i) or (ii).

    (3) Example.  The following example illustrates the rules of 
this paragraph (a):
    (i) Taxpayer A owns a 50 percent capital interest in Partnership 
P. Under section 1400Z 2(e)(1), 90 percent of A's investment is 
described in section 1400Z-2(e)(1)(A)(i) (an investment that only 
includes amounts to which the election under section 1400Z-2(a) 
applies), and 10 percent is described in section 1400Z-
2(e)(1)(A)(ii) (a separate investment consisting of other amounts). 
Partnership P borrows $8 million. Under Sec.  1.752-3(a), taking 
into account the terms of the partnership agreement, $4 million of 
the $8 million liability is allocated to A. Under section 752(a), A 
is treated as contributing $4 million to Partnership P. Under 
paragraph (2) of this section, A's deemed $4 million contribution to 
Partnership P is ignored for purposes of determining the percentage 
of A's investment in Partnership P subject to the deferral election 
under section 1400Z-2(a) or the portion not subject to such the 
deferral election under section 1400Z-2(a). As a result, after A's 
section 752(a) deemed contribution, 90 percent of A's investment in 
Partnership P is described in section 1400Z-2(e)(1)(A)(i) and 10 
percent is described in section 1400Z-2(e)(1)(A)(ii).
    (ii) [Reserved]
    (b) [Reserved]
    (c) Applicability date. This section applies to investments in, and 
deemed contributions of money to, a QOF that occur on or after the date 
of publication in the Federal Register of a Treasury decision adopting 
these proposed rules as final regulations. An eligible taxpayer, 
however, may rely on the proposed rules in this section with respect to 
investments, and deemed contributions, before the date of applicability 
of this section, but only if the taxpayer applies the rules in their 
entirety and in a consistent manner.

Kirsten B. Wielobob,
Deputy Commissioner for Services and Enforcement.
[FR Doc. 2018-23382 Filed 10-25-18; 4:15 pm]
 BILLING CODE 4830-01-P