[Federal Register Volume 85, Number 8 (Monday, January 13, 2020)]
[Rules and Regulations]
[Pages 1866-2001]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2019-27846]



[[Page 1865]]

Vol. 85

Monday,

No. 8

January 13, 2020

Part II





Department of the Treasury





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Internal Revenue Service





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26 CFR 1





Investing in Qualified Opportunity Funds; Final Rule

Federal Register / Vol. 85 , No. 8 / Monday, January 13, 2020 / Rules 
and Regulations

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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[TD 9889]
RIN 1545-BP04


Investing in Qualified Opportunity Funds

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final regulation.

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SUMMARY: This document contains final regulations governing the extent 
to which taxpayers may elect the Federal income tax benefits provided 
by section 1400Z-2 of the Internal Revenue Code (Code) with respect to 
certain equity interests in a qualified opportunity fund (QOF). The 
final regulations address the comments received in response to the two 
notices of proposed rulemaking issued under section 1400Z-2 and provide 
additional guidance for taxpayers eligible to elect to temporarily 
defer the inclusion in gross income of certain gains if corresponding 
amounts are invested in certain equity interests in QOFs, as well as 
guidance on the ability of such taxpayers to exclude from gross income 
additional gain recognized after holding those equity interests for at 
least 10 years. The final regulations also address various requirements 
that must be met for an entity to qualify as a QOF, including 
requirements that must be met for an entity to qualify as a qualified 
opportunity zone business. The final regulations affect entities that 
self-certify as QOFs and eligible taxpayers that make investments, 
whether qualifying or non-qualifying, in such entities.

DATES: 
    Effective date: The final regulations contained in this document 
are effective on March 13, 2020.
    Applicability dates: See SUPPLEMENTARY INFORMATION.

FOR FURTHER INFORMATION CONTACT: Concerning section 1400Z-2 and these 
regulations generally, Alfred H. Bae, (202) 317-7006, or Kyle C. 
Griffin, (202) 317-4718, of the Office of Associate Chief Counsel 
(Income Tax and Accounting); concerning issues related to C 
corporations and consolidated groups, Jeremy Aron-Dine, (202) 317-6848, 
or Sarah Hoyt, (202) 317-5024, of the Office of Associate Chief Counsel 
(Corporate); concerning issues related to gains from financial 
contracts, REITs, or RICs, Andrea Hoffenson or Pamela Lew, (202) 317-
7053, of the Office of Associate Chief Counsel (Financial Institutions 
and Products); concerning issues related to investments by foreign 
persons, Eric Florenz, (202) 317-6941, or Milton Cahn (202) 317-6937, 
of the Office of Associate Chief Counsel (International); concerning 
issues related to partnerships, S corporations or trusts, Marla 
Borkson, Sonia Kothari, or Vishal Amin, at (202) 317-6850, and 
concerning issues related to estates and gifts, Leslie Finlow or 
Lorraine Gardner, at (202) 317-6859, of the Office of Associate Chief 
Counsel (Passthroughs and Special Industries). These numbers are not 
toll-free numbers.

SUPPLEMENTARY INFORMATION: 

Background

    This document amends the Income Tax Regulations (26 CFR part 1) by 
adding final regulations under section 1400Z-2 of the Code. Section 
13823 of Public Law 115-97, 131 Stat. 2054 (December 22, 2017), 
commonly referred to as the Tax Cuts and Jobs Act (TCJA), added 
sections 1400Z-1 and 1400Z-2 to the Code. Section 1400Z-1 addresses the 
designation of population census tracts located in the 50 states, U.S. 
territories, and the District of Columbia as qualified opportunity 
zones (QOZs). See Notice 2018-48, 2018-28 I.R.B. 9, and Notice 2019-42, 
2019-29 I.R.B. 352, for the list of population census tracts designated 
as QOZs (each, a QOZ designation notice).
    Section 1400Z-2 provides two main Federal income tax benefits to 
eligible taxpayers that make longer-term investments of new capital in 
one or more designated QOZs through QOFs and qualified opportunity zone 
businesses. The first main Federal income tax benefit provided by 
section 1400Z-2 is the ability of an eligible taxpayer, upon the making 
of a valid election, to defer until as late as December 31, 2026, the 
inclusion in gross income of certain gains that would otherwise be 
recognized in a taxable year if the taxpayer invests a corresponding 
amount of such gain in a qualifying investment in a QOF within a 180-
day statutory period. The eligible taxpayer may potentially exclude 10 
percent of such deferred gain from gross income if the eligible 
taxpayer holds the qualifying investment in the QOF for at least five 
years. See section 1400Z-2(b)(2)(B)(iii). An additional five percent of 
such gain may potentially be excluded from gross income if the eligible 
taxpayer holds that qualifying investment for at least seven years. See 
section 1400Z-2(b)(2)(B)(iv). The second main Federal income tax 
benefit provided by section 1400Z-2 is the ability for the eligible 
taxpayer, upon the making of a separate valid election, to exclude from 
gross income any appreciation on the eligible taxpayer's qualifying 
investment in the QOF if the eligible taxpayer holds the qualifying 
investment for at least 10 years. See section 1400Z-2(c).
    On October 29, 2018, the Department of the Treasury (Treasury 
Department) and the IRS published a notice of proposed rulemaking (REG-
115420-18) in the Federal Register (83 FR 54279) containing a first set 
of proposed regulations under section 1400Z-2 (October 2018 proposed 
regulations). The October 2018 proposed regulations addressed the type 
of gain that is eligible for deferral by eligible taxpayers, the timing 
by which eligible taxpayers must invest amounts in QOFs corresponding 
to the gains to be deferred, and the manner in which eligible taxpayers 
could make deferral elections of any gains. The October 2018 proposed 
regulations also provided rules for the self-certification of QOFs, 
valuation of QOF assets, and general guidance on the requirements for a 
corporation or partnership to be a qualified opportunity zone business, 
including providing that the term ``substantially all'' as used in 
section 1400Z-2(d)(3)(A)(i) means at least 70 percent. The Treasury 
Department and the IRS received 180 written and electronic comments 
responding to the October 2018 proposed regulations. A public hearing 
on the October 2018 proposed regulations was held on February 14, 2019.
    A second notice of proposed rulemaking (REG-120186-18) was 
published in the Federal Register (84 FR 18652) on May 1, 2019, 
containing additional proposed regulations under section 1400Z-2 (May 
2019 proposed regulations). The May 2019 proposed regulations updated 
portions of the October 2018 proposed regulations to address various 
issues, including: The definition of the term ``substantially all'' in 
each of the various places the term appears in section 1400Z-2; 
transactions resulting in the inclusion under section 1400Z-2(a)(1)(B) 
and (b) of eligible gain that an eligible taxpayer elected to defer 
under section 1400Z-2(a); the treatment of leased property used by a 
QOF or qualified opportunity zone business; the use of qualified 
opportunity zone business property in the QOZ; the sourcing of gross 
income to the qualified opportunity zone business; and the ``reasonable 
period'' for a QOF to reinvest proceeds from the sale of qualifying 
assets without paying the penalty imposed by section 1400Z-2(f)(1). The 
Treasury Department and

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the IRS received 127 written and electronic comments responding to the 
May 2019 proposed regulations. A public hearing on the May 2019 
proposed regulations was held on July 9, 2019.
    The October 2018 proposed regulations and the May 2019 proposed 
regulations are collectively referred to in this Treasury decision as 
the ``proposed regulations.'' All comments received on the proposed 
regulations are available at www.regulations.gov or upon request.
    The preamble to the May 2019 proposed regulations stated that the 
Treasury Department and the IRS would schedule tribal consultation with 
officials of governments of Federally recognized Indian tribes (Indian 
tribal governments) before finalizing the proposed regulations to 
obtain additional input, within the meaning of the Treasury 
Department's Tribal Consultation Policy (80 FR 57434, September 23, 
2015), in accordance with Executive Order 13175, ``Consultation and 
Coordination with Indian tribal governments'' (65 FR 67249, November 6, 
2000), on the ability of entities organized under the law of an Indian 
tribe to be QOFs or qualified opportunity zone businesses, whether any 
additional guidance may be needed regarding the ability of QOFs or 
qualified opportunity zone businesses to lease tribal government 
Federal trust lands or leased real property located on such lands, and 
any other tribal implications of the proposed regulations. This tribal 
consultation took place via telephone on October 21, 2019 
(Consultation) (see part VI. of the Special Analyses for additional 
discussion).
    After full consideration of all comments received on the proposed 
regulations, including comments received from the Consultation, and the 
testimony heard at both public hearings, this Treasury decision adopts 
the proposed regulations with modifications in response to such 
comments and testimony, as described in the Summary of Comments and 
Explanation of Revisions following this Background.
    For dates of applicability, see Sec. Sec.  1.1400Z2(a)-1, 
1.1400Z2(b)-1, 1.1400Z2(c)-1, 1.1400Z2(d)-1, 1.1400Z2(d)-2, 
1.1400Z2(f)-1, 1.1502-14Z, and 1.1504-3 set forth in this document, 
which provide that the final regulations set forth in Sec. Sec.  
1.1400Z2(a)-1 through 1.1400Z2(d)-2, 1.1400Z2(f)-1, 1.1502-14Z, and 
1.1504-3 are generally applicable for taxable years beginning after 
March 13, 2020. With respect to the portion of a taxpayer's first 
taxable year ending after December 21, 2017 that began on December 22, 
2017, and for taxable years beginning after December 21, 2017, and on 
or before March 13, 2020, taxpayers may choose either (1) to apply the 
final regulations set forth in Sec. Sec.  1.1400Z2(a)-1 through 
1.1400Z2(d)-2, 1.1400Z2(f)-1, 1.1502-14Z, and 1.1504-3 contained in 
this document, if applied in a consistent manner for all such taxable 
years, or (2) to rely on each section of proposed Sec. Sec.  
1.1400Z2(a)-1 through 1.1400Z2(g)-1, except for proposed Sec.  
1.1400Z2(c)-1, contained in the notice of proposed rulemaking documents 
published on October 29, 2018, and on May 1, 2019, in the Federal 
Register (83 FR 54279; 84 FR 18652), but only if relied upon in a 
consistent manner for all such taxable years. Taxpayers relying on each 
section of proposed Sec. Sec.  1.1400Z2(a)-1 through 1.1400Z2(g)-1, 
except for proposed Sec.  1.1400Z2(c)-1, contained in the notice of 
proposed rulemaking documents published on October 29, 2018, and on May 
1, 2019, in the Federal Register (83 FR 54279; 84 FR 18652), must apply 
Sec.  1.1400Z2(c)-1 of the final regulations contained in this document 
with respect to any elections made under section 1400Z-2(c).

Summary of Comments and Explanation of Revisions

I. Overview

    The final regulations set forth in Sec. Sec.  1.1400Z2(a)-1 through 
1.1400Z2(f)-1, 1.1502-14Z, and 1.1504-3 (section 1400Z-2 regulations) 
retain the basic approach and structure of the proposed regulations, 
with certain revisions. The Treasury Department and the IRS have 
refined and clarified certain aspects of the proposed regulations in 
these final regulations to make the rules easier to follow and 
understand. Specifically, proposed Sec.  1.1400Z2(d)-1 has been split 
into two separate sections: Sec. Sec.  1.1400Z2(d)-1 and 1.1400Z2(d)-2. 
Further, the Treasury Department and the IRS have combined duplicative 
rules regarding QOFs and qualified opportunity zone businesses, and 
have added defined terms to allow the reader to more intuitively grasp 
the meaning of the numerous provisions cross-referenced in the final 
regulations.
    This Summary of Comments and Explanation of Revisions discusses 
those revisions as well as comments received in response to each of 
Sec. Sec.  1.1400Z2(a)-1 through 1.1400Z2(g)-1 of the proposed 
regulations (proposed Sec. Sec.  1.1400Z2(a)-1 through 1.1400Z2(g)-1). 
The rules proposed in the October 2018 proposed regulations and the May 
2019 proposed regulations are explained in greater detail in the 
Explanation of Provisions sections of the preambles to each set of 
proposed regulations.

II. Comments on and Changes to Proposed Sec.  1.1400Z2(a)-1

    Proposed Sec.  1.1400Z2(a)-1 prescribed rules regarding the 
election to defer gains under section 1400Z-2(a)(1), including rules 
regarding which taxpayers are eligible to make the election, which 
gains are eligible for deferral, and the method by which eligible 
taxpayers may make deferral elections. This part II describes the 
revisions made to proposed Sec.  1.1400Z2(a)-1 based on the comments 
received on those proposed rules, including revisions to the definition 
of eligible gain and revisions to the rules applying the statutory 180-
period and other requirements with regard to the making of a qualifying 
investment in a QOF.

A. Definitions and Related Operating Rules

1. Eligible Gain
    Proposed Sec.  1.1400Z2(a)-1(b)(2) generally provided that an 
amount of gain would be eligible for deferral under section 1400Z-2(a) 
if the gain (i) is treated as a capital gain for Federal income tax 
purposes that 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 (ii) did not arise from a sale or exchange 
with a related person within the meaning of section 1400Z-2(e)(2) 
(eligible gain). This part II.A.1. describes the comments received on 
various aspects of the proposed definition of eligible gain and 
explains the revisions, based on those comments, adopted by Sec.  
1.1400Z2(a)-1(b)(11) of the final regulations.
a. Gains From Section 1231 Property
    Proposed Sec.  1.1400Z2(a)-1(b)(2)(iii) of the May 2019 proposed 
regulations provided that the only gain arising from property used in 
the taxpayer's trade or business (section 1231 property) eligible for 
deferral under section 1400Z-2(a)(1) was ``capital gain net income'' 
for a taxable year, which was defined as the amount by which the 
capital gains arising from all of a taxpayer's section 1231 property 
exceeded all of the taxpayer's losses from section 1231 property for a 
taxable year. The Treasury Department and the IRS have reconsidered 
this approach based on the numerous comments received on this aspect of 
the May 2019 proposed regulations.

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i. Section 1231 Generally
    Section 1231 governs the character of a taxpayer's gains or losses 
with respect to section 1231 property not otherwise characterized by 
section 1245 or 1250. Section 1231(b) defines ``section 1231 property'' 
generally as depreciable or real property that is used in the 
taxpayer's trade or business and held for more than one year, subject 
to enumerated exceptions (for example, property held by the taxpayer 
primarily for sale to customers in the ordinary course of the 
taxpayer's trade or business).
    Under section 1231(a)(1), if a taxpayer's aggregate gains from each 
sale and exchange (each gain, a section 1231 gain) during the taxable 
year exceed the taxpayer's aggregate losses from each sale and exchange 
(each loss, a section 1231 loss), the taxpayer's section 1231 gains and 
section 1231 losses are treated as long-term capital gains and long-
term capital losses, respectively. However, if the aggregate section 
1231 gains do not exceed the aggregate section 1231 losses (that is, 
the aggregate amount of section 1231 gains equals or is less than the 
aggregate amount of section 1231 losses), those gains and losses are 
not treated as gains and losses from sales or exchanges of capital 
assets (that is, they are treated as ordinary income and ordinary 
losses). See sections 64, 1221, 1222, and 1231(a)(2) of the Code.
    Several provisions of the Code may apply to limit the long-term 
capital treatment otherwise potentially provided under section 
1231(a)(1). For example, prior to the aggregation of section 1231 gains 
and losses under section 1231(a), the recapture rules of sections 1245 
and 1250 must be applied on an asset-by-asset basis. Section 1245, 
which applies to sales, exchanges, or dispositions of depreciable 
tangible and intangible property, characterizes any gain recognized as 
ordinary income (as defined in section 64) to the extent depreciation 
or amortization has been allowed or allowable with respect to that 
property. Section 1250 provides a similar ``pre-aggregation'' recapture 
rule with regard to sales, exchanges, or dispositions of depreciable 
real property that is not section 1245 property, and it characterizes 
as ordinary income (as defined in section 64) any gain recognized in 
excess of straight line depreciation.
    Section 1231(c), on the other hand, sets forth a ``post-
aggregation'' recapture provision, requiring the net section 1231 gain 
for any taxable year to be treated as ordinary income to the extent 
that such gain does not exceed the non-recaptured net section 1231 
losses. Non-recaptured net section 1231 losses are net section 1231 
losses for the five most recent preceding taxable years of the taxpayer 
that have not yet been recaptured. However, section 1231(c)(5), 
provides that the principles of section 1231(a)(4) apply for purposes 
of section 1231(c). Under section 1231(a)(4), to determine whether 
gains exceed losses for the section 1231(a) character determination, 
section 1231 gains are included only if and to the extent that they are 
taken into account in computing gross income, and section 1231 losses 
are included only if and to the extent that they are taken into account 
in computing taxable income.
    Essentially, the operation of the ``pre-aggregation'' recapture 
rules under sections 1245 and 1250, as well as the ``post-aggregation'' 
recapture rule under section 1231(c), requires a gain recognized with 
respect to section 1231 property potentially to be treated as ordinary 
income, even if that gain otherwise would have been characterized 
differently under section 1231(a) in the absence of such recapture 
rules.
    Section 64 defines the term ``ordinary income'' for purposes of 
subtitle A of the Code (subtitle A), which includes sections 1231, 
1245, 1250, and 1400Z-2, to include ``any gain from the sale or 
exchange of property which is neither a capital asset nor property 
described in section 1231(b),'' and provides further that ``[a]ny gain 
from the sale or exchange of property which is treated or considered, 
under other provisions of this subtitle, as `ordinary income' shall be 
treated as gain from the sale or exchange of property which is neither 
a capital asset nor property described in section 1231(b).'' See for 
example, sections 1231(c), 1245, and 1250; see also Sec. Sec.  1.1245-
1(a)(1), 1.1245-1(b)(2), 1.1250-1(a)(1), 1.1250-1(b)(1), and 1.1250-
1(c)(1).
ii. Comments on Treatment of Section 1231 Property
    Commenters suggested that the gross amount of section 1231 gain 
realized from sales or exchanges of section 1231 property should be 
eligible gain, provided that such gain is determined to be capital gain 
at the end of the taxable year by taking into account all section 1231 
gains and section 1231 losses. Some commenters also recommended that 
the 180-day period for investment begin on the date of the sale or 
exchange that gives rise to a section 1231 gain instead of at the end 
of the taxable year. Many of the commenters recognized that, because 
section 1231(a)(1) requires a netting process to determine whether 
section 1231 gains and losses are capital in character, investors might 
not be certain if any of the section 1231 gain invested from sales or 
exchanges before the end of the taxable year is capital in character. 
Therefore, several commenters suggested that gross section 1231 gains 
be eligible for investment on the date of the sale or exchange, 
contingent on such gains being capital in character as determined by 
the netting process at the end of the taxable year. Under this 
approach, if the section 1231 gains invested in a QOF during a taxable 
year are determined not to be capital in character because section 1231 
gains for the year do not exceed section 1231 losses, the section 1231 
gains invested that year would constitute an investment that does not 
qualify for deferral under section 1400Z-2(a)(1) (a non-qualifying 
investment).
    In the alternative, many commenters recommended an election to 
permit a taxpayer to begin the 180-day period for section 1231 gains on 
the last day of the taxable year. This election would accommodate the 
needs of taxpayers who are unable to determine whether section 1231 
gains will be capital in character until all transactions involving 
section 1231 property have been completed for a taxable year. As a 
model for this elective approach, commenters referred to proposed Sec.  
1.1400Z2(a)-1(c)(2)(iii)(B), which permits a partner to elect to align 
its 180-day period with that of the partnership, that is, the date of 
the sale or exchange giving rise to such gain.
    Commenters observed that because gain that is deferred under 
section 1400Z-2 would not be taken into account in computing gross 
income until recognized, pursuant to section 1231(a)(4), any deferred 
gains would be excluded from the section 1231(a) character 
determination. As a result, taxpayers could ensure that section 1231 
gains do not exceed section 1231 losses for a taxable year under 
section 1231(a) by investing the excess of gains realized from the sale 
or exchange of section 1231 property over the losses from those sales, 
thus, rendering all section 1231 losses, that otherwise would be 
capital in character, ordinary in character. However, commenters noted 
that section 1231(a)(4) gives rise to a circularity issue if applied in 
this manner. If the only section 1231 gains that are eligible for 
deferral under section 1400Z-2 are capital character section 1231 
gains, then, if a taxpayer invests an amount of section 1231 gains in a 
QOF such that the character determination under section 1231(a) 
produces ordinary character gains and

[[Page 1869]]

losses for a taxable year, then all section 1231 gains in that taxable 
year would not be eligible gains. Therefore, in light of the 
application of section 1231(a)(4), a taxpayer could only defer an 
amount of section 1231 gains such that even after subtracting deferred 
gains, the remaining non-deferred section 1231 gains for the taxable 
year would still exceed section 1231 losses. In many cases, this excess 
amount would be substantially less than the gross amount of section 
1231 gains realized from the sale or exchange section 1231 property for 
the taxable year. To resolve both the issue of shifting the character 
of otherwise capital character section 1231 losses to ordinary 
character section 1231 losses and the circularity issue described 
previously, a commenter suggested treating section 1231 gains deferred 
under section 1400Z-2 as if they were ``taken into account in computing 
gross income'' for purposes of section 1231(a)(4). Under such a rule, 
even if the full amount of section 1231 gains that are capital in 
character were deferred under section 1400Z-2, section 1231 gains would 
still exceed section 1231 losses and both section 1231 gains and losses 
would retain their capital character after the application of section 
1231(a).
    Several commenters also requested additional rules with respect to 
the application of the rules of section 1231(c) (described earlier) to 
deferred section 1231 gain. Commenters suggested a rule providing that 
deferred section 1231 gain to the extent of non-recaptured net section 
1231 losses be treated as ordinary income when those gains are 
recognized rather than in the year of gain deferral. In some instances, 
this approach may require a taxpayer to account for its non-recaptured 
net section 1231 losses for a period longer than the five most recent 
taxable years section 1231(c) requires. A commenter suggested that the 
extension of the recapture period be accomplished by means of an 
election by the taxpayer at the time any section 1231 gain is deferred 
under section 1400Z-2. In electing to defer section 1231 gain, a 
taxpayer also would elect to extend the section 1231(c) recapture 
period to the longer of the statutory five-year period or the taxable 
year that includes December 31, 2026. Alternatively, some commenters 
asked that section 1231(c) not apply at all to deferred section 1231 
gains.
    One commenter also noted that the term ``capital gain net income'' 
already is defined in section 1222(9), and that its separate definition 
and use in the section 1400Z-2 regulations might lead to confusion.
    In response to these comments, the final regulations provide that 
eligible gains that may be deferred pursuant to section 1400Z-
2(a)(1)(A) and the section 1400Z-2 regulations include gains from the 
sale or exchange of property described in section 1231(b) not required 
to be characterized as ordinary income by sections 1245 or 1250 
(qualified section 1231 gains), regardless of whether section 1231(a) 
(without regard to section 1231(a)(4)) would determine those gains to 
be capital or ordinary in character. As noted earlier, section 64 
provides that gains from the sale or exchange of section 1231 property 
generally are not considered ordinary income for purposes of subtitle 
A, although recaptured income under section 1245 or 1250 would be 
ordinary income under section 64.
    However, the final regulations do not set forth a special rule to 
address the application of section 1231(a)(4) for purposes of applying 
section 1400Z-2 and the section 1400Z-2 regulations. Thus, section 
1231(a)(4) applies to eligible section 1231 gains deferred pursuant to 
section 1400Z-2(a)(1)(A) as it would under similar deferral provisions, 
such as sections 453 and 1031. That is, unless a section 1231 gain (as 
defined in section 1231(a)(3)(A)) is taken into account in computing 
gross income in a taxable year, section 1231(a)(4) does not include 
that gain in calculating whether section 1231 gains exceed section 1231 
losses under section 1231(a)(1) for the taxable year.
    Additionally, these final regulations do not alter the statutory 
application of the section 1231(c) recapture of net ordinary loss. 
Therefore, if a deferral election with respect to an eligible section 
1231 gain is made in year 1, any non-recaptured net section 1231 losses 
from the five most recent taxable years that precede year 1 apply to 
recapture as ordinary income in year 1 any net section 1231 gain that 
has not been deferred in year 1. In other words, the section 1231(c) 
amount that would have applied to the eligible section 1231 gain absent 
a deferral election and corresponding investment in a QOF is not an 
attribute associated with the deferred eligible section 1231 gain that 
is taken into account in applying section 1231 in the ultimate year in 
which the deferred gain is included in income under section 1400Z-2(b) 
and the section 1400Z-2 regulations. Instead, when deferred eligible 
section 1231 gain is subsequently included in income on December 31, 
2026, or on an earlier date as a result of an inclusion event, section 
1231(c) will recapture net section 1231 gain in the year of inclusion 
by taking into account non-recaptured section 1231 losses only from the 
five most recent taxable years preceding the taxable year of inclusion.
    Unlike the net approach of the proposed regulations, the final 
regulations adopt a gross approach to eligible section 1231 gains 
without regard to any section 1231 losses. In addition, under the final 
regulations, the character of eligible section 1231 gains, other than 
as gains arising from the sale or exchange of section 1231 property, is 
not determined until the taxable year such gains are taken into account 
in computing gross income pursuant to section 1231(a)(4). Accordingly, 
the term ``capital gain net income'' used in the proposed regulations 
is no longer applicable when referring to the amount of any gain from 
the sale or exchange of section 1231 property that is eligible for 
deferral under section 1400Z-2(a)(1)(A) and the section 1400Z-2 
regulations.
    The Treasury Department and the IRS have determined that a gross 
approach that does not apply section 1231(a) and (c) (gross approach) 
to determine eligible gain from the sale or exchange of section 1231 
property is consistent with the long-standing rules of section 64, and 
is appropriate due to the complexity of applying section 1231 to 
deferred gains generally. Moreover, limiting eligible gain from the 
sale or exchange of section 1231 property to an amount less than the 
net section 1231 gains for a taxable year would impose a significant 
administrative burden on persons that are required to report the 
recognition of such gains during the taxable year under Federal income 
tax accounting principles (eligible taxpayers). Similarly, a gross 
approach to determine eligible section 1231 gains eliminates complexity 
and uncertainty in determining eligible gain for partnerships and S 
corporations that are eligible taxpayers.
    As discussed in part II.A.3.a. of this Summary of Comments and 
Explanation of Revisions, because eligible gains include the gross 
amount of eligible section 1231 gains unreduced by section 1231 losses 
regardless of character, it is not necessary for an investor to wait 
until the end of the taxable year to determine whether any eligible 
section 1231 gains are eligible gains. As a consequence, the final 
regulations provide that the 180-day period for investing an amount 
with respect to an eligible section 1231 gain for which a deferral 
election is to be made begins on the date of the sale or exchange that 
gives rise to the eligible section 1231 gain.

[[Page 1870]]

b. Character of Eligible Gain
    Section 1400Z-2(a)(1)(A) provides that if a taxpayer has ``gain 
from the sale to, or exchange with, an unrelated person of any property 
held by the taxpayer,'' the taxpayer may elect to exclude from gross 
income for the taxable year the aggregate amount of such gain invested 
by the taxpayer in a QOF during the 180-day period beginning on the 
date of such sale or exchange. The Treasury Department and the IRS 
considered whether ``gain'' eligible for deferral under section 1400Z-2 
should include both gain from the disposition of a capital asset as 
well as gain treated as ordinary income under subtitle A.
    As noted in part II.A.1.a, section 64 of the Code provides 
generally that for purposes of subtitle A, the term ``ordinary income'' 
includes any gain from the sale or exchange of property which is 
neither a capital asset nor property described in section 1231(b). Any 
gain from the sale or exchange of property which is treated or 
considered, under other provisions of subtitle A, as ``ordinary 
income'' shall be treated as gain from the sale or exchange of property 
which is neither a capital asset nor property described in section 
1231(b). Thus, for purposes of subtitle A, including section 1400Z-2, 
section 64 defines gains treated as ordinary income as categorically 
different from gains from the sale or exchange of capital assets or 
section 1231 property.
    In this regard, proposed Sec.  1.1400Z2(a)-1(b)(2)(i) as contained 
in the October 2018 proposed regulations provided that an amount of 
gain is an ``eligible gain,'' and thus is eligible for deferral under 
section 1400Z-2(a), if the gain is treated as a capital gain for 
Federal income tax purposes. In addition, the May 2019 proposed 
regulations provided that the only gain arising from section 1231 
property eligible for deferral under section 1400Z-2(a)(1) was 
``capital gain net income'' for a taxable year, which was defined as 
the amount by which the capital gains arising from all of a taxpayer's 
section 1231 property exceeded all of the taxpayer's losses from 
section 1231 property for a taxable year.
    Based on the statutory text of section 1400Z-2(a)(1)(A), several 
commenters requested that the final regulations permit taxpayers to 
treat both capital gains and ordinary gains (that is, gains treated as 
ordinary income) as eligible gains. For example, commenters requested 
that gain from property used in a trade or business required to be 
characterized as ordinary income, such as recapture income under 
section 1231(c) or 1245(a), should be permitted to be invested in a 
QOF.
    After consideration of the language, structure and purpose of 
section 1400Z-2 as a whole, the Treasury Department and the IRS have 
determined that it would be inconsistent with section 64 and the 
statutory framework of section 1400Z-2 to extend the meaning of the 
term ``gain'' in section 1400Z-2(a)(1) to gain required to be treated 
as ordinary income under subtitle A, including section 1245 gain. The 
interpretation of the Treasury Department and the IRS of the text and 
structure of the statute is confirmed by the legislative history, which 
explicitly identifies ``capital gains'' as the gains that are eligible 
for deferral. See H.R. Rep. No. 115-466, at 537-540 (Dec. 15, 2017) 
(Conference Report).
    Accordingly, the Treasury Department and the IRS have retained in 
the final regulations the general rule set forth in the proposed 
regulations that limits eligible gains to gains treated as capital 
gains for Federal income tax purposes. For purposes of section 1400Z-
2(a)(1), eligible gains generally include gains from the disposition of 
capital assets as defined in section 1221(a), gains from the 
disposition of property described in section 1231(b), and income 
treated as capital gain under any provision of the Code, such as 
capital gain dividends distributed by certain corporations. For this 
purpose, both long-term capital gain and short-term capital gain may be 
determined to be eligible gain under the section 1400Z-2 regulations. 
However, consistent with section 64, any gain required to be treated as 
ordinary income under subtitle A, such as section 1245 recapture 
income, is not eligible gain.
    In that regard, one commenter suggested that, unlike other 
investors in QOFs, existing residents of a QOZ should be provided a 
special accommodation not available to other eligible taxpayers--such 
residents should be permitted to invest any gain, regardless of 
character, in QOFs and elect to defer the corresponding amounts in 
accordance with section 1400Z-2. The Treasury Department and the IRS 
have determined that neither the statutory language nor legislative 
history of section 1400Z-2 supports different treatment for residents 
of QOZs regarding the deferral of eligible gains. Section 1400Z-2 
references the term ``taxpayer,'' which section 7701(a)(14) defines as 
``any person subject to any internal revenue tax.'' In turn, section 
7701(a)(1) defines the term ``person'' to include ``an individual, a 
trust, estate, partnership, association, company or corporation.''
    The Treasury Department and the IRS have determined that 
construction of the term ``taxpayer'' in accordance with section 
7701(a)(14) would be consistent with the language and purpose of 
section 1400Z-2 as a whole, and therefore would give effect to the 
intent of Congress. Moreover, disparate treatment of eligible taxpayers 
residing in QOZs and those who do not is not warranted given that the 
statute equally incents investment in QOZs by any taxpayer, including 
those that have historically invested in businesses operated within 
QOZs and those that have not. Accordingly, the section 1400Z-2 
regulations do not adopt the comment recommending special treatment for 
residents of QOZs to invest ordinary income, including gain required to 
be treated as ordinary income under subtitle A, in QOFs.
c. Gain From Sales of Capital Assets, Unreduced by Any Losses
    One commenter also requested clarification that the deferral 
election under section 1400Z-2(a)(1) applies to the gross amount of 
gain treated as capital gain unreduced by losses. The proposed 
regulations generally provided that in the case of gain from the sale 
of a capital asset as defined under section 1221, the full amount of 
capital gain from that sale or exchange, unreduced by any losses, is 
eligible gain that generally may be invested during the 180-day period 
beginning on the date of the sale or exchange of the property giving 
rise to the gain.
    The section 1400Z-2 regulations retain the general rule of the 
proposed regulations providing that the full amount of gain that would 
be recognized from the sale or exchange of a capital asset as defined 
under section 1221, unreduced by any losses, is eligible gain and 
therefore eligible taxpayers do not have to net a gain from a section 
1221 capital asset against the sum of the taxpayer's losses from 
section 1221 capital assets. Thus, if a capital gain is realized by an 
eligible taxpayer during a taxable year, section 1400Z-2 and the 
section 1400Z-2 regulations generally do not require that any losses 
reduce the amount of the gain that may be an eligible gain.
    However, gain that otherwise may qualify as a capital gain may be 
required to be recharacterized or redetermined by other provisions of 
the Code. For example, sections 1245 and 1250 may require gain that 
potentially could be characterized as capital in nature to instead be 
treated as ordinary income ``notwithstanding any other provision of

[[Page 1871]]

this subtitle,'' referring to subtitle A, which includes section 1400Z-
2. Consistent with section 64, if a provision of the Code requires the 
character of a potential capital gain to be recharacterized, 
redetermined, or treated as ordinary income for purposes of subtitle A, 
such gain cannot be, and is not, treated as other than ordinary income 
under the Code, and therefore is not eligible gain for purposes of 
section 1400Z-2 and the section 1400Z-2 regulations. See Sec. Sec.  
1.1245-1(a)(1), 1.1245-1(b)(2), 1.1250-1(a)(1), 1.1250-1(b)(1), and 
1.1250-1(c)(1).
d. Gains From Sales to, or Exchanges of Property With, a QOF or 
Qualified Opportunity Zone Business
    The October 2018 proposed regulations provided that eligible gain 
does not include gain from the sale to, or the exchange of property 
with, a person that is related to the taxpayer within the meaning of 
section 1400Z-2(e)(2). Section 1400Z-2(d)(2)(D) and the May 2019 
proposed regulations provided that qualified opportunity zone business 
property that a QOF owns must be acquired by the QOF by purchase from 
an unrelated party. As a result, property that is purchased by a QOF 
from a related party, as well as property that is contributed to a QOF 
in a transfer to which section 351 or section 721(a) applies, is not 
qualified opportunity zone business property.
    Commenters have requested confirmation that eligible gain includes 
gain arising from the sale to, or the exchange of property with, a QOF 
if the amount of the gain is later invested in that QOF. Commenters 
similarly have requested confirmation that gain from the sale to, or 
the exchange of property with, a qualified opportunity zone business is 
eligible for investment into the QOF that owns the qualified 
opportunity zone business. Relatedly, commenters have requested that 
the final regulations provide that a sale to, or an exchange of 
property with, a QOF or qualified opportunity zone business, followed 
by an investment of the amount of the sales proceeds into the QOF, 
would not be characterized as a purchase from a related party for 
purposes of section 1400Z-2(d)(2)(D).
    One commenter expressed concern that, if a taxpayer sold property 
to an unrelated QOF and then invested the amount of the sales proceeds 
in the same QOF, that sequence of transactions could be characterized 
under circular cash flow principles as if the taxpayer contributed the 
property directly to the QOF (and each transfer of the amount of the 
sales proceeds would be disregarded for Federal income tax purposes). 
If this construct applied, the acquired property would not qualify as 
qualified opportunity zone business property.
    The Treasury Department and the IRS agree that generally applicable 
Federal income tax principles would require this result if, under the 
facts and circumstances, the consideration paid by the QOF or by a 
qualified opportunity zone business returns to its initial source as 
part of the overall plan. See Rev. Rul. 83-142, 1983-2 C.B. 68; Rev. 
Rul. 78-397, 1978-2 C.B. 150. Under the step transaction doctrine and 
circular cash flow principles, the circular movement of the 
consideration in such a transaction would be disregarded for Federal 
income tax purposes, including for purposes of section 1400Z-2 and the 
section 1400Z-2 regulations. Thus, the transaction would be treated for 
Federal income tax purposes as a transfer of property to the purchasing 
QOF for an interest therein or, if applicable, as a transfer of 
property to a QOF for an interest therein followed by a transfer of 
such property by the QOF to the purchasing qualified opportunity zone 
business.
    Accordingly, an eligible taxpayer's gain from a sale to or an 
exchange of property with an unrelated QOF (acquiring QOF), as part of 
a plan that includes the investment of the consideration received by 
the eligible taxpayer back into the acquiring QOF, is not eligible gain 
to the eligible taxpayer because the transaction would not be 
characterized as a sale or exchange to an unrelated person for Federal 
income tax purposes. Similarly, an eligible taxpayer's gain from a sale 
to or an exchange of property with an unrelated qualified opportunity 
zone business (acquiring qualified opportunity zone business) is not 
eligible gain to the eligible taxpayer if the sale occurs as part of a 
plan that includes (i) the investment of the consideration received by 
the eligible taxpayer back into the QOF that owns the acquiring 
qualified opportunity zone business, followed by (ii) the contribution 
by the QOF of that consideration to the qualified opportunity zone 
business. Furthermore, because the transaction is not treated as a 
``purchase'' of tangible property by the qualified opportunity zone 
business from an unrelated party, the newly acquired property will not 
qualify as qualified opportunity zone business property under section 
1400Z-2(d)(2)(D).
    The Treasury Department and the IRS also note that, if an eligible 
taxpayer sells property to, or exchanges property with, an unrelated 
qualified opportunity zone business as part of a plan that includes the 
investment of the consideration by the taxpayer back into the QOF that 
owns the acquiring qualified opportunity zone business, the transaction 
potentially may be recast or recharacterized as a non-qualifying 
investment even if the QOF retains the consideration (rather than 
transferring the consideration to the qualified opportunity zone 
business). See Sec.  1.1400Z2(f)-1(c)(1). See also part II.D 
(discussing the transfer of property for a qualifying investment) and 
part VI.A (discussing the applicability of the step transaction 
doctrine) of this Summary of Comments and Explanation of Revisions.
e. Gain Not Subject to Federal Income Tax
    The Treasury Department and the IRS received comments regarding the 
scope of the term ``eligible gain'' with respect to gains realized by 
persons that generally are not subject to Federal income tax with 
respect to those gains, such as persons that are not United States 
persons under section 7701(a)(30) (foreign persons) or that are 
entities generally exempt from tax under the Code. Some commenters 
suggested that an eligible gain should include all realized capital 
gains, including gains that are not subject to Federal income tax. 
However, other commenters stated that permitting deferral elections 
with respect to gains that are not subject to Federal income tax would 
be inappropriate because section 1400Z-2 is premised on the assumption 
that a person could make qualified investments in a QOF only with 
respect to amounts of capital gains for which taxation is deferred.
    The Treasury Department and the IRS have determined that eligible 
taxpayers generally should be able to make an election under section 
1400Z-2(a)(1) and the section 1400Z-2 regulations only for capital 
gains that would be subject to tax under subtitle A before January 1, 
2027 (subject to Federal income tax) but for the making of a valid 
deferral election under section 1400Z-2(a)(1) and the section 1400Z-2 
regulations. Section 1400Z-2 defers the time when eligible gains are 
included in income, and there would not be any taxable income to defer 
for a gain that is not subject to Federal income tax. This approach 
ensures that both United States persons and foreign persons may be 
eligible for the Federal income tax benefits of section 1400Z-2 under 
the same conditions. Moreover, particularly with respect to foreign 
persons, the lack of any requirement that a gain be subject to Federal 
income tax would make it difficult for the IRS to verify the extent to 
which the amount being invested in

[[Page 1872]]

a QOF was, in fact, with respect to a capital gain.
    Accordingly, the final regulations clarify that deferral of a gain 
under section 1400Z-2(a)(1) and the section 1400Z-2 regulations 
generally is available only for capital gain that would be subject to 
Federal income tax but for the making of a valid deferral election 
under section 1400Z-2(a)(1) and the section 1400Z-2 regulations. Thus, 
for example, a deferral election may generally be made by nonresident 
alien individuals and foreign corporations with respect to an item of 
capital gain that is effectively connected with a U.S. trade or 
business. Further, individual bona fide residents of U.S. territories 
who are United States persons may generally make a deferral election 
with respect to an item of capital gain that is derived from sources 
outside their territory of residence. Similarly, an organization that 
is subject to the unrelated business income tax imposed by section 511 
may generally make a deferral election with respect to an item of 
capital gain to the extent the item would be included in computing the 
organization's unrelated business taxable income (such as under the 
unrelated debt-financed income rules).
    In contrast, an eligible taxpayer who is not a United States person 
within the meaning of section 7701(a)(30), or who is treated as a 
resident of another country for purposes of an applicable income tax 
treaty (foreign eligible taxpayer), should not be able to elect to 
defer an item of capital gain if, in the taxable year in which such 
gain is includible, the item is treated as exempt from Federal income 
tax under a provision of an applicable income tax treaty (for example, 
capital gain that is effectively connected with a U.S. trade or 
business but is not attributable to a permanent establishment of the 
taxpayer within the United States). To prevent foreign eligible 
taxpayers from taking inconsistent positions with respect to treaty 
benefits in the taxable year of deferral and the taxable year of 
inclusion, the final regulations provide that a foreign eligible 
taxpayer cannot make a deferral election under section 1400Z-2(a) and 
the section 1400Z-2 regulations with respect to an eligible gain unless 
the foreign eligible taxpayer irrevocably waives, in accordance with 
forms and instructions, any treaty benefits that would exempt that gain 
from Federal income tax at the time of inclusion pursuant to an 
applicable U.S. income tax convention.
    In the event that forms and instructions have not yet been 
published incorporating the treaty waiver requirement for a foreign 
eligible taxpayer for the taxable year that the deferral election 
applies to, the final regulations require the attachment of a written 
statement to waive such treaty benefits. Eligible taxpayers other than 
foreign eligible taxpayers will only be required to make this treaty 
waiver if and to the extent required in forms and publications.
    The Treasury Department and the IRS have determined that it would 
be unduly burdensome to require a partnership to determine the extent 
to which a capital gain would be, but for a deferral election by the 
partnership under section 1400Z-2(a) and the section 1400Z-2 
regulations, subject to Federal income tax by its direct or indirect 
partners because partnerships do not generally have sufficient 
information about the tax treatment and positions of their partners to 
perform this analysis. Thus, in the case of partnerships, the final 
regulations provide an exception to the general requirement that gain 
be subject to Federal income tax in order to constitute eligible gain.
    The Treasury Department and the IRS are aware that foreign persons 
who are not subject to Federal income tax may plan to enter into 
transactions including, but not limited to, the use of partnerships 
formed or availed of to circumvent the rule generally requiring 
eligible gains to be subject to Federal income tax. Therefore, under an 
anti-abuse rule added in Sec.  1.1400Z2(f)-1(c)(2), a partnership 
formed or availed of with a significant purpose of avoiding of avoiding 
the requirement in Sec.  1.1400Z2(a)-1(b)(11)(i)(B) that eligible gains 
be subject to Federal income tax will be disregarded, in whole or in 
part to prevent the creation of a qualifying investment by the 
partnership with respect to any partner that would not otherwise 
satisfy the requirement of that paragraph. The anti-abuse rule may 
apply even if some of the partners in the partnership are subject to 
Federal income tax. See Sec.  1.1400Z2(f)-1(c)(3)(i) and (ii), Examples 
1 and 2.
    Finally, in response to comments expressing uncertainty as to 
whether persons who do not or cannot make a valid deferral election for 
eligible gains nevertheless may invest in QOFs, the Treasury Department 
and the IRS note that nothing in section 1400Z-2 or the section 1400Z-2 
regulations prevents persons who do not have eligible gains from 
investing in QOFs. Thus, Indian tribal governments, and tax-exempt 
organizations that invest amounts other than items of capital gain that 
would be included in computing their unrelated business taxable income, 
may invest in a QOF to the extent otherwise permitted by law or 
regulation. However, those investments will not qualify for the Federal 
income tax benefits under section 1400Z-2 or the section 1400Z-2 
regulations. That is, those investments are not qualifying investments 
described in section 1400Z-2(e)(1)(A)(i).
f. Measuring Gain From Sales or Exchanges of Virtual Currency
    Section 1400Z-2 and the proposed regulations clearly provide that 
eligible gain is gain that has been realized pursuant to a sale or 
exchange. One commenter identified a potential obstacle in calculating 
the eligible gain from sales or exchanges of certain types of digital 
assets, including virtual currency. The commenter expressed concern 
that the vast majority of digital assets could not directly be 
exchanged for traditional types of money. The commenter explained that 
these digital assets first must be converted into other digital assets 
in taxable transactions before ultimately being sold for the type of 
currency that would be invested in a QOF. The commenter expressed 
concern that gain or loss from these intermediate transactions in which 
a digital asset is exchanged for another digital asset may not 
necessarily be tracked in detail. Thus, the commenter requested a 
separate rule for these digital assets under which eligible gain would 
be calculated by reference to the basis of the original digital asset 
and to the actual proceeds received in the ultimate transaction that 
converts an intermediate digital asset to money or property that would 
be invested in a QOF.
    Notice 2014-21, 2014-16 I.R.B. 938 provides that convertible 
virtual currency is property for Federal income tax purposes, and that 
general Federal income tax principles applicable to property 
transactions apply to transactions involving convertible virtual 
currency. Section 1400Z-2(a) applies to gain that, absent a deferral 
election, would be included in the taxpayer's gross income. To 
determine the amount of such gain, the taxpayer must know the basis of 
the property, regardless of the type of such property. If the amount 
invested in a QOF exceeds the amount of eligible gain, then the 
taxpayer will have a non-qualifying investment for the amount of gain 
invested in excess of eligible gain invested in the QOF and a 
qualifying investment for the amount of eligible gain invested in the 
QOF (mixed-funds investment). Taxpayers selling digital assets are not 
prevented from investing eligible gain generated from the sale into a 
QOF simply because one digital asset must be converted into another 
type of

[[Page 1873]]

asset before the taxpayer can convert its assets into U.S. dollars. 
Therefore, the Treasury Department and the IRS decline to adopt the 
commenter's request for a special rule for digital assets.
g. Gain From a Section 1256 Contract or a Position Part of an 
Offsetting-Positions Transaction
    The preamble to the October 2018 proposed regulations explained 
that 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, but concluded that such a rule would 
pose significant administrative burdens. Proposed Sec.  1.1400Z2(a)-
1(b)(2)(iv) provided that, 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 this 
purpose, an offsetting-positions transaction generally 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) and includes positions with respect 
to personal property that is not actively traded.
    Proposed Sec.  1.1400Z2(a)-1(b)(2)(iii)(A) provided that the only 
gain arising from section 1256 contracts that is eligible for deferral 
under section 1400Z-2(a)(1) is capital gain net income from all of a 
taxpayer's section 1256 contracts for a taxable year. Additionally, 
proposed Sec.  1.1400Z2(a)-1(b)(2)(iii)(B) provided that, if at any 
time during the taxable year, any of the taxpayer's section 1256 
contracts were part of an offsetting-positions transaction 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.
    Two commenters expressed concern about the application of the 
offsetting-positions transaction rule in the October 2018 proposed 
regulations to positions that are not part of a straddle under section 
1092. One commenter stated that the IRS did not adequately describe its 
policy concerns when extending the offsetting-positions transaction 
rule beyond the scope of section 1092. The second commenter argued that 
a taxpayer is permitted to recognize losses while deferring gains by 
continuing to hold an asset that is not actively traded, and that 
allowing deferral under section 1400Z-2(a)(1) would be no different 
than having the taxpayer continue to hold its gain position. The 
Treasury Department and the IRS appreciate the concerns expressed 
regarding the extension of the proposed offsetting-positions 
transaction rule to transactions that are not straddles under section 
1092 and the final regulations do not include the provisions that 
applied to transactions that are not straddles under section 1092.
    Two commenters expressed concern that the proposed offsetting-
positions transaction rule excluded gains from a position that, at any 
time, had been part of an offsetting-positions transaction, including 
offsetting-positions transactions that occurred many years ago. The 
commenters recommended either deleting the phrase ``or has been'' or 
limiting application of that phrase to permit deferral of capital gain 
from an offsetting-positions transaction if there is no offsetting 
position on or after the enactment of the TCJA. The Treasury Department 
and the IRS have concluded that the rule should not exclude gains that 
have, at any time, been part of an offsetting position but should 
instead exclude gains based on whether an offsetting position was in 
existence during a limited time period. Limiting the application of the 
straddle rules to situations in which there was an offsetting position 
on or after the date of the enactment of the TCJA would, in future 
years, require taxpayers and the IRS to look back over an extended 
period of time. This requirement could result in significant 
administrative burdens without serving a significant tax policy 
purpose. As a result, the Treasury Department and the IRS have revised 
the limitation on the use of gains from a straddle to net gain from a 
position that was either part of a straddle during the taxable year or 
part of a straddle in a prior taxable year if a loss from that straddle 
is carried over under section 1092(a)(1)(B) to the taxable year.
    One commenter suggested that, in the context of a straddle, the 
deferral under section 1400Z-2(a)(1) of gain from the disposition of a 
position in a straddle would not permit the current recognition of an 
otherwise suspended loss from an offsetting position in the straddle. 
The commenter also recognized, however, that it might be overly 
generous for a taxpayer investing in a QOF to eliminate 15 percent of 
the taxpayer's deferred gain (assuming that the taxpayer holds that QOF 
interest for seven years by December 31, 2026), if the taxpayer was 
also permitted ultimately to recognize all of its suspended loss from 
the offsetting straddle position. The commenter suggested a rule 
eliminating any suspended loss in the same proportion as any 
elimination of gain in one or more offsetting positions.
    The Treasury Department and the IRS have determined that there 
would be significant administrative burdens for taxpayers and the IRS 
in tracking specific gains deferred under section 1400Z-2(a)(1) for the 
purpose of determining whether and when some or all of a deferred 
straddle loss might ultimately become deductible. In addition, the 
Treasury Department and the IRS have determined that the tracking of 
deferred losses for multiple taxable years after the positions in the 
straddle have been disposed of and a potential proportional elimination 
of a suspended loss, years after the suspension, would create 
additional complexity and administrative burdens for both taxpayers and 
the IRS. The final regulations therefore provide a general rule that 
net gain from positions that are or, as described previously, in 
certain circumstances have recently been part of a straddle, are not 
eligible for deferral under section 1400Z-2(a)(1).
    Another commenter suggested that, absent a clearly articulated 
policy concern with permitting deferral of net gain from a straddle, 
the Treasury Department and the IRS should consider eliminating or 
minimizing the scope of capital gains subject to the prohibition in the 
proposed regulations. The Treasury Department and the IRS have 
concluded that, in certain circumstances, deferral of net gain from a 
straddle does not present significant policy concerns or unreasonable 
administrative burdens for taxpayers and the IRS. Under the final 
regulations, if during the taxable year: (i) A position was covered by 
an identification under section 1092 or 1256(d), (ii) no gain or loss 
with respect to any position that was part of the identified straddle 
remains unrecognized at the end of the taxable year (other than gain 
that would be recognized but for deferral under section 1400Z-2(a)(1)), 
(iii) none of the positions in the identified straddle were part of any 
other straddle during the taxable year, and (iv) none of the positions 
in the identified straddle were part of a straddle in a previous 
taxable year from which a loss was carried over to the taxable year 
under section 1092(a)(1)(B), then the net gain during the taxable year 
from positions that were part of the identified straddle is not 
prevented from being an eligible gain. Net gain from an identified 
straddle during the taxable year is equal to the excess of the capital 
gains recognized for Federal income tax

[[Page 1874]]

purposes in the taxable year, determined without regard to section 
1400Z-2(a)(1), over the sum of the capital losses and net ordinary 
losses from all positions that were part of the straddle, including 
capital gains and losses from section 1256 contracts and other 
positions marked to market on the last business day of the taxable year 
or upon transfer or termination and annual account net gain from 
positions in a mixed straddle account.
    The final regulations clarify that, if a taxpayer identifies a 
straddle under section 1092(a)(2), the taxpayer must adjust basis in 
accordance with section 1092(a)(2)(A)(ii) and (iii) when determining 
the net gain during the taxable year from positions that were part of 
the straddle. The net gain realized during the taxable year that is 
deferred under section 1400Z-2(a)(1) is not treated as unrecognized 
gain for purposes of determining whether a loss from a position in the 
straddle is deferred under section 1092(a)(3)(A)(ii).
    A commenter suggested that the provision in the October 2018 
proposed regulations disqualifying all gains from section 1256 
contracts if at any time during the taxable year, any of the taxpayer's 
section 1256 contracts were part of an offsetting-positions transaction 
and any other position in that transaction was not a section 1256 
contract be revised to limit the disqualification to the specific type 
of offsetting-positions transaction identified by the Treasury 
Department and the IRS. In response to this comment, under the final 
regulations net gain during the taxable year from section 1256 
contracts that were not part of a straddle is not prevented from being 
eligible gain.
    The final regulations also provide that additional exceptions to 
the general rule may be provided in guidance published in the Internal 
Revenue Bulletin. The Treasury Department and the IRS request comments 
on whether there are other situations that might warrant an exception 
from the general rule that net gain from a position that was either 
part of a straddle during the taxable year or part of a straddle in a 
prior year if a loss from that straddle is carried over under section 
1092(a)(1)(B) to the taxable year is not eligible gain.
2. Eligible Interests
    Proposed Sec.  1.1400Z2(a)-1(b)(3) provided that an eligible 
interest in a QOF must be an equity interest issued by a QOF, and that 
eligible interests do not include debt instruments as defined in 
section 1275(a)(1) and Sec.  1.1275-1(d). One commenter requested 
clarification with respect to debt instruments issued by a QOF or a 
potential investor. The commenter set forth a fact pattern in which an 
eligible taxpayer lends money to a QOF prior to the sale of property 
that generates eligible gain. After the sale of the property, the 
taxpayer essentially transfers its creditor position in the loan to the 
QOF. The commenter requested confirmation that such an arrangement 
would result in a qualifying investment in a QOF. Determination of the 
tax treatment of the arrangement described previously would require a 
debt-equity analysis based on a careful examination of all relevant 
facts and circumstances and Federal income tax principles apart from 
those found in section 1400Z-2 and these regulations. Accordingly, such 
an analysis would exceed the scope of these regulations.
    The commenter also described a second fact pattern in which an 
eligible taxpayer issues a promissory note to the QOF in exchange for 
an interest in the QOF. The commenter requested clarification as to 
whether such an exchange would give rise to an amount invested in the 
QOF. A taxpayer can make an investment in a QOF by contributing cash or 
property. The contribution of a promissory note, however, is 
inconsistent with the policy of the section 1400Z-2 statute to 
incentivize investments in QOZs, and is beyond the scope of these 
regulations. The Treasury Department and the IRS have determined that a 
taxpayer should not receive the benefits under section 1400Z-2 merely 
by promising to pay, and thereby invest in a QOZ, in the future. As 
such, the Treasury Department and the IRS decline to adopt this 
comment.
3. 180-Day Investment Requirement
a. Section 1231 Gains
    As discussed in part II.A.1.a. of this Summary of Comments and 
Explanation of Revisions, proposed Sec.  1.1400Z2(a)-1(b)(2)(iii) of 
the May 2019 proposed regulations provided that the 180-day period for 
investment with respect to capital gain net income from section 1231 
property for a taxable year began on the last day of the taxable year 
without regard to the date of any particular disposition of section 
1231 property.
    The Treasury Department and the IRS have received numerous comments 
regarding the ``capital gain net income'' approach of the May 2019 
proposed regulations. In response to the May 2019 proposed regulations, 
taxpayers and practitioners consistently have emphasized that the year-
long character testing period under section 1231 often can frustrate a 
taxpayer's ability to defer gains resulting from sales or exchanges of 
section 1231 property. Unlike typical transactions that result in 
ordinary or capital gain upon their completion, taxpayers generally 
lack the ability to determine whether section 1231 gain from a sale or 
exchange of section 1231 property will be capital in character until 
the completion of all sales or exchanges of section 1231 property 
during a taxable year. See generally section 1231(a), (c) (describing 
taxable-year-based determination). However, to defer recognition under 
section 1400Z-2(a), taxpayers must invest eligible gain within a 180-
day period that begins on the date on which the taxpayer otherwise 
would have recognized that gain (180-day investment requirement). See 
section 1400Z-2(a)(1)(A) (setting forth the 180-day investment 
requirement). Accordingly, commenters have recommended a wide spectrum 
of approaches to integrate the rules of section 1231 with section 
1400Z-2, including approaches that would (i) modify the timing of the 
section 1231 calculation (including recapture), the start of the 180-
day period, or both; or (ii) allow for immediate investment of gross 
section 1231 gains to be treated as eligible gains if those gains are 
determined to be capital at the end of the taxable year.
    As described in part II.A.1.a. of this Summary of Comments and 
Explanation of Revisions, the Treasury Department and the IRS have 
determined that a ``gross approach'' solely with regard to eligible 
section 1231 gains (without regard to any section 1231 losses) would 
eliminate unnecessary barriers to potential QOF investors. 
Specifically, the final regulations provide that eligible gains include 
gains from the sale or exchange of property described in section 
1231(b) not required to be characterized as ordinary income by section 
1245 or 1250 (eligible section 1231 gains), regardless of whether 
section 1231(a) (without regard to section 1231(a)(4)) would determine 
those gains to be capital or ordinary in character. This approach will 
eliminate significant complexity, as well as uncertainty in determining 
eligible gain for partnerships and S corporations that are eligible 
taxpayers. Importantly, although the determination under section 
1231(a) of the character of an eligible section 1231 gain would 
ordinarily occur at the end of a taxable year, that section 1231(a) 
determination is not necessary to determine whether that gain is 
eligible for deferral under section 1400Z-2 and the section 1400Z-2 
regulations. Because status as an

[[Page 1875]]

eligible gain relies on facts that are known at the time of a sale or 
exchange, the 180-day period for an eligible taxpayer to invest an 
amount with respect to an eligible section 1231 gain begins on the date 
of the sale or exchange giving rise to the gain rather than at the end 
of the taxable year. Therefore, an investor can invest an amount with 
respect to an eligible section 1231 gain from a sale or exchange of 
section 1231 property and have certainty as to the amount of the 
qualifying investment on the date the investment is made. Finally, 
allowing the 180-day period to begin on the date of the sale, exchange, 
or other disposition that gives rise to the eligible section 1231 gain 
accelerates both capital infusion into a QOZ and allows an investor to 
invest eligible proceeds from dispositions of section 1231 property as 
soon as any such funds are available to invest.
b. RIC and REIT Capital Gain Dividends
    Several commenters noted that the application of the 180-day 
investment requirement to real estate investment trust (REIT) capital 
gain dividends may preclude some shareholders from making qualifying 
investments in QOFs because REIT capital gain dividends are based on 
the net capital gain of the REIT during the relevant taxable year of 
the REIT. In other words, REITs determine that a dividend, or part 
thereof, is eligible for capital gain dividend status after the REIT's 
taxable year has ended, when the REIT can compute net capital gain for 
the year. Thus, a shareholder may receive a dividend during the year 
but may not receive the designation that the dividend is a capital gain 
dividend until after the REIT's taxable year has ended. To facilitate 
investment in QOZs, commenters requested that the 180-day investment 
requirement apply beginning on the last day of the REIT's taxable year, 
rather than the date on which the shareholder receives a dividend, 
thereby providing a 180-day period after the shareholder has notice of 
the dividend's capital gain designation. In the alternative, some 
commenters proposed beginning the 180-day period for investment of REIT 
capital gain dividends on the date that is 30 days after the close of 
the REIT's taxable year. Commenters also noted that the same concerns 
apply to regulated investment company (RIC) capital gain dividends and 
maintained that the 180-day period should be the same for both RIC and 
REIT capital gain dividends.
    The Treasury Department and the IRS seek to facilitate the ability 
of RIC and REIT shareholders to make qualifying investments in QOFs 
that result from capital gain dividends received during a taxable year. 
However, because shareholders may not have the same taxable year as the 
RIC or REIT in which they are invested, these final regulations provide 
that the 180-day period for RIC or REIT capital gain dividends 
generally begins at the close of the shareholder's taxable year in 
which the capital gain dividend would otherwise be recognized by the 
shareholder. To ensure that RIC and REIT shareholders do not have to 
wait until the close of their taxable year to invest capital gain 
dividends received during the taxable year, these final regulations 
provide that shareholders may elect to begin the 180-day period on the 
day each capital gain dividend is paid. The 180-day period for 
undistributed capital gain dividends, however, begins on either the 
last day of the shareholder's taxable year in which the dividend would 
otherwise be recognized or the last day of the RIC or REIT's taxable 
year, at the shareholder's election. Regardless of the 180-day period 
applicable to its capital gain dividends, the aggregate amount of a 
shareholder's eligible gain with respect to capital gain dividends 
received from a RIC or a REIT in a taxable year cannot exceed the 
aggregate amount of capital gain dividends that the shareholder 
receives as reported or designated by that RIC or that REIT for the 
shareholder's taxable year. Any excess investments will be treated 
under the final regulations as non-qualifying investments.
c. Installment Sales
    Commenters requested clarification regarding the application of the 
180-day investment requirement to gains recognized in an installment 
sale pursuant to the installment method under section 453. See section 
453(c) (defining the term ``installment method''). Section 453(a) 
provides generally that income from an installment sale must be taken 
into account for purposes of the Code under the installment method. In 
general, the installment method allows taxpayers to report gain from a 
sale of property in the taxable year or years during which payments are 
received rather than in the year of the sale. Commenters expressed 
concern that, for taxpayers who are considering investing the gain from 
an installment sale in a QOF, it is not clear whether (i) there is a 
single 180-day period for all income from the installment sale that 
begins on the date and year of the sale (for example, March 15, 2020), 
or (ii) there are multiple 180-day periods, each beginning in the year 
during which a payment is received and income is recognized under the 
installment method.
    To provide flexibility to these types of potential investors in 
QOZs, the Treasury Department and the IRS have included in these final 
regulations a rule that accommodates both of the potential options 
described by the commenters previously. Specifically, the final 
regulations allow an eligible taxpayer to elect to choose the 180-day 
period to begin on either (i) the date a payment under the installment 
sale is received for that taxable year, or (ii) the last day of the 
taxable year the eligible gain under the installment method would be 
recognized but for deferral under section 1400Z-2. As a result, if the 
taxpayer defers gain from multiple payments under an installment sale, 
there might be multiple 180-day periods, or a single 180-day period at 
the end of the taxpayer's taxable year, depending upon taxpayer's 
election.
    One commenter also requested confirmation that only capital gain 
realized with respect to an installment sale that occurred after the 
effective date of section 1400Z-2 (that is, December 22, 2017) should 
be eligible gain. The Treasury Department and the IRS have determined 
that it would be inconsistent with the general rule for eligible gains 
in the final regulations, as well as installment sale case law, to 
exclude from the definition of eligible gains any capital gains 
recognized by an eligible taxpayer under the installment method, 
regardless of whether the installment sale occurred before the 
effective date of section 1400Z-2. Accordingly, the Treasury Department 
and the IRS decline to adopt this comment.
d. Special 180-Day Period for Partners, S Corporation Shareholders, and 
Trust Beneficiaries
    The May 2019 proposed regulations provided that, for purposes of 
the 180-Day Investment Requirement, the period during which a partner 
must invest an amount equal 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). 
However, 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 
regarding the partner's distributive share of that gain as being the 
same as the partnership's 180-day period.
    Several commenters requested an additional special rule for 
application of the 180-day investment requirement

[[Page 1876]]

with regard to partners in a partnership, shareholders in an S 
corporation, and beneficiaries of a trust. These commenters highlighted 
that owners of flow-through entities experience information delays 
regarding the Federal income tax consequences of transactions taken by 
such entities due to the ordinary course timing of Schedule K-1 
issuances. As a result of this delay in receiving information necessary 
to determine the existence of eligible gain, commenters contended that 
partners in a partnership, shareholders in an S corporation, and 
beneficiaries of a trust should have an additional option to commence 
the 180-day period upon the due date of the entity's tax return.
    The Treasury Department and the IRS agree with the commenters' 
suggestions. As a result, the final regulations provide partners of a 
partnership, shareholders of an S corporation, and beneficiaries of 
decedents' estates and non-grantor trusts with the option to treat the 
180-Day period as commencing upon the due date of the entity's tax 
return, not including any extensions. However, the Treasury Department 
and the IRS have determined that similar rules for a grantor trust are 
not necessary because the grantor is treated as the owner of the 
grantor trust's property for Federal income tax purposes. Therefore, 
the final regulations set forth different rules applicable to the 
grantor.
4. Additional Deferral of Previously Invested Gains
    Section 1400Z-2(a)(2)(A) provides that no deferral election under 
section 1400Z-2(a)(1) may be made with respect to a sale or exchange if 
an election previously made with respect to the sale or exchange is in 
effect. In proposed Sec.  1.1400Z2(a)-1(b)(4)(ii)(D), Example 4 
(Proposed Example 4), a taxpayer disposed of its entire qualifying 
investment in a QOF in 2025 in a transaction that constituted an event 
described in proposed Sec.  1.1400Z(b)-1(c) (inclusion event) and 
recognized gain as a result. In the example, the taxpayer wanted to 
defer the amount of gain from the inclusion transaction by making 
another qualifying investment. The example concluded that the gain 
recognized due to the inclusion event may be invested in either the 
original QOF or a different QOF within 180 days of the inclusion event 
in order to make a new deferral election under section 1400Z-2. The 
preamble to the May 2019 proposed regulations explained that, upon 
disposition of that QOF interest, deferring an inclusion otherwise 
mandated by section 1400Z-2(a)(1)(B) is permitted only if the taxpayer 
has disposed of the entire initial investment 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.
    A commenter requested that gain from an inclusion event in which a 
taxpayer disposes of less than its entire investment in a QOF be 
eligible for the deferral election under section 1400Z-2(a)(1). The 
commenter asserted that gain arising from an inclusion event, whether 
representing all or part of the initially deferred gain, represents new 
gain that should be eligible for deferral under section 1400Z-2(a).
    The Treasury Department and the IRS agree with the commenter. The 
final regulations adopt the position that gain arising from an 
inclusion event is eligible for deferral under section 1400Z-2(a) even 
though the taxpayer retains a portion of its qualifying investment 
after the inclusion event. Although such gain relates in part to gain 
from a sale or exchange for which there was a prior election in effect, 
it is no longer subject to that prior election within the meaning of 
section 1400Z-2(a)(2)(A) as soon as the inclusion event triggers an 
income inclusion. Therefore, if an inclusion event relates only to a 
portion of a taxpayer's qualifying investment in the QOF, (i) the 
deferred gain that otherwise would be required to be included in income 
(inclusion gain amount) may be invested in a different QOF, and (ii) 
the taxpayer may make a deferral election under section 1400Z-2(a) with 
respect to the inclusion gain amount, so long as taxpayer satisfies all 
requirements for a deferral election on the inclusion gain amount. To 
satisfy the requirements under section 1400Z-2(a) and Sec.  
1.1400Z2(a)-1(b)(11)(iv), the eligible taxpayer must treat the 
inclusion gain amount to be deferred as if it were originally realized 
as a result of the inclusion event. In addition, the eligible taxpayer 
must meet all other requirements to defer gain under section 1400Z-2. 
See section 1400Z-2(a)(1) and Sec.  1.1400Z2(a)-1(b)(11)(i)(C) (gain 
that arises from a sale or exchange of property with a related person 
is not eligible gain); section 1400Z-2(a)(2)(B) (election may not be 
made for gain arising after December 31, 2026). Consistent with 
Proposed Example 4, included in these regulations as Sec.  1.1400Z2(a)-
1(b)(7)(iv)(D), the 180-day period for the inclusion gain amount begins 
on the date of the inclusion event, and the holding period for the 
second QOF investment begins on the date that an amount corresponding 
to the inclusion gain amount is invested in the second QOF. See Sec.  
1.1400Z2(a)-1(b)(7)(iv), Example 4.
    A commenter also requested clarification as to whether additional 
gain deferral under section 1400Z-2(a)(1)(A), as in Proposed Example 4, 
is permitted for gain included due to the operation of section 1400Z-
2(b)(1)(B), which requires the full amount of gain that was deferred 
under section 1400Z-2(a)(1)(A), reduced by the amount of gain 
previously included under proposed Sec.  1.1400Z2(b)-1(b) (remaining 
deferred gain) to be included in income in the taxable year of the 
eligible taxpayer that includes December 31, 2026. The commenter 
explained that the ability to reinvest gains required to be included in 
income under section 1400Z-2(b) would facilitate liquidity and capital 
mobility for investors. Moreover, in the event that additional gain 
deferral is permitted after a taxable year that includes December 31, 
2026, the commenter requested clarification regarding the effect of 
such an additional gain deferral election on items including the proper 
amount includible as well as the amount of deferred gain that may be 
reinvested for the benefits of the election under section 1400Z-2(c).
    Proposed Example 4 only illustrated that a taxpayer may invest gain 
that otherwise would be included pursuant to section 1400Z-2(b)(1)(A) 
upon the complete disposition of a QOF interest prior to December 31, 
2026 (that is, an inclusion event), where the amount of that gain is 
reinvested in any QOF during the 180-day period beginning on the date 
of the inclusion event. No inferences should be drawn regarding gains 
from dispositions after December 31, 2026, because deferral of any gain 
from such dispositions is expressly prohibited by section 1400Z-
2(a)(2)(B). Section 1400Z-2(b)(1) provides that all gain to which 
section 1400Z-2(a)(1)(A) deferral applies must be included in income in 
the taxable year that includes the earlier of the date on which a QOF 
investment is sold or exchanged or December 31, 2026. Further, section 
1400Z-2(a)(2)(B) provides that no deferral election may be made under 
section 1400Z-2(a)(1) with respect to any sale or exchange after 
December 31, 2026. Accordingly, the statutory language of section 
1400Z-2 clearly states, and therefore the section 1400Z-2 regulations 
provide, that (i) the ability to defer eligible gains pursuant to 
section 1400Z-2(a)(1)(A) is not permitted with respect to a gain 
arising after December 31, 2026, and (ii) no additional deferral of any 
gain is permitted if such gain is required to be

[[Page 1877]]

included in gross income under section 1400Z-2(b)(1)(B).
5. Qualifying Investment
    Section 1400Z-2 provides Federal income tax benefits to an eligible 
taxpayer that makes an equity investment in a QOF described in section 
1400Z-2(e)(1)(A)(i) (that is, a qualifying investment) if the 
qualifying investment is held for the various statutorily prescribed 
holding periods. For example, in the case of an eligible taxpayer that 
maintains a qualifying investment for seven years, the eligible 
taxpayer's basis in the qualifying investment will be increased by a 
total amount equal to 15 percent of the amount of the taxpayer's 
deferred gain. See section 1400Z-2(b)(2)(B)(iii) and (iv) (providing 
for basis increases of 10 and five percent, respectively). With respect 
to a qualifying investment that is sold or exchanged after being held 
by the eligible taxpayer for at least 10 years, if the eligible 
taxpayer makes an election under section 1400Z-2(c), the basis of the 
qualifying investment will be increased to an amount equal to the fair 
market value of that investment on the date on which it is sold or 
exchanged. See section 1400Z-2(c).
    In the May 2019 proposed regulations, the Treasury Department and 
the IRS specified transactions that would cause the inclusion in gross 
income of an eligible taxpayer's gain that had been deferred under 
section 1400Z-2(a)(1)(B) and (b). Defined as an ``inclusion event,'' 
each of these transactions ``would reduce or terminate the QOF 
investor's direct (or, in the case of partnerships, indirect) 
qualifying investment for Federal income tax purposes or (in the case 
of distributions) would constitute `cashing out' of the QOF investor's 
qualifying investment. . . . It is necessary to treat such 
[distributive] transactions as inclusion events to prevent taxpayers 
from `cashing out' a qualifying investment in a QOF without including 
in gross income any amount of their deferred gain.'' See May 2019 
proposed regulations, Explanation of Provisions, part VII.A.
    As indicated in the first sentence of part VII.E. (Transfers of 
Property by Gift or by Reason of Death) and elsewhere in the 
Explanation of Provisions in the May 2019 proposed regulations, the 
termination of a direct interest in a qualifying investment that 
resulted in an inclusion event terminated the status of an investment 
in a QOF as a qualifying investment `` [f]or purposes of sections 
1400Z-2(b) and (c).'' This is because the statutory text of each of 
section 1400Z-2(a), (b), (c), and (e)(1) focuses on one holding period 
of ``the taxpayer'' tested at various points during a period of at 
least 10 years.
    The May 2019 proposed regulations excepted certain enumerated 
dispositions of qualifying investments from treatment as inclusion 
events to provide for business flexibility for QOFs or qualified 
opportunity zone businesses. However, those exceptions were premised 
upon the requirement that the same eligible taxpayer generally be 
treated as continuing to hold the same interest in the QOF, and thereby 
continue to bear the Federal income tax liability associated with 
holding the interest, such as by reason of section 381 or section 
704(c). This degree of identity of taxpayer is fundamentally different 
(and more demanding) than a mere ``step in the shoes'' concept based on 
whether the transferee of the interest can tack the holding period and 
basis of the transferor. Accordingly, the May 2019 proposed regulations 
treated, among other transactions, gifts and section 351 exchanges as 
inclusion events because, in each instance, (i) the initial eligible 
taxpayer had severed the direct investment interest in the QOF and (ii) 
the transferee taxpayer was not treated for Federal income tax purposes 
either as the same taxpayer as the initial eligible taxpayer or as a 
successor taxpayer. This is true even though in each such case, the 
acquiring taxpayer's basis and holding period for purposes of 
determining gain or loss may be identical to that of the taxpayer that 
made the initial investment in the QOF. See id., parts VII.E (regarding 
gifts) and VII.G (regarding section 351 exchanges).
    Commenters have requested clarification of the treatment of 
investments in QOFs under section 1400Z-2(c) that have been disposed of 
by gift, in section 351 exchanges, and in other transactions treated as 
inclusion events. For the foregoing reasons, the final regulations 
clarify that transactions described as inclusion events result in a 
reduction or termination of a qualifying investment's status as a 
qualifying investment to the extent of the reduction or termination, 
except as otherwise provided in Sec.  1.1400Z2(b)-1(c) or other 
provisions of the section 1400Z-2 regulations. See part IV.C of this 
Summary of Comments and Explanation of Revisions. Moreover, the 
reduction or termination of that status applies for purposes of section 
1400Z-2(c) as well as section 1400Z-2(a)(1)(B) and (b). An inclusion 
event is a transaction that reduces or terminates the QOF investor's 
direct (or, in the case of partnerships, indirect) qualifying 
investment for Federal income tax purposes or, in the case of 
distributions, constitutes a ``cashing out'' of the eligible taxpayer's 
qualifying investment in the QOF. For that reason and to that extent, 
the taxpayer holding the reduced investment in the QOF after the 
inclusion event no longer possesses a qualifying investment. Thus, the 
benefits provided under section 1400Z-2(c) generally are available only 
to a taxpayer that not only makes an equity investment in a QOF 
described in section 1400Z-2(e)(1)(A)(i) (that is, a qualifying 
investment), but also then continuously maintains that qualifying 
investment throughout statutorily prescribed holding periods.
    However, consistent with that rationale, the May 2019 proposed 
regulations did not treat as an inclusion event a gift by the taxpayer 
to a grantor trust of which the taxpayer is the deemed owner because, 
for Federal income tax purposes, the owner of the grantor trust is 
treated as the owner of the trust's property and thus of the qualifying 
investment in its QOF. See id., part VII.E. See also id., part VII.F.1 
(providing a similar exception regarding section 381 transactions based 
on a statutory successor taxpayer concept). Accordingly, eligibility 
for benefits under section 1400Z-2 in these limited instances would be 
maintained.
    The Treasury Department and the IRS have received several comments 
requesting clarification that qualifying investments include interests 
received in a transfer by reason of death that is not an inclusion 
event. In the case of a decedent, section 1400Z-2(e)(3) provides a 
special rule requiring amounts recognized under section 1400Z-2, if not 
properly includible in the gross income of the decedent, to be 
includible in gross income as provided by section 691. In that specific 
case, the beneficiary that receives the qualifying investment has the 
obligation to include the deferred gain in gross income in the event of 
any subsequent inclusion event, including for example, any further 
disposition by that recipient. See id., part VII.E. In other words, 
unlike an inclusion event contemplated by the general rules of section 
1400Z-2(b), the obligation to include the original taxpayer investor's 
deferred gain in income travels with that taxpayer's qualifying 
investment to the beneficiary. Accordingly, the May 2019 proposed 
regulations excepted transfers of a qualifying investment to the 
deceased owner's estate, as well as distributions by the estate, from 
the definition of ``inclusion event.'' See id., part VII.E.
    As indicated in part VII.E. of the Explanation of Provisions of the 
May 2019 proposed regulations, the Treasury Department and the IRS have

[[Page 1878]]

determined that interests received in a transfer by reason of death 
continue to be a qualifying investment in the hands of the beneficiary 
for purposes of section 1400Z-2(c). As described earlier, sections 691 
and 1400Z-2(e)(2) require such a transfer to not give rise to an 
inclusion event because the beneficiary is treated as a successor to 
the original eligible taxpayer that made the qualifying investment 
(that is, the beneficiary ``steps into the shoes'' of the original 
taxpayer investor with regard to both the benefits of the qualifying 
investment and the obligation to ultimately include the original 
taxpayer's deferred gain into the beneficiary's income). As a result, 
the Treasury Department and the IRS have determined that a qualifying 
investment received by a beneficiary in a transfer by reason of death 
should continue to be a qualifying investment in the hands of the 
beneficiary for purposes of section 1400Z-2(b) and (c).
    The Treasury Department and the IRS have also received a comment 
suggesting that the final regulations should permit QOFs to make loans 
to qualified opportunity zone businesses and treat as qualifying 
investments the debt instruments arising from such loans. Confirmation 
of the tax treatment of such debt instruments as qualifying investments 
(that is, equity investments in a QOF) would require a debt-equity 
analysis based on a careful examination of all relevant facts and 
circumstances and Federal income tax principles apart from those found 
in section 1400Z-2 and the section 1400Z-2 regulations. Such an 
analysis would exceed the scope of these regulations. As a result, the 
final regulations do not adopt the commenter's suggestion.

B. Making an Investment for Purposes of an Election Under Section 
1400Z-2(a)

1. Acquisition of an Eligible Interest From a Person Other Than a QOF
    Proposed Sec.  1.1400Z2(a)-1(b)(9)(iii) permitted a taxpayer to 
make a deferral election under section 1400Z-2(a)(1)(A) for an eligible 
interest acquired from a person other than a QOF. Commenters asked 
whether the transferor of that eligible interest needed to have made an 
election under section 1400Z-2(a) prior to the taxpayer's acquisition. 
Commenters also asked whether the acquirer must have realized eligible 
gain within the 180-day period prior to the acquisition of the eligible 
interest in order for acquisition of that interest to support a 
deferral election under section 1400Z-2(a)(1)(A) with respect to the 
eligible gain. Additionally, commenters requested confirmation 
regarding whether shares or partnership interests in a pre-existing 
entity that becomes a QOF pursuant to proposed Sec.  1.1400Z2(d)-
1(a)(3) become eligible interests when the pre-existing corporation or 
partnership becomes a QOF.
    The final regulations do not require the transferor to have made a 
prior election under section 1400Z-2(a) for the acquirer of an eligible 
interest to make such an election. Further, for interests in entities 
that existed before the enactment of section 1400Z-2, if such entities 
become QOFs pursuant to Sec.  1.1400Z2(d)-1(a)(3), then the interests 
in those entities, even though not qualifying investments in the hands 
of a transferor, are eligible interests that may (i) be acquired by an 
investor and (ii) result in a qualifying investment of the acquirer if 
the acquirer has eligible gain and the acquisition was during the 180-
day period with respect to that gain.
2. Eligibility of Built-In Gain for Deferral
    One commenter requested confirmation that the built-in gain of a 
REIT, a RIC, or an S corporation potentially subject to corporate-level 
tax under section 1374 or Sec.  1.337(d)-7 is eligible for deferral 
under section 1400Z-2. To the extent the built-in gain is an eligible 
gain, an election under section 1400Z-2 may be made for such gain of a 
REIT, a RIC, or an S corporation. If such election is made, the amount 
of such gain will not be included in the calculation of the entity's 
net recognized built-in gain (as defined in section 1374(d)(2)) in the 
year of deferral. Similarly, if a deferral election is made with 
respect to an eligible gain that, absent the deferral election, would 
constitute a recognized built-in gain (RBIG) within the meaning of 
section 382(h)(2)(A) or section 1374(d)(3), the amount of such eligible 
gain deferred as a result of a qualifying investment in a QOF is not 
taken into account as RBIG in the year of deferral.
3. Grantor Trusts
    A commenter pointed out that the rule in proposed Sec.  
1.1400Z2(a)-1(c)(3) does not achieve the proper result for grantor 
trusts that do not make the deferral election but distribute the 
deferred gain to a trust beneficiary other than the deemed owner of the 
trust. The commenter pointed out that the proposed rule should not 
apply to grantor trusts because the deemed owner of the trust is liable 
for the Federal income tax on the gain regardless of whether that gain 
is distributed currently to a trust beneficiary other than the deemed 
owner. The commenter also requested clarification that either the 
grantor trust recognizing the gain or the deemed owner of that trust is 
eligible to both make the deferral election and make a qualifying 
investment, regardless of whether the grantor trust distributes the 
gain to the deemed owner or to any other person. The Treasury 
Department and the IRS agree with the commenter and have made the 
requested adjustments in the final regulations.

C. Identification of Disposed Interests in a QOF

    Under the May 2019 proposed regulations, if a taxpayer held 
interests in a QOF with identical rights (for example, equivalent 
shares of stock in a QOF corporation) that were acquired on different 
days, and if the taxpayer disposed of less than all of those interests 
on a single day, the taxpayer was required to use the first-in-first-
out (FIFO) method to identify which interests were disposed of for 
certain specified purposes, such as determining the character and other 
attributes of the deferred gain that is included as a result of the 
disposition. In circumstances in which the FIFO method did not provide 
a complete answer, taxpayers were required to use a pro-rata method. In 
requesting comments as to whether methods other than the FIFO method 
and the pro-rata method should be used, the Treasury Department and the 
IRS stipulated that any such 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) 
that certain dispositions of an interest in a QOF cause deferred gain 
be included in a taxpayer's income.
    In response, commenters requested that taxpayers be permitted to 
specifically identify the QOF interests that are sold or otherwise 
disposed of, and they recommended that the final regulations adopt 
rules similar to those in Sec.  1.1012-1(c). Under such rules, a 
taxpayer would be required to use the FIFO method only if the taxpayer 
fails to adequately identify which shares were disposed of.
    The Treasury Department and the IRS agree that specific 
identification should be permitted for dispositions of interests in QOF 
corporations. Thus, the final regulations permit taxpayers to employ 
the rules and principles of Sec.  1.1012-1(c) to specifically identify 
the QOF stock that is sold or otherwise disposed. If a taxpayer fails 
to adequately identify which QOF shares are disposed of, then the FIFO 
identification method applies. If, after application of the FIFO 
method, a taxpayer is treated as having disposed

[[Page 1879]]

of less than all of its investment interests that the taxpayer acquired 
on one day and the investments vary in its characteristics, then the 
pro-rata method will apply to the remainder.
    However, the final regulations do not extend this specific 
identification methodology to the disposition of interests in a QOF 
partnership because, under Federal income tax law, a partnership 
interest represents an undivided, unitary interest in all of the 
partnership assets and liabilities. Other than in the case of a mixed-
funds investment in a QOF partnership, where the section 1400Z-2 
statute mandates a division of partnership interests, the final 
regulations do not adopt the commenters' recommendation because it 
would broaden the complexities associated with dividing partnership 
interests into separate components with associated assets and 
liabilities.
    In addition, the final regulations make it clear that if a taxpayer 
is required to include in income some or all of a previously deferred 
gain, the gain so included has the same attributes that the gain would 
have had if the recognition of gain had not been deferred under section 
1400Z-2. The final regulations generally provide that forms, 
instructions, and other administrative guidance control in determining 
which deferred gains are associated with particular interests in QOFs. 
However, the final regulations also provide that, to the extent that 
such guidance does not clearly associate an investment in a QOF with an 
amount of deferred gain, an ordering rule applies that permits 
taxpayers to determine how to associate investments in QOFs with 
particular deferred gains.

D. Property Transferred in Exchange for a Qualifying Investment Is Not 
Qualified Opportunity Zone Business Property

    The May 2019 proposed regulations clarify that taxpayers may 
transfer property other than cash to a QOF in exchange for a qualifying 
investment. A commenter asked whether property that is purchased in a 
QOZ and contributed to a QOF could be qualified opportunity zone 
business property, or whether such property would be excluded 
automatically because it is not purchased by the QOF. The commenter 
further asked why taxpayers are permitted to contribute property to a 
QOF in exchange for a qualifying investment if the property cannot be 
qualified opportunity zone business property.
    Taxpayers are permitted to transfer property to a QOF in exchange 
for a qualifying investment because the statute does not preclude 
taxpayers from investing in a QOF in this manner and because permitting 
such transfers is not inconsistent with the policies underlying section 
1400Z-2. As the commenter noted, property that is contributed to a QOF 
cannot be qualified opportunity zone business property because 
qualified opportunity zone business property must be purchased by a 
QOF. See section 1400Z-2(d)(2)(D)(i)(I). The QOF may retain the 
contributed property among its assets that are not qualified 
opportunity zone property, or it may sell the property and use the 
proceeds to acquire qualified opportunity zone property in accordance 
with section 1400Z-2(d) and the section 1400Z-2 regulations.

E. Amount Invested in a QOF Partnership for Purposes of Section 1400Z-
2(a)(1)(A)

    The May 2019 proposed regulations contained two rules that, if 
either were applicable, would reduce the amount of a taxpayer's 
qualifying investment.
    First, proposed Sec.  1.1400Z2(a)-1(b)(11)(ii)(A)(1) provided that, 
to the extent the transfer of property to a QOF partnership is 
characterized other than as a contribution (for example, a transfer 
that is characterized as a disguised sale under section 707), the 
transfer is not an investment within the meaning of section 1400Z-
2(a)(1)(A) (section 1400Z-2(a)(1)(A) investment). The Treasury 
Department and the IRS confirm that the reference to the disguised sale 
regulations under section 707 is intended to provide an existing 
analytical framework and rules applicable to transfers of property to a 
QOF partnership to determine whether the transfer is a contribution for 
purposes of making a qualifying investment. All guidance under section 
707 that otherwise would be applicable, including any exception, 
applies. In particular, Sec.  1.707-4(b)(2) (relating to operating cash 
flow distributions) applies to transfers to and distributions from a 
QOF partnership. Therefore, to the extent a transfer of property is 
characterized as a sale under the existing section 707 framework, there 
is no contribution and section 1400Z-2 would not apply to the transfer. 
These final regulations do not modify section 707 or the regulations in 
this part under section 707.
    Second, proposed Sec.  1.1400Z2(a)-1(b)(11)(ii)(A)(2) provided 
that, to the extent proposed Sec.  1.1400Z2(a)-1(b)(11)(ii)(A)(1) did 
not apply, the transfer to the partnership would not be treated as a 
section 1400Z-2(a)(1)(A) investment to the extent the partnership makes 
a distribution to the partner and the transfer to the partnership and 
the distribution would be recharacterized as a disguised sale under 
section 707 if (i) any cash contributed were non-cash property, and 
(ii) in the case of a distribution by the partnership to which Sec.  
1.707-5(b) (relating to debt-financed distributions) applies, the 
partner's share of liabilities is zero. The Treasury Department and the 
IRS received comments asking for clarification of the application of 
proposed Sec.  1.1400Z2(a)-1(b)(11)(ii)(A)(2) and confirmation that the 
regulations under section 707, including the exceptions to the 
disguised sale rules, apply in determining whether a contribution, in 
whole or part, is treated as part of a disguised sale. In particular, 
commenters asked how debt-financed distributions should be treated and 
requested confirmation that operating cash flow distributions would not 
be presumed to be a part of a disguised sale.
    The Treasury Department and the IRS note that, even if a 
contribution were not recharacterized as a disguised sale under section 
707 and the regulations in this part under section 707, the amount of 
the qualifying investment is reduced under the modified application of 
the section 707 disguised sale rules in Sec.  1.1400Z2(a)-
1(c)(6)(iii)(A)(2). This provision adopts the rule contained in the May 
2019 proposed regulations without change. However, in making the 
qualifying investment determination under this rule, the other 
exceptions to the disguised sale rules still would apply. For example, 
a distribution by the partnership would not reduce the amount of the 
qualifying investment to the extent the operating cash flow 
distribution exception of Sec.  1.707-4(b) applied.
    Commenters also requested clarification regarding the Federal 
income tax consequences of distributions by an ``overfunded'' QOF 
partnership carried out to eliminate the amount of excess cash invested 
therein. Commenters explained that, in this situation, an eligible 
taxpayer would contribute a cash amount in excess of the amount that 
the QOF partnership desires to invest and, within the same year, the 
QOF partnership distributes the excess cash back to the eligible 
taxpayer. The final regulations provide an example clarifying and 
illustrating the application of the rules. The later distribution by 
the QOF partnership would be tested under the normal distribution rules 
for purposes of determining whether there is an inclusion event. For 
QOF partnerships, there would be an inclusion event to the extent the 
distribution exceeds the

[[Page 1880]]

partner's outside basis in its qualifying investment. Although the 
basis in the qualifying investment is initially zero, that basis may be 
increased by the partner's share of debt and net income.

F. At-Risk Basis

    One commenter requested clarification that investors get at-risk 
basis for their qualifying investments. The May 2019 proposed 
regulations did not address whether a taxpayer has at-risk basis in its 
qualifying investment. Thus, the commenter stated that there is 
uncertainty under the May 2019 proposed regulations as to whether 
investors' capital contributions will give rise to at-risk basis under 
section 465 even though taxpayers must take zero basis in their 
qualifying investments.
    Section 465 generally provides that a taxpayer shall be considered 
``at risk'' for an activity with respect to amounts including the 
amount of money and the adjusted basis of other property contributed by 
the taxpayer to the activity. The Treasury Department and the IRS note 
that a taxpayer's amount at risk generally is determined by reference 
to the amount of money and the basis of property contributed, not to 
the basis of the interest received in exchange for the property. 
Additionally, section 465 and the regulations in this part under 
section 465 provide the necessary guidance for this determination. As a 
result, the Treasury Department and the IRS have determined that the 
commenter's requested clarification exceeds the scope of the section 
1400Z-2 regulations.

G. Withholding Tax and FIRPTA

    The Treasury Department and the IRS received comments regarding the 
application of withholding tax regimes within the context of section 
1400Z-2(a). For example, a commenter requested that a foreign taxpayer 
engaging in a sale subject to withholding under section 1445(a) 
(imposing a 15 percent withholding tax as part of the Foreign 
Investment in Real Property Tax Act (FIRPTA)) be able to provide a 
certificate or other form of documentation to avoid withholding on the 
basis of the taxpayer's intention to invest the resulting gain in a QOF 
pursuant to a deferral election under section 1400Z-2(a)(1). Another 
commenter requested an exemption from withholding when a person enters 
into an agreement with the IRS to pay the tax when the deferred gain is 
included under section 1400Z-2(a)(1)(B) and (b), similar to when a gain 
recognition agreement is ``triggered'' under section 367 and the 
regulations in this part under section 367. The Treasury Department and 
the IRS continue to consider this comment and other matters related to 
the mechanics of applying section 1400Z-2 in the context of a sale 
subject to withholding tax.
    The final regulations clarify that section 1400Z-2 is not a 
``nonrecognition provision'' for purposes of section 897(e) and Sec.  
1.897-6T. See Sec.  1.1400Z2(a)-1(e). A non-recognition provision is 
defined in section 897(e)(3) as any provision of the Code for ``not 
recognizing gain or loss.'' Similarly, Sec.  1.897-6T(a)(2) defines a 
non-recognition provision as any Code provision ``which provides that 
gain or loss shall not be recognized.'' Pursuant to section 897(e)(1) 
and Sec.  1.897-6T(a)(1), nonrecognition provisions generally do not 
apply upon the exchange of a U.S. real property interest in a 
transaction subject to FIRPTA unless the asset received in exchange is 
also a U.S. real property interest. The Treasury Department and the IRS 
have determined that section 1400Z-2 is not a nonrecognition provision 
for purposes of section 897(e) and Sec.  1.897-6T because an election 
under that provision generally defers, rather than prevents altogether, 
the recognition of gain. By deferring gain recognition, section 1400Z-2 
is fundamentally different from the provisions identified as 
nonrecognition provisions in Sec.  1.897-6T(a)(2), such as sections 
332, 351, 721, and 1031.

III. Comments on and Changes to Proposed Sec.  1.1400Z2(b)-1

    Proposed Sec.  1.1400Z2(b)-1 provided rules regarding the inclusion 
in income of gain deferred under section 1400Z-2(a)(1)(A), including 
rules regarding which events trigger the inclusion of deferred gain, 
how much gain is included, and the effects of these events on the 
investor's basis and holding period in its qualifying investment.

A. General Rule Regarding Inclusion Events

    Proposed Sec.  1.1400Z2(b)-1(c)(1) generally provided that, except 
as otherwise provided in proposed Sec.  1.1400Z2(b)-1(c), certain 
events (that is, inclusion events) result in the inclusion of gain 
under proposed Sec.  1.1400Z2(b)-1(b) if and to the extent that: (i) A 
taxpayer's transfer of a qualifying investment reduces the taxpayer's 
equity interest in the qualifying investment; (ii) a taxpayer receives 
property in a transaction treated as a distribution for Federal income 
tax purposes, regardless of whether the receipt reduces the taxpayer's 
ownership of the QOF; or (iii) a taxpayer claims a worthlessness 
deduction with respect to its qualifying investment. Proposed Sec.  
1.1400Z2(b)-1(c)(2) through (15) then provided specific rules for 
certain types of transactions that are or are not treated as inclusion 
events.
    The Treasury Department and the IRS received several comments and 
questions regarding the general rule set forth in proposed Sec.  
1.1400Z2(b)-1(c)(1). For example, one commenter asked whether the 
phrase ``the following events'' refers to the items in proposed Sec.  
1.1400Z2(b)-1(c)(2) through (15) or whether the phrase instead refers 
to the items in proposed Sec.  1.1400Z2(b)-1(c)(1)(i) through (iii). 
Another commenter stated that the general rule in proposed Sec.  
1.1400Z2(b)-1(c)(1)(i) could be read to suggest that there is no 
inclusion event so long as a taxpayer retains an equity interest, 
whether direct or indirect, in a qualifying investment after a 
transfer, even though the preamble to the May 2019 proposed regulations 
indicated that any reduction in a taxpayer's direct interest in a 
qualifying investment is an inclusion event, other than in the case of 
partnerships. Yet another commenter asserted that the specific rules in 
proposed Sec.  1.1400Z2(b)-1(c)(2) through (15) appear to cover all 
potentially relevant transactions and therefore the purpose of the 
general rule seems unclear. As a result, commenters recommended that 
the Treasury Department and the IRS clarify or eliminate the general 
rule.
    As explained in the preamble to the May 2019 proposed regulations, 
proposed Sec.  1.1400Z2(b)-1(c) reflected the general principle that, 
except as otherwise provided, an inclusion event results from: A 
transfer of a qualifying investment, to the extent the transfer reduces 
the taxpayer's direct equity interest; the receipt of a distribution on 
or with respect to a qualifying investment, which constitutes an 
impermissible ``cashing out'' of the taxpayer's qualifying investment; 
or the claim of a worthlessness deduction (under section 165(g) or 
otherwise) in respect of a qualifying investment. Proposed Sec.  
1.1400Z2(b)-1(c)(1) set forth these principles as a general rule, and 
proposed Sec.  1.1400Z2(b)-1(c)(2) through (15) provided elaborations 
of, and exceptions to, the general rule. The Treasury Department and 
the IRS did not intend the general rule to suggest that a taxpayer may 
avoid an inclusion event by retaining an indirect interest in a QOF, 
and the specific rules clearly indicated that a transfer that reduces a

[[Page 1881]]

taxpayer's direct interest is an inclusion event except as otherwise 
provided.
    These final regulations retain the general rule in proposed Sec.  
1.1400Z2(b)-1(c)(1). However, this general rule has been clarified in 
response to the foregoing comments. In addition to the changes 
described in this part III, the specific rules in Sec.  1.1400Z2(b)-
1(c)(2) through (c)(15) have been clarified as necessary.
    These final regulations also clarify that if a QOF is decertified, 
either through the QOF's voluntary self-decertification or an 
involuntary decertification, such decertification is an inclusion event 
that terminates the qualifying investment status of the taxpayer's 
interest in the QOF.
    A commenter also requested clarification as to whether an inclusion 
event terminates the application of section 1400Z-2 to an interest in a 
QOF. In some cases, an inclusion event may be the result of a transfer 
of the qualifying investment that reduces or terminates the owner's 
interest in the QOF, but in other cases it may not (for example, a 
distribution from a QOF C corporation subject to section 301(c)(3)). 
Thus, the commenter argued that the occurrence of an inclusion event is 
not the appropriate test for determining whether an interest in a QOF 
ceases to be a qualifying investment eligible for the basis adjustments 
under section 1400Z-2(b).
    As discussed in part II.A.5 of this Summary of Comments and 
Explanation of Revisions, the Treasury Department and the IRS have 
determined that an inclusion event generally results in a reduction or 
termination of a qualifying investment's status as a qualifying 
investment to the extent of the reduction or termination for purposes 
of section 1400Z-2(a)(1)(B), (b), and (c). However, the Treasury 
Department and the IRS agree that certain types of inclusion events 
(namely, certain distributions) do not terminate a taxpayer's 
qualifying investment. See part IV.C of this Summary of Comments and 
Explanation of Revisions.
    The Treasury Department and the IRS also recognize that the 
language in proposed Sec.  1.1400Z2(b)-1(g)(2), which provided that 
``[t]he increases in basis under section 1400Z-2(b)(2)(B)(iii) and (iv) 
only apply to that portion of the qualifying investment that has not 
been subject to previous gain inclusion under section 1400Z-
2(b)(2)(A),'' could be read to suggest that all inclusion events cause 
interests in a QOF to cease to be qualifying investments. In other 
words, by restricting the five-year and seven-year basis increases to 
qualifying investments that have ``not been subject to previous gain 
inclusion,'' proposed Sec.  1.1400Z2(b)-1(g)(2) appeared to exclude any 
qualifying investment that has been subject to any inclusion event, 
even if substantial amounts of deferred gain remain.
    The Treasury Department and the IRS have determined that qualifying 
investments that have been subject to inclusion events should continue 
to be eligible for the five-year and seven-year basis increases to the 
extent deferred gain has not yet been recognized at the time of these 
basis increases. For example, if a taxpayer invests $100x of eligible 
gain in a QOF corporation and the corporation subsequently makes a 
section 301(c)(3) distribution of $20x with respect to the taxpayer's 
qualifying investment, the taxpayer still should be eligible to receive 
a five-year basis increase of $8x (10 percent of its remaining deferred 
gain of $80x) and a seven-year basis increase of $4x (five percent of 
its remaining deferred gain of $80x). Section 1.1400Z2(b)-1(g)(2) of 
the final regulations has been modified accordingly.

B. Transactions Treated as Distributions for Federal Income Tax 
Purposes

1. Overview
    Proposed Sec.  1.1400Z2(b)-1(c)(1)(ii) generally provided that, 
except as otherwise provided in proposed Sec.  1.1400Z2(b)-1(c), an 
inclusion event occurs if and to the extent a taxpayer receives 
property in a transaction that is treated as a distribution for Federal 
income tax purposes, regardless of whether the receipt reduces the 
taxpayer's ownership of the QOF. Proposed Sec.  1.1400Z2(b)-1(c)(8) 
modified this general rule by providing that a distribution of property 
by a QOF C corporation with respect to a qualifying investment, 
including a distribution of stock that is treated as a distribution of 
property to which section 301 applies under section 305(b), is an 
inclusion event only to the extent section 301(c)(3) applies to the 
distribution. In the preamble to the May 2019 proposed regulations, the 
Treasury Department and the IRS requested comments on the proposed 
treatment of distributions to which section 305(b) applies.
    In turn, proposed Sec.  1.1400Z2(b)-1(c)(9) generally provided that 
a redemption described in section 302(d) by a QOF C corporation is an 
inclusion event with respect to the full amount of the distribution. 
However, if the QOF C corporation is wholly and directly owned by a 
single shareholder (or by members of a single consolidated group), the 
section 302(d) redemption is an inclusion event only to the extent 
section 301(c)(3) applies.
2. Section 302(d) Redemptions
    Commenters made several recommendations with respect to the 
foregoing rules. For example, commenters questioned the treatment of 
dividend-equivalent redemptions in the May 2019 proposed regulations. 
One commenter acknowledged that a section 302(d) redemption reduces a 
taxpayer's direct equity interest, but the commenter recommended 
treating such redemptions in the same manner as section 301 
distributions for purposes of section 1400Z-2 because section 302 
treats such redemptions as distributions rather than as sales or 
exchanges. The commenter further recommended that section 302(d) 
redemptions in which each shareholder surrenders a pro rata percentage 
of its shares not be treated as inclusion events. Another commenter 
recognized that requiring an inclusion event only upon a complete 
redemption of a shareholder's qualifying investment would enable 
taxpayers to avoid taxation by retaining even a small amount of 
qualifying QOF stock, but the commenter still questioned why a partial 
redemption should cause acceleration. Both commenters recommended that 
section 302(d) redemptions and section 301 distributions be treated 
similarly for purposes of section 1400Z-2, with the exception of 
complete redemptions, which would be an inclusion event to the extent 
of the full amount of the distribution.
    As noted in the foregoing comments, a redemption transaction 
reduces a taxpayer's direct qualifying investment in a QOF, regardless 
of whether such transaction is treated as a dividend for Federal income 
tax purposes. The Treasury Department and the IRS have determined that 
the general treatment of section 302(d) redemptions as section 301 
distributions for Federal income tax purposes should not override the 
general requirement that QOF shareholders must retain their direct 
qualifying investment in a QOF corporation in order to retain the 
benefits of section 1400Z-2. See section 1400Z-2(b)(1)(A) (``Gain to 
which subsection (a)(1)(B) applies shall be included in income in the 
taxable year which includes . . . the date on which such investment is 
sold or exchanged . . .''). As a result, the Treasury Department and 
the IRS have determined that it would be inappropriate to treat such 
redemptions in the same manner as section 301 distributions for 
purposes of section 1400Z-2.

[[Page 1882]]

    However, in certain circumstances, a reduction in a taxpayer's 
qualifying investment by virtue of a section 302(d) redemption is 
meaningless. For example, if a wholly owned QOF C corporation partially 
redeems its sole shareholder, the shareholder will continue to wholly 
own the QOF C corporation after the redemption. Similarly, if a QOF C 
corporation redeems its single outstanding class of stock from all 
shareholders on a pro rata basis, each QOF shareholder will retain the 
same proportionate interest in the QOF after the partial redemption.
    As a result, the final regulations generally continue to treat 
dividend-equivalent redemptions by QOF C corporations as inclusion 
events with respect to the full amount of the distribution, with an 
exception for redemptions by wholly owned QOF C corporations, which are 
inclusion events only to the extent section 301(c)(3) applies. The 
Treasury Department and the IRS agree with the commenter that an 
additional exception should be created for pro rata section 302(d) 
redemptions, so long as the QOF C corporation has only one class of 
stock outstanding. The final regulations have been modified to treat 
such redemptions in the same manner as redemptions by wholly owned QOF 
C corporations. In other words, an inclusion event occurs only to the 
extent section 301(c)(3) applies. Similarly, with respect to QOF S 
corporations, the final regulations continue to treat dividend-
equivalent redemptions as inclusion events to the extent that the 
distributed property has a fair market value in excess of the 
shareholder's basis, including any basis adjustments under section 
1400Z-2(b)(2)(B)(iii) and (iv). See part III.E.2.a of this Summary of 
Comments and Explanation of Revisions.
3. Section 305 Distributions and Section 306 Redemptions
    A commenter agreed with the treatment of section 305(b) 
distributions in the May 2019 proposed regulations--namely, that such 
distributions should be included as distributions subject to the rule 
in proposed Sec.  1.1400Z2(b)-1(c)(8). However, the commenter further 
recommended that the final regulations address the treatment of stock 
received in a section 305(a) distribution with respect to qualifying 
QOF stock. When a corporation distributes its own stock to its 
shareholders, section 305(a) provides that the shareholders do not 
include the distribution in gross income. The basis of the new stock 
received and of the stock with respect to which the distribution is 
made (old stock) is determined by allocating the basis of the old stock 
between the old stock and the new stock in proportion to the respective 
fair market values of the old stock and the new stock on the date on 
which the new stock is distributed, and the holding period for the new 
stock is the same as the holding period for the old stock. See Sec.  
1.307-1(a) (regarding allocation of basis) and section 1223(4) 
(regarding determination of holding period). The commenter requested 
clarification that the new stock received in a section 305(a) 
distribution with respect to qualifying QOF stock is also qualifying 
QOF stock, with the remaining deferred gain being allocated pro rata 
between the old stock and the new stock, and with the holding period 
for the new stock being the same as the holding period for the old 
stock. The Treasury Department and the IRS agree with the commenter's 
recommendation, and the final regulations have been modified 
accordingly.
    The commenter also requested clarification regarding the treatment 
of redemptions of section 306 stock. Section 306 stock generally 
includes stock, other than common stock, that was received tax-free in 
certain transactions by the shareholder disposing of such stock, 
including a stock dividend under section 305(a), a corporate 
reorganization described in section 368(a), or a distribution or 
exchange to which section 355 (or so much of section 356 as relates to 
section 355) applied. See section 306(c). Section 306(a)(2) provides 
that, if a shareholder disposes of its section 306 stock in a 
redemption, the amount realized is treated as a distribution of 
property to which section 301 applies. The commenter recommended that 
such a redemption be subject to the rules for section 301 distributions 
in proposed Sec.  1.1400Z2(b)-1(c)(8).
    The Treasury Department and the IRS agree that the final 
regulations should address the treatment of section 306(a)(2) 
redemptions. For the reasons discussed in part III.B.2 of this Summary 
of Comments and Explanation of Revisions, the Treasury Department and 
the IRS have determined that section 306(a)(2) redemptions should be 
treated in the same manner as dividend-equivalent redemptions for 
purposes of section 1400Z-2. The final regulations have been modified 
accordingly.
4. Distributions Subject to Section 1059
    A commenter recommended that qualifying investments in QOF C 
corporations be excluded from the application of section 1059. 
Alternatively, the commenter requested confirmation that (1) the 
recognition of gain under section 1059(a)(2) would result in an 
inclusion event to the extent of that gain, and (2) the ordering rule 
in proposed Sec.  1.1400Z2(b)-1(g)(1)(ii), which applied to basis 
increases under section 1400Z-2(b)(2)(B)(ii), also would apply to such 
inclusion event.
    The commenter contended that, in many instances, the policy 
concerns underlying section 1059, as described by the commenter, would 
not be applicable to distributions made by a QOF C corporation. 
However, an example in the commenter's analysis illustrated that the 
concerns underlying section 1059 are present any time a QOF corporation 
has earnings and profits (E&P) predating the date on which a qualifying 
investment is made. The Treasury Department and the IRS have determined 
that, to the extent consistent with the application of section 1400Z-2, 
and unless provided otherwise by the section 1400Z-2 regulations, the 
rules of subchapter C apply with respect to a QOF C corporation. The 
commenter's analysis did not set forth any statutory authority under 
section 1400Z-2 or subchapter C for not applying section 1059 to 
distributions from a QOF C corporation. As a result, the Treasury 
Department and the IRS have determined that section 1059 should apply 
to a QOF C corporation, and the final regulations do not adopt the 
commenter's primary recommendation.
    However, the Treasury Department and the IRS agree with the 
commenter's alternative recommendation that the recognition of gain 
under section 1059(a)(2) should result in an inclusion event to the 
extent of that gain, and that the ordering rule in proposed Sec.  
1.1400Z2(b)-1(g)(1)(ii) should apply to such inclusion event. The final 
regulations have been modified accordingly.

C. Reorganizations of QOF Corporations

1. Overview
    Proposed Sec.  1.1400Z2(b)-1(c)(10) generally provided that, if the 
assets of a QOF corporation are acquired in a qualifying section 381 
transaction, and if the acquiring corporation is a QOF within a 
prescribed period of time after the acquisition, the transaction would 
not be an inclusion event. The proposed regulations included this rule 
because, after the transaction, the taxpayer would have retained a 
direct qualifying investment in an acquiring QOF that is a successor to 
the transferor QOF under section 381. The proposed regulations defined 
the term ``qualifying section 381 transaction'' to mean an acquisitive 
asset reorganization described in section

[[Page 1883]]

381(a)(2), with certain enumerated exceptions. See proposed Sec.  
1.1400Z2(b)-1(a)(2)(xx).
    However, if a QOF shareholder received boot in a qualifying section 
381 transaction with respect to the shareholder's qualifying 
investment, the taxpayer would have an inclusion event because the 
taxpayer would have reduced its direct qualifying investment in the QOF 
or cashed out part of its investment. For this purpose, the term 
``boot'' means money or other property that section 354 or 355 does not 
permit to be received without the recognition of gain. Under the May 
2019 proposed regulations, if the taxpayer realizes a gain on the 
transaction, the amount that gives rise to the inclusion event is the 
amount of gain under section 356 that is not treated as a dividend 
under section 356(a)(2). If the taxpayer realizes a loss on the 
transaction, the amount that gives rise to the inclusion event is an 
amount equal to the fair market value of the boot received. If a single 
taxpayer or members of a single consolidated group wholly own both the 
target QOF and the acquiring QOF, the boot is treated as if it were 
distributed from the QOF in a separate section 301 transaction and is 
only taxable to the extent section 301(c)(3) applies.
    In turn, proposed Sec.  1.1400Z2(b)-1(c)(12) generally provided 
that, if a QOF corporation engages in a recapitalization transaction 
described in section 368(a)(1)(E) (recapitalization), or if a QOF 
shareholder engages in a stock-for-stock exchange described in section 
1036 (section 1036 exchange), and if the transaction does not have the 
result of decreasing the shareholder's proportionate interest in the 
QOF corporation, the transaction is not an inclusion event. However, 
any property or boot received by the shareholder in the transaction is 
treated as property or boot to which section 301 or section 356 
applies, as determined under general Federal income tax principles. 
Proposed Sec.  1.1400Z2(b)-1(c)(8) or (10), respectively, then 
determined the extent to which the receipt of such property or boot 
triggers an inclusion event. Moreover, if the transaction decreases the 
shareholder's proportionate qualifying investment in the QOF 
corporation, the shareholder has an inclusion event equal to the amount 
of the reduction in fair market value of the shareholder's qualifying 
QOF stock.
2. Proposed Treatment of Recapitalizations and Section 1036 Exchanges
    Several commenters recommended that a single inclusion event rule 
be applied to qualifying section 381 transactions, recapitalizations, 
and section 1036 exchanges. One commenter argued that, if a taxpayer's 
proportionate interest were reduced in a recapitalization or in a 
section 1036 exchange, the taxpayer either would have received actual 
consideration (that is, boot) in the transaction or would be deemed to 
have received boot in the transaction under general Federal income tax 
principles. See, for example, Rev. Rul. 74-269, 1974-1 C.B. 87. Another 
commenter argued that a reduction in a shareholder's proportionate 
interest by virtue of the QOF's issuance of new stock to a new investor 
should not be treated as an inclusion event, and that a reduction in 
the shareholder's interest by virtue of the shareholder's receipt of 
non-stock consideration should be covered by the boot rules for 
reorganizations. Thus, the commenters argued that recapitalizations and 
section 1036 exchanges should be governed by the same rules that govern 
qualifying section 381 transactions.
    The Treasury Department and the IRS agree with many of the 
foregoing comments. For example, the Treasury Department and the IRS 
agree that the reduction of a shareholder's proportionate interest in a 
QOF through a recapitalization should not be treated as an inclusion 
event unless the shareholder receives, or is deemed to receive, boot in 
the transaction. Thus, a shareholder should not have an inclusion event 
by virtue of the QOF's issuance of qualifying QOF stock to a new 
investor. The Treasury Department and the IRS also agree that the rules 
for recapitalizations and section 1036 exchanges should be modified to 
mirror more closely the rules for qualifying section 381 transactions. 
The final regulations reflect these determinations. However, the final 
regulations retain separately numbered rules for reorganizations, and 
for recapitalizations and section 1036 exchanges.
3. Receipt of Boot
    Commenters also recommended simplifying the proposed rules 
regarding boot. For example, one commenter recommended eliminating the 
special rule for the receipt of boot from a wholly owned QOF in 
proposed Sec.  1.1400Z2(b)-1(c)(10)(i)(C)(2) and subjecting qualifying 
section 381 transactions, recapitalizations, and section 1036 exchanges 
to a single rule similar to proposed Sec.  1.1400Z2(b)-
1(c)(10)(i)(C)(1) (the general rule regarding the receipt of boot by 
QOF shareholder in a qualifying section 381 transaction). Another 
commenter questioned the disparate treatment of boot in reorganizations 
depending on whether gain or loss is realized.
    The Treasury Department and the IRS agree with commenters that the 
proposed rules regarding the receipt of boot should be simplified. 
Accordingly, the final regulations adopt a single rule for the receipt 
of boot in a qualifying section 381 transaction. Under this rule, a 
taxpayer is treated as disposing of a portion of its qualifying 
investment equal to the portion of total consideration received in the 
transaction with respect to the taxpayer's qualifying investment that 
consists of boot. For example, if a QOF engages in a merger that is a 
qualifying section 381 transaction, and if 10 percent of the 
consideration received by a QOF shareholder, as measured by fair market 
value, consists of boot, the QOF shareholder is treated as having 
disposed of 10 percent of its qualifying investment. This rule applies 
regardless of whether the QOF shareholder recognizes gain or loss on 
the transaction, and regardless of whether the QOF is wholly owned.
    For property or boot received in recapitalizations or section 1036 
exchanges, the final regulations provide that the property or boot is 
treated as property or boot to which section 301 or section 356(a) or 
(c) applies, as determined under general Federal income tax principles. 
The receipt of property to which section 301 applies is an inclusion 
event only to the extent section 301(c)(3) applies. The receipt of boot 
to which section 356(a) or (c) applies is subject to the single rule 
for the receipt of boot in a qualifying section 381 transaction.
    If a taxpayer receives boot with respect to its qualifying 
investment in a qualifying section 355 transaction, as defined in 
proposed Sec.  1.1400Z2(b)-1(a)(2)(xix), and if section 356(a) applies 
to the transaction, the receipt of boot also is subject to the single 
rule for the receipt of boot in a qualifying section 381 transaction. 
In turn, if a taxpayer receives boot with respect to its qualifying 
investment in a qualifying section 355 transaction, and if section 
356(b) applies to the transaction, the receipt of boot is an inclusion 
event only to the extent section 301(c)(3) applies.
4. Treatment of the Surviving or Acquiring Corporation as a QOF
    A commenter also requested clarification that, in the event of 
mergers, consolidations, share exchanges, asset acquisitions, and 
conversions in which the acquiring or surviving enterprise is a QOF, 
such

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acquiring or surviving enterprise continues to be a QOF.
    Whether the surviving or acquiring corporation after a merger, 
consolidation, share exchange, or asset acquisition continues to be a 
QOF depends on whether the surviving or acquiring corporation satisfies 
the requirements of section 1400Z-2(d) and the section 1400Z-2 
regulations. Therefore, the final regulations do not adopt the 
commenter's recommended clarification. For a discussion of conversions 
of QOF partnerships to QOF corporations, see part III.E.1 of this 
Summary of Comments and Explanation of Revisions.

D. Reorganizations of QOF Shareholders

    Proposed Sec.  1.1400Z2(b)-1(c)(10)(ii) generally provided that a 
transfer of a QOF shareholder's assets in a qualifying section 381 
transaction (qualifying owner reorganization) is not an inclusion 
event, except to the extent the QOF shareholder transfers less than all 
of its qualifying investment in the transaction, because the section 
381 successor to the QOF shareholder retains a direct qualifying 
investment in the QOF. In other words, the section 381 successor is 
treated as the historic QOF shareholder and therefore no disposition of 
the direct qualifying investment in the QOF has occurred. Based on the 
same rationale, proposed Sec.  1.1400Z2(b)-1(c)(2)(ii)(B) provided that 
the transfer of a QOF shareholder's qualifying investment in a complete 
liquidation under section 332 is not an inclusion event to the extent 
section 337(a) applies (qualifying owner liquidation). Special rules 
applied to S corporations that are shareholders of a QOF, and generally 
tracked the rules of subchapter C described previously, to the extent 
consistent with the rules of subchapter S. See proposed Sec.  
1.1400Z2(b)-1(c)(7).
    Proposed Sec.  1.1400Z2(b)-1(d)(1) and (2) contained special rules 
for qualifying section 381 transactions in which the target corporation 
was a QOF immediately before the acquisition and the acquiring 
corporation is a QOF immediately after the acquisition. For purposes of 
section 1400Z-2(b)(2)(B) and 1400Z-2(c), the May 2019 proposed 
regulations provided that the holding period for the QOF stock 
relinquished by a taxpayer is ``tacked'' onto the holding period of the 
QOF stock received in the transaction, and any qualified opportunity 
zone property transferred by the transferor QOF to the acquiring QOF in 
connection with the transaction does not lose its status as qualified 
opportunity zone property solely as a result of the transfer. However, 
the May 2019 proposed regulations did not provide similar rules for 
qualifying owner reorganizations or liquidations. As a result, one 
commenter requested that a ``tacked'' holding period be expressly 
provided for a QOF shareholder's qualifying investment in such 
transactions. Another commenter requested a rule for qualifying owner 
liquidations and reorganizations similar to proposed Sec.  1.1400Z2(b)-
1(c)(6)(ii)(C), which generally provided that the resulting partnership 
after certain partnership mergers or consolidations is subject to 
section 1400Z-2 and the section 1400Z-2 regulations to the same extent 
as the original partnership before the transaction.
    The Treasury Department and the IRS agree that a ``tacking'' rule 
should apply to stock of a QOF shareholder after a qualifying owner 
reorganization or liquidation. Section 1.1400Z2(b)-1(d)(1)(ii) of the 
final regulations has been modified accordingly.

E. Partnerships, S Corporations, and Trusts

1. Inclusion Events for QOF Partnerships
    Proposed Sec.  1.1400Z2(b)-1(c)(6)(i) provided inclusion rules for 
QOF partnerships and partnerships that directly or indirectly own 
interests in QOFs. These rules applied to transactions involving any 
direct or indirect partner of a QOF to the extent of the partner's 
share of any eligible gain. Proposed Sec.  1.1400Z2(b)-1(c)(6)(ii)(B) 
provided that a contribution by a QOF owner of its direct or indirect 
partnership interest in a qualifying investment to a partnership is not 
an inclusion event to the extent the transaction is governed by section 
721(a), provided the transfer does not cause a termination of a QOF 
partnership, or of the direct or indirect owner of a QOF, under section 
708(b)(1).
    The Treasury Department and the IRS received several comments on 
whether certain transactions involving QOF partnerships should be 
considered inclusion events. One commenter requested clarification of 
proposed Sec.  1.1400Z2(b)-1(c)(6)(iii), which provided that a 
distribution of property by a QOF partnership to a partner is an 
inclusion event if the distributed property has a fair market value in 
excess of the partner's basis in its qualifying investment, and that 
similar rules apply to distributions involving tiered partnerships. The 
final regulations provide that, for amounts relating to a partner's 
qualifying investment, a distribution by a QOF partnership to a partner 
is an inclusion event to the extent the distribution is of cash or 
property with a fair market value in excess of the partner's outside 
basis in the QOF partnership. However, with respect to distributions by 
a partnership that owns a QOF, such distribution will only be an 
inclusion event for the indirect QOF owner if the distribution is a 
liquidating distribution.
    The commenter suggested that such a distribution should not be an 
inclusion event to the extent the partner in the QOF ultimately would 
be allocated the gain recognized upon the distribution. The commenter 
also requested an exception from inclusion event treatment for section 
731 distributions of a QOF interest by an upper-tier partnership to the 
extent the distribution is to the partner that made the initial 
qualifying investment in the QOF. The Treasury Department and the IRS 
decline to adopt these recommendations. Under the rules in subchapter K 
of chapter 1 of subtitle A (subchapter K), a distribution of property 
with a fair market value in excess of basis reduces a partner's equity 
interest in the partnership. Such a reduction is an inclusion event and 
is economically the same as an investor cashing out its investment or 
reducing its equity investment in the QOF.
    One commenter also requested that a contribution of an interest in 
a partnership that holds a direct interest in a QOF partnership to 
another partnership not be considered an inclusion event. This 
transaction was addressed by proposed Sec.  1.1400Z2(b)-1(c)(6)(ii)(B), 
which applied to contributions under section 721(a) by a QOF owner, 
including a QOF partner. See proposed Sec.  1.1400Z2(b)-1(a)(2)(xii), 
which defined a QOF partner as a person that directly owns a qualifying 
investment in a QOF partnership or a person that owns such a qualifying 
investment through equity interests solely in one or more partnerships. 
The final regulations clarify that the rule in proposed Sec.  
1.1400Z2(b)-1(c)(6)(ii)(B) applies to any QOF owner that contributes 
its qualifying QOF stock or direct or indirect partnership interest in 
a qualifying investment to a partnership in a transaction governed by 
section 721(a).
    Another commenter requested that the list of inclusion events 
exclude not only section 721 contributions, but also the merger of a 
fund formed as a REIT into another REIT. The commenter recommended that 
the final regulations clarify and expand the scope of the permitted 
transactions under the rules for inclusion. The Treasury Department and 
the IRS decline to adopt this

[[Page 1885]]

suggestion but note that the exceptions to inclusion event treatment 
applicable to QOF C corporations, such as the exception for qualifying 
section 381 transactions, also apply to RICs and REITs.
    Proposed Sec.  1.1400Z2(b)-1(c)(6)(ii)(C) provided that a merger or 
consolidation of a partnership holding a qualifying investment, or of a 
partnership holding an interest in such partnership solely through one 
or more partnerships, with another partnership in a transaction to 
which section 708(b)(2)(A) applies is not an inclusion event. A 
commenter noted that the May 2019 proposed regulations did not 
explicitly provide that a merger of a QOF partnership into another 
partnership in a transaction to which section 708(b)(2)(A) applies is 
not an inclusion event, even if the acquiring partnership is a QOF 
immediately after the merger.
    The Treasury Department and the IRS adopt the comment in part. The 
Treasury Department and the IRS have determined that the rule in Sec.  
1.1400Z2(b)-1(c)(6)(iii) of the May 2019 proposed regulations, which 
provided that a QOF partnership distribution with a fair market value 
in excess of the distributee partner's basis is an inclusion event, 
should be modified in the case of certain mergers or consolidations 
under section 708(b)(2)(A).
    The final regulations provide that, in the case of an assets-over 
merger or consolidation of a QOF partnership with another QOF 
partnership in a transaction to which section 708(b)(2)(A) applies, the 
fair market value of property distributed in the merger or 
consolidation is reduced by the fair market value of the partnership 
interest received in the merger or consolidation for purposes of 
determining whether there has been an inclusion event. Therefore, the 
transaction will not be an inclusion event to a partner that receives 
only a partnership interest in the resulting partnership. However, 
there will be an inclusion event to the extent that a partner receives 
other property that exceeds that partner's basis in the partnership.
    Additionally, the final regulations provide that a merger or 
consolidation of a QOF partnership with another QOF partnership in a 
transaction to which section 708(b)(2)(A) applies is not an inclusion 
event under Sec.  1.1400Z2(b)-1(c)(2)(i), which provides that there is 
an inclusion event if a QOF ceases to exist for Federal income tax 
purposes. The resulting partnership becomes subject to section 1400Z-2 
and the section 1400Z-2 regulations to the same extent that the 
terminated partnership was so subject prior to the transaction, and 
must allocate and report any gain inclusion under section 1400Z-2(b) to 
the same extent and to the same partners that the terminated 
partnership would have been required to allocate and report those items 
prior to the transaction.
    A commenter also requested clarification that any partnership 
distribution of property pursuant to a division governed by Sec.  
1.708-1(d) is not an inclusion event, provided the taxpayer's 
beneficial interest in a QOF has not changed and all deferred gain 
still would be recognized by the same taxpayer. Several other 
commenters requested that pro-rata divisions of QOF partnerships into 
two or more QOF partnerships pursuant to section 708 not be treated as 
inclusion events, provided the amount of a taxpayer's equity interest 
in its qualifying investment remains the same.
    The Treasury Department and the IRS decline to adopt a general rule 
excluding divisions as inclusion events because divisions may result in 
deemed distributions arising from debt shifts, as well as distributions 
in excess of basis, which may result in gain recognition under the 
subchapter K rules. Additionally, as described in part IV.E.4 of this 
Summary of Comments and Explanation of Revisions, the final regulations 
expand the rule of proposed Sec.  1.1400Z2(c)-1(b)(2)(ii) to provide 
that, with the exception of gain from the sale of inventory in the 
ordinary course of business, all gain from the sale of property by a 
QOF partnership or by a qualified opportunity zone business that is a 
partnership is eligible for exclusion as long as the qualifying 
investment in the QOF has been held for at least 10 years. This change 
to proposed Sec.  1.1400Z2(c)-1(b)(2)(ii) may minimize the need for 
divisions of QOF partnerships as a way to dispose of certain assets.
    One commenter also asked that a distribution by a QOF partnership 
of its net cash flow, measured on an annual basis by reference to 
taxable income, plus depreciation deductions, not constitute an 
inclusion event. The Treasury Department and the IRS decline to adopt 
this recommendation because allowing such distributions in excess of 
the QOF partner's basis would add significant complexity, requiring the 
tracing of distributions of net cash flow proceeds versus cash from 
other sources.
    One commenter asked why proposed Sec.  1.1400Z2(b)-1(c)(6) used the 
phrase ``eligible gain.'' Proposed Sec.  1.1400Z2(b)-1(c)(6) stated, in 
relevant part, that ``the inclusion rules of this paragraph (c) apply 
to transactions involving any direct or indirect partner of the QOF to 
the extent of such partner's share of eligible gain of the QOF.'' The 
commenter further noted that proposed Sec.  1.1400Z2(b)-1(c)(6) used 
this phrase three times, and the inclusion of that phrase seemed 
inappropriate.
    The Treasury Department and the IRS confirm that ``eligible gain'' 
was the intended term in proposed Sec.  1.1400Z2(b)-1(c)(6). Eligible 
gain is a defined term in proposed Sec.  1.1400Z2(a)-1(b)(2), and 
generally refers to gain that is eligible to be deferred under section 
1400Z-2(a). The term is further defined in Sec.  1.1400Z2(a)-1(b)(11) 
of the final regulations. In addition, proposed Sec.  1.1400Z2(b)-
1(c)(6) provided special rules relating to inclusion events for 
partners and partnerships, and used the defined term ``eligible gain'' 
to reference the amount of gain deferred under section 1400Z-2(a) that 
is required to be included in income upon the occurrence of certain 
inclusion events.
    Proposed Sec.  1.1400Z2(b)-1(c)(7)(iv) provided special rules 
regarding inclusion events for conversions of S corporations to 
partnerships or disregarded entities. Otherwise, the May 2019 proposed 
regulations did not expressly address whether a QOF's change in 
classification, such as from a partnership to a corporation, is an 
inclusion event. A commenter recommended that the conversion of a QOF 
from a partnership to a corporation for Federal tax purposes be treated 
as neither an inclusion event nor a disposition of a qualifying 
investment for purposes of the election in section 1400Z-2(c).
    The Treasury Department and the IRS note that, if a partnership 
elects under Sec.  301.7701-3(c)(1)(i) to be classified as an 
association, under Sec.  301.7701-3(g)(1)(i) the partnership is deemed 
to contribute all of its assets and liabilities to the association in 
exchange for stock and to liquidate immediately thereafter. See also 
Rev. Rul. 2004-59, 2004-1 C.B. 1050 (applying the same treatment to a 
partnership that converts to a corporation under a state law formless 
conversion statute). As provided in proposed Sec.  1.1400Z2(b)-
1(c)(2)(i), a taxpayer generally has an inclusion event for all of its 
qualifying investment if the QOF ceases to exist for Federal income tax 
purposes, and no specific rule in proposed Sec.  1.1400Z2(b)-1(c) 
provides an exception for liquidations of QOF partnerships. Thus, the 
conversion of a partnership to a corporation would be an inclusion 
event. No change has been made to the

[[Page 1886]]

final regulations with respect to this comment.
2. Inclusion Events for QOF S Corporations
a. General Principle of Section 1371(a)
    The May 2019 proposed regulations relied upon the principle set 
forth in section 1371(a), which provides that the rules of subchapter C 
of chapter 1 of subtitle A (subchapter C) applicable to C corporations 
and their shareholders apply to S corporations and their shareholders, 
except to the extent inconsistent with the provisions of subchapter S. 
In such instances, S corporations and their shareholders are subject to 
the specific rules of subchapter S. For example, similar to rules 
applicable to QOF partnerships, a distribution of property to which 
section 1368 applies by a QOF S corporation is an inclusion event to 
the extent that the distributed property has a fair market value in 
excess of the shareholder's basis, including any basis adjustments 
under section 1400Z-2(b)(2)(B)(iii) and (iv). In addition, the rules 
set forth in the May 2019 proposed regulations regarding redemptions, 
liquidations, and reorganizations of QOF C corporations and QOF C 
corporation shareholders apply equally to QOF S corporations and QOF S 
corporation shareholders to the extent consistent with the rules of 
subchapter S. For example, because the stock of an S corporation cannot 
be held by a C corporation, no exception is provided for a liquidation 
or upstream asset reorganization of an S corporation investor in a QOF.
    However, the May 2019 proposed regulations also reflect that flow-
through principles under subchapter S apply to S corporations when the 
application of subchapter C would be inconsistent with subchapter S. 
For example, under the May 2019 proposed regulations, if an inclusion 
event were to occur with respect to deferred gain of an S corporation 
that is an investor in a QOF, the shareholders of the S corporation 
would include the gain pro rata in their respective taxable incomes. 
See section 1366(a)(1)(A). Consequently, those S corporation 
shareholders would increase their bases in their S corporation stock at 
the end of the taxable year during which the inclusion event occurred. 
See section 1367(a)(1)(A). Pursuant to the S corporation distribution 
rules set forth in section 1368, the S corporation shareholders would 
receive future distributions from the S corporation tax-free to the 
extent of the deferred gain amount included in income and included in 
stock basis. If the S corporation has accumulated E&P, the S 
corporation's accumulated adjustments account would be increased by the 
same amount as the increase in stock basis to ensure the shareholders' 
tax-free treatment of the future distributions. See section 1368(c), 
(e)(1).
b. Specific Inclusion Event Rules for S Corporations
    The May 2019 proposed regulations also set forth specific rules for 
S corporations to provide certainty to taxpayers regarding the 
application of particular provisions under section 1400Z-2. Regarding 
section 1400Z-2(b)(1)(A), the May 2019 proposed regulations clarified 
that a conversion of an S corporation that holds a qualifying 
investment in a QOF to a C corporation (or a conversion of a C 
corporation to an S corporation) is not an inclusion event because the 
interests held by each shareholder of the C corporation or S 
corporation, as appropriate, would remain unchanged with respect to the 
corporation's qualifying investment in a QOF. For mixed-funds 
investments in a QOF S corporation described in section 1400Z-2(e)(1), 
if different blocks of stock are created for otherwise qualifying 
investments to track basis in these qualifying investments, the May 
2019 proposed regulations made clear that the separate blocks would not 
be treated as different classes of stock for purposes of S corporation 
eligibility under section 1361(b)(1).
    The Treasury Department and the IRS received favorable comments 
regarding the reliance of the May 2019 proposed regulations upon the 
principle set forth in section 1371(a). In addition, commenters 
provided favorable comments regarding the foregoing rules, which the 
Treasury Department and the IRS drafted in accordance with that 
principle. As a result, the final regulations adopt those rules without 
modification.
c. Elimination of 25-Percent Aggregate Ownership Change Rule
    The May 2019 proposed regulations set forth a special rule that, 
solely for purposes of section 1400Z-2, an S corporation's qualifying 
investment in a QOF would be treated as disposed of if there is a 
greater-than-25 percent aggregate change in ownership of the S 
corporation (25-percent aggregate ownership change rule). Under that 
rule, upon a greater-than-25 percent aggregate change in ownership, the 
S corporation would have an inclusion event for all of the S 
corporation's remaining deferred gain, and neither section 1400Z-
2(b)(2)(B)(iii) or (iv), nor section 1400Z-2(c), would apply to the S 
corporation's qualifying investment after that date. In proposing the 
25-percent aggregate ownership change rule, the Treasury Department and 
the IRS attempted to ``balance the status of the S corporation as the 
owner of the qualifying investment with the desire to preserve the 
incidence of the capital gain inclusion and income exclusion benefits 
under section 1400Z-2.'' Section VII.D.3 of the preamble to the May 
2019 proposed regulations.
    The Treasury Department and the IRS have received comments from the 
taxpayer and practitioner communities critical of the 25-percent 
aggregate ownership change rule. In particular, commenters have 
emphasized that the proposed rule conflicts with the stated purpose of 
inclusion events under section 1400Z-2, which is to ``prevent taxpayers 
from `cashing out' a qualifying investment in a QOF without including 
in gross income any amount of their deferred gain.'' Section VII.A of 
the preamble to the May 2019 proposed regulations. In addition, 
commenters have noted that subchapter S of the Code already contains 
provisions, such as section 1377, that achieve more effectively the 
``balance'' intended through the proposed 25-percent aggregate 
ownership change rule.
    As previously stated, for purposes of the Code, including section 
1400Z-2, the rules of subchapter C apply to an S corporation and its 
shareholders unless inconsistent with subchapter S. See section 
1371(a). For example, if an S corporation investor in a QOF were to 
have an inclusion event regarding the S corporation's qualifying 
investment, the rules of subchapter S would apply to ensure that the 
shareholders of the S corporation would include the resulting gain pro 
rata in their respective taxable incomes and increase their bases in 
their S corporation stock at the end of the taxable year during which 
the inclusion event occurred. See generally section 1366. However, 
neither subchapter S nor section 1400Z-2 provides that the disposition 
of any stock held by a shareholder of an S corporation should cause an 
inclusion event under section 1400Z-2 for a qualifying investment held 
by the S corporation in a QOF (that is, should be treated as a 
disposition by the S corporation). Rather, the rules of subchapter S 
indicate the opposite, as evidenced by the ability for S corporation 
shareholders to dispose of their stock without affecting the S 
corporation's tax-free treatment resulting from a like-kind exchange of 
one of its assets. See generally section 1031. The Treasury Department 
and the

[[Page 1887]]

IRS have determined that, like a C corporation investor in a QOF C 
corporation, an S corporation investor should not have an inclusion 
event for its qualifying investment solely as the result of a 
disposition of shares by one of its shareholders, regardless of the 
disposition's magnitude.
    Furthermore, the Treasury Department and the IRS have determined 
that the proposed 25-percent aggregate ownership change rule does not 
achieve its stated purpose of balancing the status of the S corporation 
as the owner of the qualifying investment while directing capital gain 
inclusion to the proposed rule's intended parties (that is, the S 
corporation's shareholders, upon an inclusion event). See section 
VII.D.3 of the May 2019 proposed regulations. Indeed, the Treasury 
Department and the IRS note that the proposed rule conflicts with 
section 1377, the longstanding provision in subchapter S that governs 
the allocation of items of income among S corporation shareholders.
    Under section 1377(a)(1), each shareholder's pro rata share of any 
item for any tax year generally equals the sum of the amounts 
determined for the shareholder by (1) assigning an equal portion of the 
item to each day of the tax year, and then (2) dividing that portion 
pro rata among the shares outstanding on that day, per share, per day. 
As an exception for terminations of a shareholder's interest, section 
1377(a)(2) permits an S corporation and the affected shareholders (that 
is, the remaining shareholders of the S corporation at the time of the 
termination) to agree to a ``closing of the books'' of the S 
corporation and allocate the S corporation's items of income among 
those shareholders based on their ownership before and after the 
termination (that is, treat the taxable year as two taxable years, the 
first of which ends on the date of the termination). As highlighted by 
one commenter, in the absence of a ``closing of the books'' election, 
the inclusion of capital gain resulting from an inclusion event will be 
allocated pro rata among all of the S corporation's shareholders as of 
the end of the S corporation's taxable year, rather than to those 
shareholders who were shareholders at the time the S corporation 
invested its deferred capital gain in its QOF. In other words, the 
allocation rules of section 1377 do not operate to match S corporation 
items to specific shareholders. For these reasons, the Treasury 
Department and the IRS agree with the comments received and have 
removed the proposed 25-percent aggregate ownership change rule from 
the final regulations.
d. Contributions of QOF Investments to a Partnership
    With respect to the contribution of a qualifying investment to an 
upper-tier partnership or the acquisition of an interest in an upper-
tier partnership by another person, one commenter requested that 
forward section 704(c) and reverse section 704(c) principles apply to 
ensure that deferred gains, or any built-in gains on the QOF interest, 
are allocable to the proper taxpayers and that appropriate basis 
adjustments are made. The Treasury Department and the IRS agree that 
forward section 704(c) and reverse section 704(c) principles, which 
otherwise would apply, also apply in this context.
    In addition, several commenters requested that the final 
regulations provide greater flexibility in the structuring of 
investments in QOF partnerships by allowing investors to use master-
feeder structures and similar structures such as aggregator funds. The 
commenters noted that proposed Sec.  1.1400Z2(b)-1(c)(6)(ii)(B) 
permitted a QOF owner to contribute its direct or indirect interest in 
a QOF partnership to another partnership under certain circumstances in 
a transaction governed by section 721(a) without the transfer being 
treated as an inclusion event. The final regulations decline to 
incorporate that comment because it is inconsistent with the statute. 
Specifically, section 1400Z-2(a)(1)(A) requires an eligible taxpayer to 
make an investment in a QOF within 180 days of the sale or exchange 
that gave rise to the eligible gain in order for the taxpayer to have 
made a qualifying investment.
    The final regulations clarify that, when a QOF partner contributes 
its qualifying investment to a transferee partnership in a section 721 
transaction, the transferee partnership is the party that recognizes 
the deferred gain and is eligible for the five- and seven-year basis 
adjustments. However, the transferee partnership must allocate all such 
amounts to the contributing partner, applying the principles of section 
704(c). The contributing partner no longer will be eligible to make the 
elections under section 1400Z-2(c) and Sec.  1.1400Z2(c)-1(b)(2). 
Instead, the transferee partnership will be the sole person eligible to 
make these elections, and the elections will apply to all partners in 
the transferee partnership for that tax year.
e. Mixed-Funds Investments in QOF Partnerships
    Proposed Sec.  1.1400Z2(b)-1(c)(6)(iv) provided that a partner that 
holds a mixed-funds investment in a QOF partnership (mixed-funds 
partner) is treated as holding separate interests in the QOF 
partnership--a qualifying investment and a non-qualifying investment--
solely for purposes of section 1400Z-2. Under proposed Sec.  
1.1400Z2(b)-1(c)(6)(iv)(B), all section 704(b) allocations of income, 
gain, loss, and deduction, all section 752 allocations of debt, and all 
distributions made to a mixed-funds partner were treated as made to the 
separate interests based on the allocation percentages of the 
interests, which generally were determined based on the relative 
capital contributions attributable to the qualifying investment and the 
non-qualifying investment. However, if a partner received a profits 
interest in the partnership in exchange for services, the May 2019 
proposed regulations provided that the profits interest was a non-
qualifying investment and that the allocation percentage for the 
profits interest was based on the highest share of residual profits the 
mixed-funds partner would receive with respect to that interest.
    The Treasury Department and the IRS received a number of comments 
advocating different methods of allocating section 704(b) items, debt, 
and distributions between qualifying and non-qualifying investments in 
a mixed-funds investment. For example, one commenter requested that 
taxpayers be allowed to treat partnership distributions as made 
disproportionately to non-qualifying investments to minimize the 
likelihood that a distribution will cause a qualifying investment to be 
considered sold or exchanged. Another commenter requested that all debt 
be allocated to the non-qualifying investment. One commenter also 
recommended that gain on the sale of property by a QOF partnership be 
treated as attributable to the non-qualifying investment and qualifying 
investment based on each investment's share of section 704(b) gain with 
respect to the property.
    The Treasury Department and the IRS decline to adopt these comments 
because the recommended changes would (i) increase the complexities in 
determining the items attributable to qualifying and non-qualifying 
investments comprising a mixed-funds investment, and (ii) be 
significantly more difficult to administer for both taxpayers and the 
IRS. The Treasury Department and the IRS have

[[Page 1888]]

determined that the approach in the May 2019 proposed regulations is 
the most straightforward option, and the option that minimizes 
administrable burden, for determining allocation percentages for 
qualifying and non-qualifying investments. Therefore, the final 
regulations retain the rule in the May 2019 proposed regulations and 
continue to determine allocation percentages based on relative capital 
contributions.
    Commenters generally agreed with the rule in proposed Sec.  
1.1400Z2(a)-1(b)(9)(ii) that profits interests received for services 
should not be treated as qualifying investments. However, a number of 
commenters requested changes to the rule for calculating allocation 
percentages in the case of a profits interest received for services. 
One commenter highlighted that the proposed rule could result in a 
profits interest holder receiving an allocation percentage that is 
higher than its actual share of residual profits. Another commenter 
recommended that the allocation percentage for a profits interest be 
determined by comparing the profits received by the service provider 
with those derived by another significant partner that does not provide 
services to the QOF partnership. Yet another commenter requested that 
the final regulations incorporate the definition of ``applicable 
partnership interest'' under section 1061. This commenter recommended 
that the final regulations provide that the highest share of residual 
profits that a partner holding the mixed-funds investment would receive 
with respect to an ``applicable partnership interest'' would be 
determined by the highest share of residual profits less a reasonable 
return on the partner's capital interest, based on consideration of all 
facts and circumstances at the time of the receipt of the interest.
    The Treasury Department and the IRS decline to adopt any of these 
comments because the approach in proposed Sec.  1.1400Z2(b)-1(c)(6)(iv) 
is simpler and more administrable. The final regulations require a 
partner who receives a profits interest for services as part of a 
mixed-funds investment in a QOF partnership to determine the allocation 
percentage of the profits interest based on the share of residual 
profits that the mixed-funds partner would receive from the 
partnership. In addition, the final regulations provide that, if the 
residual share provided in the partnership agreement is not reasonably 
likely to apply, then that share will be disregarded in determining 
allocation percentages, and the allocation percentage for the profits 
interest will be the final share of profits provided in the partnership 
agreement that is likely to apply.
f. QSST and ESBT Conversions
    A commenter requested clarification as to whether a conversion from 
a qualified subchapter S trust (QSST) to an electing small business 
trust (ESBT), and vice versa, falls within the exceptions to an 
inclusion event. The final regulations confirm that neither type of 
conversion is an inclusion event if the person who is both the deemed 
owner of the portion of the ESBT holding the qualifying investment and 
the QSST beneficiary is the person taxable on the income from the 
qualifying investment both before and after the conversion. For this 
purpose, Sec.  1.1361-1(j)(8) is deemed not to apply because the 
conversion of a QSST to an ESBT differs from a disposition of the QSST 
asset where there is recognition of gain on the asset. However, there 
will be an inclusion event upon conversion if the qualifying investment 
is in the grantor portion of the ESBT and the ESBT's deemed owner is a 
nonresident alien.
g. Holding Periods
    One commenter suggested clarifying how the principles of proposed 
Sec.  1.1400Z2(b)-1(d)(1) and (2), which provided rules for holding 
periods for QOF investments, would be applied to partnership 
transactions described in proposed Sec.  1.1400Z2(b)-1(c)(6)(ii), such 
as section 721(a) contributions and section 708(b)(2)(A) mergers or 
consolidations.
    Proposed Sec.  1.1400Z2(b)-1(d)(3) allowed the holding period of 
qualifying investments transferred in non-inclusion events listed in 
proposed Sec.  1.1400Z2(b)-1(c)(6)(ii) to tack onto the holding period 
of the transferor under section 1223(1). The final regulations retain 
this provision. Under Sec.  1.1400Z2(b)-1(d)(1), the holding period of 
the transferee partnership will include the holding period of the 
contributing partner.
h. Special Amount Includible Rule for Partnerships and S Corporations
    Proposed Sec.  1.1400Z2(b)-1(e)(4) provided that, for inclusion 
events involving partnerships and S corporations, the amount includible 
is equal to the percentage of the qualifying QOF partnership or QOF S 
corporation interest disposed of, multiplied by the lesser of (1) the 
remaining deferred gain less the five-year and seven-year basis 
adjustments; or (2) the gain that would be recognized by the partner or 
shareholder if the interest were sold in a fully taxable transaction 
for its then fair market value.
    Section 1400Z-2(b)(2)(A) provides that the amount of gain included 
in gross income under section 1400Z-2(a)(1)(A) is the excess of (i) the 
lesser of the amount of gain excluded under paragraph (1) of that 
section or the fair market value of the investment as determined as of 
the date described in paragraph (1), over (ii) the taxpayer's basis in 
the investment.
    Several commenters requested that the special amount includible 
rule for partnerships and S corporations be changed to follow the 
statutory language in section 1400Z-2(b)(2)(A). Commenters acknowledged 
that the special amount includible rule was intended to prevent 
taxpayers from avoiding the recognition of deferred gain upon an 
inclusion event when the fair market value of their qualifying 
investment has diminished due to debt-financed deductions or 
distributions. However, these commenters emphasized that the special 
amount includible rule creates inequitable results for debt-financed 
losses attributable to periods before December 31, 2026, as compared to 
debt-financed losses incurred after this date. Certain commenters also 
suggested that this rule has adversely affected the ability to develop 
low-income housing tax credit projects and other community development 
properties in QOZs.
    The Treasury Department and the IRS have determined that the 
proposed special amount includible rule for partnerships and S 
corporations conforms to the underlying intent of the capital gain 
deferral allowed under section 1400Z-2. Thus, the Treasury Department 
and the IRS decline to adopt this request, and the final regulations 
retain the special amount includible rule for partnerships and S 
corporations found in proposed Sec.  1.1400Z2(b)-1(e)(4). Further, 
although the final regulations do not limit the combining (commonly 
referred to as ``twinning'') of other tax incentives with the benefits 
provided by section 1400Z-2, the creation of special rules in this 
regard exceeds the scope of section 1400Z-2 and the section 1400Z-2 
regulations.
3. Grantor Trusts
    Proposed Sec.  1.1400Z2(b)-1(c)(5)(i) provided that a taxpayer's 
transfer of its qualifying investment in a QOF to a grantor trust of 
which the taxpayer is the deemed owner was not an inclusion event for 
purposes of section 1400Z-2(b)(1) and proposed Sec.  1.1400Z2(b)-1(c). 
One commenter asked whether a gift to a ``defective grantor trust'' 
would be an

[[Page 1889]]

inclusion event. The Treasury Department and the IRS note that a 
defective grantor trust is a grantor trust for Federal income tax 
purposes, so its funding does not change the conclusion that the 
transfer is not an inclusion event under section 1400Z-2. In each 
situation, the deemed owner of the grantor trust's property for Federal 
income tax purposes (that is, the taxpayer) would be treated as 
maintaining a direct qualifying investment in the QOF for Federal 
income tax purposes. See part II.A.5 of this Summary of Comments and 
Explanation of Revisions (describing rationale for not treating such 
transfers as inclusion events).
    Another commenter stated that proposed Sec.  1.1400Z2(b)-
1(c)(5)(ii), which addressed inclusion events related to grantor 
trusts, was too broad because the proposed rule applied to ``a change 
in the status of a grantor trust.'' The commenter noted that this 
language could be read to apply to a taxpayer that owned a QOF 
investment and was the deemed owner of a grantor trust, regardless of 
whether the grantor trust itself held a QOF investment. The Treasury 
Department and the IRS agree with this comment. Accordingly, the final 
regulations clarify that the provision applies to a change in the 
status of a grantor trust owning a qualifying investment in a QOF.
    A commenter also requested clarification that non-gift transactions 
between a grantor trust and its deemed owner that are not recognition 
events for Federal income tax purposes are not inclusion events, and 
that such transactions do not start a new holding period for purposes 
of section 1400Z. In such transactions, the deemed owner of the trust 
continues, for Federal income tax purposes, to be the taxpayer liable 
for the Federal income tax on the qualifying investment. Thus, the 
Treasury Department and the IRS have determined that, like transfers by 
the deemed owner to the grantor trust, these transactions (including 
transfers from the grantor trust to its deemed owner) are not inclusion 
events.

F. Transfers of Property by Gift or by Reason of Death, or Incident to 
Divorce

1. Gifts
    The May 2019 proposed regulations provided that a transfer by gift 
of a qualifying investment in a QOF is an inclusion event for purposes 
of section 1400Z-2(b)(1) and proposed Sec.  1.1400Z2(b)-1(c). One 
commenter asserted that a donor's gift of a qualifying investment in a 
QOF should not be considered a sale or exchange for purposes of section 
1400Z-2, provided that the gift otherwise is not treated as a taxable 
disposition for Federal income tax purposes.
    As noted in the preamble to the May 2019 proposed regulations, 
section 1400Z-2(b)(1) does not directly address non-sale or exchange 
dispositions, such as gifts and bequests. However, the Conference 
Report provides that, under section 1400Z-2(b)(1), the ``deferred gain 
is recognized on the earlier of the date on which the [qualifying] 
investment is disposed of or December 31, 2026.'' See Conference Report 
at 539 (indicating that continued gain recognition deferral requires 
the taxpayer to maintain directly the taxpayer's qualifying 
investment).
    Section 1400Z-2 requires the deferred Federal income tax on capital 
gains to be paid by the taxpayer who incurred that gain and reinvested 
an amount up to the amount of the net proceeds from the sale into the 
qualifying investment in the QOF. The only exception is the recognition 
under section 691 of a decedent's deferred gain that is not properly 
includible in the decedent's gross income. The Treasury Department and 
the IRS have concluded that (i) no authority exists to impose the 
donor's deferred capital gains tax liability on the donee of the 
qualifying investment, and therefore (ii) the Federal income tax on the 
deferred gain must be collected from the donor at the time of the gift 
of the qualifying investment. Accordingly, the final regulations 
continue to provide that a gift of the qualifying investment in a QOF 
is an inclusion event. In addition, consistent with the discussion in 
part VII.E. of the Explanation of Provisions to the May 2019 proposed 
regulations, the final regulations provide that the interest received 
by the donee is no longer a qualifying investment in a QOF as a result 
of the inclusion event, and thus the donee is not eligible to make an 
election under section 1400Z-2(c) to adjust the basis of the interest 
in the QOF to fair market value.
2. Death
    The May 2019 proposed regulations generally provided that a 
transfer of a qualifying investment by reason of the taxpayer's death 
is not an inclusion event. See proposed Sec.  1.1400Z2(b)-1(c)(4)(ii) 
(enumerating the sole exceptions to that general rule). One commenter 
noted that the recipient of a deceased owner's qualifying investment 
may not have the liquidity to pay the deferred tax on the gain the 
decedent invested in the QOF upon an inclusion event as of December 31, 
2026. The commenter requested that the final regulations permit an 
election to treat death as an inclusion event, thereby making the 
decedent's estate liable for the payment of the deferred tax, or grant 
the recipient a further deferral until the recipient's disposition of 
the qualifying investment.
    The Treasury Department and the IRS note that, if a decedent who 
dies after 2026 had not disposed of the qualifying investment prior to 
December 31, 2026, it is possible that even the decedent could have 
faced such a liquidity problem. In light of the statute's clear 
direction that the deferral be terminated no later than December 31, 
2026, the final regulations provide no election to a decedent's estate 
to treat death as an inclusion event or provide further deferral to a 
person inheriting the qualifying investment as a result of the deceased 
owner's death.
    One commenter also requested clarification regarding the 
application of section 691 to the recipient of the qualifying 
investment by reason of the death of the owner. In response, the final 
regulations provide that the tax on the decedent's deferred gain is the 
liability of the person in receipt of that interest from the decedent 
at the time of an inclusion event.
3. Transactions Between Spouses or Incident to Divorce
    A commenter requested that transfers between spouses or incident to 
divorce, as described in section 1041, be excepted from the definition 
of an inclusion event. Although those transactions are nonrecognition 
events for Federal income tax purposes, a transfer of the qualifying 
investment in such a transaction constitutes a disposition of that 
interest for purposes of section 1400Z-2(a)(1)(B) and (b). Therefore, 
the final regulations in Sec.  1.1400Z2(b)-1(c)(3)(ii) clarify that a 
transfer described in section 1041 is an inclusion event. Accordingly, 
the transferor's deferred gain is recognized, and the transferee's 
interest in the QOF no longer is a qualifying investment.

G. Basis Adjustments

1. Adjustments to Basis of Qualifying QOF Stock
    Under section 1400Z-2(b)(2)(B)(ii) and proposed Sec.  1.1400Z2(b)-
1(g), a taxpayer's basis in its qualifying investment is increased by 
the amount of gain recognized upon an inclusion event or on December 
31, 2026. Proposed Sec.  1.1400Z2(b)-1(g) also provided additional 
rules regarding the timing and amount of basis adjustments under 
section 1400Z-2(b)(2)(B)(ii).

[[Page 1890]]

    Commenters requested clarification as to how the section 1400Z-
2(b)(2)(B)(ii) basis adjustments should be made if a taxpayer disposes 
of less than all of its qualifying QOF stock or if less than all of its 
qualifying QOF stock is redeemed by the QOF corporation. If an investor 
has a qualifying investment with $0 basis and a corresponding $100 of 
deferred gain, and if the investor were to sell its entire qualifying 
investment for $100, the investor would recognize $100 of deferred 
gain, increase its basis in the qualifying investment by $100, and then 
recognize $0 of gain under section 1001 on the sale of the qualifying 
investment. If the investor were to sell half of its investment for $50 
instead, the investor would recognize $50 of deferred gain under 
proposed Sec.  1.1400Z2(b)-1(e)(1) and then increase its basis in its 
qualifying investment by $50. However, it is unclear under the May 2019 
proposed regulations whether the $50 basis increase should be applied 
to the shares that were sold, to the shares that were retained, or to 
both the sold and the retained shares proportionally.
    A commenter recommended that the section 1400Z-2(b)(2)(B)(ii) basis 
increase be made only to those specific shares that trigger the 
inclusion event. In the foregoing example, if the $50 basis adjustment 
were made solely to the sold shares, the investor would recognize $50 
of the deferred gain on the disposition of such shares and $0 of gain 
under section 1001, and the investor would continue to have $50 of 
deferred gain and $0 of basis in the retained shares. In contrast, if 
all or a proportionate amount of the section 1400Z-2(b)(2)(B)(ii) basis 
increase were made to the retained shares, the investor would recognize 
$50 of deferred gain plus an additional $50 or $25 of gain, 
respectively, under section 1001. Thus, the investor would recognize 
more gain than the amount realized in the transaction. Moreover, the 
retained portion of the investment still would be associated with $50 
of deferred gain. Although the taxpayer would have a basis of either 
$50 or $25 in its retained stock, the taxpayer could end up recognizing 
gain in excess of the amount of deferred gain if the qualifying 
investment appreciates sufficiently--an outcome that is contrary to the 
express language of the statute. See section 1400Z-2(b)(2)(A).
    Similarly, commenters recommended that, in the case of a dividend-
equivalent redemption of qualifying QOF stock owned by a sole 
shareholder of a QOF corporation, the section 1400Z-2(b)(2)(B)(ii) 
basis increase for any section 301(c)(3) gain or 1059(a)(2) gain be 
made only to the redeemed shares.
    The Treasury Department and the IRS agree with the commenters that, 
if a shareholder of a QOF corporation sells less than all of its 
qualifying QOF stock, the section 1400Z-2(b)(2)(B)(ii) basis increase 
should be made only to those specific shares that are sold. The final 
regulations have been revised accordingly. Otherwise, issues relating 
relating to the treatment of basis upon a redemption are beyond the 
scope of the final regulations. The Treasury Department and the IRS 
continue to study such issues. See REG-143686-07, 84 FR 11686 (March 
28, 2019).
2. Basis Adjustments to QOF Partnership Interests and QOF S Corporation 
Stock
a. General Application of Five-Year and Seven-Year Basis Increases
    A commenter noted that the May 2019 proposed regulations, unlike 
the preamble, did not specifically provide that the five-year and 
seven-year basis increases to a qualifying investment are basis for all 
purposes of the Code, and recommended that the final regulations 
confirm this result. The Treasury Department and the IRS agree with 
this comment. Accordingly, the final regulations in Sec.  1.1400Z2(b)-
1(g)(4)(ii) and (g)(5)(i) specifically provide that five-year and 
seven-year basis adjustments to a qualifying investment in a 
partnership or S corporation described in section 1400Z-2(b)(2)(B)(iii) 
and (iv) and section 1400Z-2(c) are basis for all purposes of the Code, 
including for purposes of suspended losses under sections 704(d) and 
1366(d).
b. Specific Stock Basis Rules for S Corporations
    The May 2019 proposed regulations provided that, if an S 
corporation is an investor in a QOF, the S corporation must adjust the 
basis of its qualifying investment in the manner set forth for C 
corporations in proposed Sec.  1.1400Z2(b)-1(g), except as otherwise 
provided in those proposed regulations. This rule does not affect 
adjustments to the basis of any other asset of the S corporation. The S 
corporation shareholder's pro-rata share of any recognized deferred 
capital gain at the S corporation level will be separately stated under 
section 1366 and will adjust the shareholders' stock basis under 
section 1367. In addition, the May 2019 proposed regulations made clear 
that any adjustment to the basis of an S corporation's qualifying 
investment under section 1400Z-2(b)(2)(B)(iii) or (iv) or section 
1400Z-2(c) will not (1) be separately stated under section 1366, and 
(2) adjust the shareholders' stock basis under section 1367 until the 
date on which an inclusion event with respect to the S corporation's 
qualifying investment occurs. If a basis adjustment under section 
1400Z-2(b)(2)(B)(ii) is made as a result of an inclusion event, then 
the basis adjustment will be made before determining the other tax 
consequences of the inclusion event.
    The Treasury Department and the IRS received favorable comments 
regarding the foregoing rules, which the Treasury Department and the 
IRS drafted in accordance with the principle of section 1371(a), as 
discussed in part III.E.2.a of this Summary of Comments and Explanation 
of Revisions. As a result, the final regulations adopt these rules 
without modification.
3. Basis Adjustments by Reason of Death
    Several commenters requested clarification regarding the basis of a 
qualifying investment in the hands of a deceased owner's heir, legatee, 
or beneficiary. More specifically, commenters requested clarification 
as to whether the basis adjustment under section 1014 would apply less 
the amount of unrecognized gain.
    If the decedent's investment in a QOF exceeded the gain the 
decedent elected to defer under section 1400Z-2(a), the investment is a 
mixed-funds investment that is treated as two separate investments--a 
qualifying investment subject to section 1400Z-2, and a non-qualifying 
investment to which section 1400Z-2 is inapplicable. See section 1400Z-
2(e)(1). Proposed Sec.  1.1400Z2(a)-1(b)(11)(i)(D) identified the basis 
of the non-qualifying investment as the taxpayer's total basis in the 
QOF less the basis of the qualifying investment, in each case 
determined without the zero-basis rule and without any other basis 
adjustment provided for in section 1400Z-2(b)(2)(B). In general, this 
amount equals the taxpayer's total investment in the QOF less the 
amount of gain invested on which the capital gains tax was deferred.
    Because section 1400Z-2 is inapplicable to the non-qualifying 
investment, the recipient's basis in the non-qualifying investment on 
the death of the owner is governed by section 1014. As with other 
income in respect of a decedent, the estate tax value is not reduced by 
the liability for the deferred income tax.
    However, section 1400Z-2(b)(2)(B) applies with regard to the 
recipient's basis in the qualifying investment. This section provides 
that the basis of the qualifying investment is zero, with

[[Page 1891]]

specified increases for gain recognized at the time of an inclusion 
event and for qualifying investments held for at least five or seven 
years. This provision governs without regard to section 1014. Because a 
taxpayer's basis in its qualifying investment is zero except as 
otherwise provided in section 1400Z-2(b)(2)(B) and section 1400Z-2(c) 
(which concerns qualifying investments held for at least 10 years), the 
Treasury Department and the IRS have determined that section 1014 does 
not apply to adjust the basis of an inherited qualifying investment to 
its fair market value as of the deceased owner's death.

H. Earnings and Profits

    A commenter requested guidance regarding the E&P consequences of 
section 1400Z-2 and the section 1400Z-2 regulations. Specifically, the 
commenter recommended that any increase to E&P as a result of gain 
deferred under section 1400Z-2 be deferred until such gain is included 
in income upon either an inclusion event or December 31, 2026.
    As noted by the commenter, section 312(f)(1) provides that gain or 
loss realized on the sale or other disposition of property by a 
corporation increases or decreases the E&P of such corporation, but 
only to the extent the realized gain or loss was recognized in 
computing taxable income under the law applicable to the year in which 
such sale or disposition was made. Section 1400Z-2 and the section 
1400Z-2 regulations enable a taxpayer to defer recognition of an 
eligible gain in the year the eligible gain was realized. As a result, 
the amount of gain so deferred does not increase the taxpayer's E&P in 
the year of realization. See section 312(f)(1). When the gain 
eventually is included in income upon an inclusion event or on December 
31, 2026, the taxpayer's E&P will be increased. See Sec.  1.312-6(b). 
The Treasury Department and the IRS have determined that section 312 
and the regulations in this part under section 312 provide this result 
in their current form, and therefore no additional rules are necessary. 
However, the examples set forth in Sec.  1.1400Z2(b)-1(g)(3) have been 
revised to illustrate the application of the existing E&P rules within 
the context of section 1400Z-2.
    The commenter also recommended that the amount of basis adjustments 
resulting from the application of section 1400Z-2(b)(2)(B)(iii) and 
(iv) and section 1400Z-2(c) should be treated as tax-exempt income that 
causes an increase to E&P under Sec.  1.312-6(b). Section 1.312-6(b) 
provides that, among other items, income exempted from Federal income 
tax by statute is entered into the computation of E&P for a particular 
period. The basis increases under section 1400Z-2(b)(2)(B)(iii) and 
(iv) exempt from tax under subtitle A those gains that are deferred 
under section 1400Z-2(a). Similarly, the election under section 1400Z-
2(c) potentially exempts from tax under subtitle A those gains that are 
attributable to the appreciation of QOF investments. Therefore, these 
basis increases are tax-exempt income for purposes of computing E&P and 
will increase the E&P of the taxpayer at the time such increases are 
made. As noted previously, the Treasury Department and the IRS have 
determined that section 312 and the regulations in this part under 
section 312 provide this result in their current form and that no 
additional rules are necessary.
    One commenter further asserted that Sec.  1.312-6(b) should not 
apply to income that is exempt from tax as a result of the basis 
increases under section 1400Z-2 in order to facilitate passing the 
benefits of a REIT's qualifying investments to the REIT's shareholders. 
See part IX.B of this Summary of Comments and Explanation of Revisions. 
However, the Treasury Department and the IRS have determined that 
section 312 and Sec.  1.312-6(b) appropriately apply to income that is 
exempt from tax under subtitle A as a result of these basis increases. 
Thus, the final regulations have not been revised in response to this 
comment.

I. Voluntary Inclusion; Applicable Tax Rate

    A commenter requested that a QOF investor be permitted to 
voluntarily recognize the full amount of deferred gain in a taxable 
year of the investor's choosing prior to the statutorily required year 
of inclusion under section 1400Z-2(b)(1), and at the Federal income tax 
rate applicable to the chosen recognition year. The investor would 
remain fully invested in the QOF, and therefore the basis increases at 
the five-year mark and seven-year mark, as well as the basis adjustment 
to fair market value after 10 years, still would be available with 
regard to the taxpayer's qualifying investment. If the investor meets 
the requirements for one or more of these basis adjustments, the 
investor could request a refund of the tax paid on the appropriate 
amount of the gain in a prior year.
    According to the commenter, voluntary gain recognition prior to the 
statutorily provided year of inclusion would accomplish two purposes. 
First, the investor could eliminate the risk that the tax rate under 
subtitle A in the statutorily required year of inclusion would be 
significantly higher than in the year of voluntary inclusion. Second, 
the investor would possess the flexibility to pay a tax liability in a 
year during which the investor is certain to have available the 
necessary amount of funds.
    The Treasury Department and the IRS do not adopt the commenter's 
recommendation. Section 1400Z-2(b) specifies two events upon which an 
investor's deferred gain under section 1400Z-2(a)(1) may be included in 
income. First, deferred gain is included in income upon the occurrence 
of an inclusion event as explained further in these regulations in 
Sec.  1.1400Z2(b)-1. Second, deferred gain is included on December 31, 
2026. It is not contemplated under the statute or legislative history 
that a taxpayer may choose to include deferred gain in income at 
another time and continue to remain invested in a QOF. Accordingly, if 
a taxpayer wishes to include deferred gain in income, it may cause the 
occurrence of an inclusion event, with the effect that the investor's 
ownership of the QOF would terminate for all purposes, including the 
basis adjustment to fair market value under section 1400Z-2(c).
    Another commenter inquired whether the proper Federal income tax 
rate to apply to the gain recognized pursuant to section 1400Z-2(b)(1) 
is the Federal income tax rate at the time of the investment and 
deferral election, or the Federal income tax rate in the taxable year 
of inclusion. The May 2019 proposed regulations provided that, 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 had not been deferred. Thus, if the Federal income tax 
rate were considered an ``attribute'' of the gain, the rate applicable 
in the year of deferral arguably would apply to gain recognized under 
section 1400Z-2(b)(1).
    Although the May 2019 proposed regulations provided rules for the 
tax attributes of the amount deferred in the year of inclusion, the May 
2019 proposed regulations did not discuss the Federal income tax rates 
for the year of inclusion. The final regulations clarify that gain 
recognized pursuant to section 1400Z-2(b)(1) and the section 1400Z-2 
regulations is subject to taxation at the applicable Federal income tax 
rates for the year of inclusion, not of the year of deferral.

[[Page 1892]]

J. Availability of Basis Adjustments Under Section 1400Z-
2(b)(2)(B)(iii) and (iv)

    Section 1400Z-2(b) provides that gain deferred under section 1400Z-
2(a)(1)(A) is included in income in the taxable year that includes the 
earlier of the date on which the QOF investment was sold or exchanged 
or December 31, 2026. Therefore, in order to be eligible for both the 
five-year and seven-year basis increases under section 1400Z-
2(b)(2)(B)(iii) and (iv), respectively, a taxpayer must invest eligible 
gain in a qualifying investment no later than December 31, 2019. 
Eligibility solely for the five-year basis increase requires an 
investment of eligible gain no later than December 31, 2021. Commenters 
requested that the statutory inclusion date be postponed to December 
31, 2027 or December 31, 2028 to provide investors additional time to 
consider investing in a QOF, and still receive the benefit of the five- 
and seven-year basis increases with the benefit of final regulatory 
guidance.
    The Treasury Department and the IRS note that the December 31, 
2026, date is mandated by statute, and that there is no indication that 
Congress intended a later inclusion date. Therefore, the final 
regulations do not adopt this recommendation.
    Another commenter requested confirmation that the inclusion dates 
in section 1400Z-2(b)(1) do not apply to the five-year and seven-year 
basis increases under section 1400Z-2(b)(2)(B)(iii) and (iv). As a 
consequence, a qualifying investment would be eligible for these basis 
increases regardless of whether the full amount of deferred gain has 
been recognized, and regardless of when the qualifying investment is 
made.
    As discussed in parts III.A and III.I of this Summary of Comments 
and Explanation of Revisions, the basis adjustments provided by section 
1400Z-2(b)(2)(B)(iii) and (iv) are based on an eligible taxpayer's 
remaining deferred gain. Moreover, section 1400Z-2(b)(1) clearly 
requires all deferred gain to be taken into account no later than 
December 31, 2026. After that date, there will be no remaining deferred 
gain to be excluded from Federal income tax as a result of the five- or 
seven-year basis adjustments. As a consequence of the commenter's 
recommendation, the five- and seven-year basis increases would operate 
not only to exclude a portion of the deferred gain from Federal income 
tax, but also to exclude a portion of subsequent appreciation in the 
value of a qualifying investment from Federal income tax. The Treasury 
Department and the IRS have determined that the statutory text of 
section 1400Z-2 does not adequately support the commenter's 
recommendation, and have clarified the final regulations.
    In addition, a commenter requested that the five-year and seven-
year basis increases under section 1400Z-2(b)(2)(B) be elective rather 
than automatic, based on the commenter's position that an investor 
should be allowed to choose to recognize deferred gain that otherwise 
would be eliminated due to those basis increases. The statute and 
legislative history do not indicate that the basis increases under 
section 1400Z-2(b)(2)(B) operate at the taxpayer's option once the 
requisite five- and seven-year holding periods have been met. 
Accordingly, the Treasury Department and the IRS decline to adopt this 
recommendation.

K. Commencement of the Holding Period for a QOF Investment

    In Examples 1 and 7 in proposed Sec.  1.1400Z2(b)-1(f), the holding 
period for a qualifying investment in a QOF begins on the date on which 
the qualifying investment is acquired rather than on the day after the 
date of its acquisition. One commenter noted that, under Rev. Rul. 70-
598, 1970-2 C.B. 168, and general Federal income tax principles, the 
holding period for a capital asset begins on the day after the 
acquisition of the asset.
    The Treasury Department and the IRS acknowledge the divergence 
between (i) the day on which the holding period of a qualifying 
investment begins, and (ii) the day on which the holding period for a 
capital asset ordinarily would begin. However, the Treasury Department 
and the IRS have determined that no provision of the Code, nor any 
Federal income tax principle, requires conformity in this context. As a 
result, the final regulations do not modify the date on which the 
holding period for a qualifying investment commences.

L. QOF Exit and Reinvestment

    Commenters requested that the final regulations provide a rule that 
would permit an investor to dispose of its entire interest in a 
qualifying investment and reinvest the resulting proceeds in another 
QOF within a short period of time, such as 180 days. Under this rule, 
the investor would be permitted to tack the holding period of the 
disposed qualifying investment onto the new qualifying investment for 
purposes of the five-year, seven-year, and ten-year basis adjustments 
under section 1400Z-2(a)(2)(B)(iii) and (iv) and section 1400Z-2(c), 
respectively. This rule would allow an investor to disinvest in a 
particular QOF as long as the investor remains invested in QOFs, in the 
aggregate, for the requisite holding periods. One commenter indicated 
that such a rule would expose investors to a lower risk of loss, which 
would facilitate investments in professionally managed QOFs from a 
wider variety of consumer-type investors.
    The Treasury Department and the IRS acknowledge the additional 
investment flexibility that would be provided through adoption of the 
commenters' recommendation. However, the Treasury Department and the 
IRS have found no support for this recommendation in the statutory text 
of section 1400Z-2 or its underlying legislative history. As a result, 
the final regulations do not incorporate the commenters' 
recommendation. With regard to the effect of specific transactions on 
the holding period of a qualifying investment for purposes of the basis 
adjustments under sections 1400Z-2(a)(2)(B)(iii) and (iv) and 1400Z-
2(c), the final regulations provide taxpayers with provisions that 
address specific inclusion events.

IV. Comments on and Changes to Proposed Sec.  1.1400Z2(c)-1

    Section 1400Z-2(c) provides that in the case of any investment held 
by the taxpayer for at least 10 years and with respect to which the 
taxpayer makes an election under section 1400Z-2(c), the basis of such 
property will be equal to the fair market value of such investment on 
the date that the investment is sold or exchanged. Proposed Sec.  
1.1400Z2(c)-1 set forth proposed rules concerning the election under 
section 1400Z-2(c), including special rules for QOF partnerships and 
QOF S corporations.

A. Gain Exclusion for Asset Sales by QOFs and Qualified Opportunity 
Zone Businesses

    Proposed Sec.  1.1400Z2(c)-1(b)(2)(ii)(A)(1) provided that an 
investor in a QOF partnership or a QOF S corporation may elect to 
exclude some, or all, of the capital gain arising from the QOF's sale 
of qualified opportunity zone business property upon satisfaction of 
the 10-year holding period in section 1400Z-2(c). A commenter requested 
guidance regarding a fact pattern in which a QOF that has been held for 
the requisite 10-year holding period owns multiple qualified 
opportunity zone businesses. Specifically, the commenter requested 
confirmation that the gain from each separate disposition of interests 
in qualified opportunity zone businesses,

[[Page 1893]]

after a 10-year holding period of a qualifying investment, qualifies 
for the basis adjustment and potential gain exclusion under section 
1400Z-2(c).
    The Treasury Department and the IRS agree that, in the case of a 
QOF partnership or QOF S corporation, the disposition of QOF assets, 
including interests in qualified opportunity zone businesses, may 
qualify for the election under section 1400Z-2(c) if the qualifying 
investment in the QOF partnership or QOF S corporation meets the 10-
year holding period of section 1400Z-2(c), notwithstanding the disposal 
of interests in qualified opportunity zone businesses at different 
times. A rule that requires a single disposition of all QOF assets in 
order to qualify for the benefits under section 1400Z-2(c) would 
provide an incentive for QOFs and their investors to dispose of a 
qualified opportunity zone business at a time when, in the absence of 
section 1400Z-2(c), such a disposition would not be made for reasons 
unrelated to section 1400Z-2. The final regulations permit interests in 
qualified opportunity zone businesses to be disposed of at different 
times. This rule provides taxpayers flexibility consistent with the 
principle that the economic success of the QOF and the qualified 
opportunity zone businesses should be the overriding concern when an 
investor decides whether to dispose of an interest in a qualified 
opportunity zone business.
    One commenter also requested clarification regarding the 
application of section 1400Z-2(c) to a disposition of assets at less 
than fair market value, including situations in which the property sold 
is government-owned or low-income housing. If an investment is held for 
at least 10 years by a QOF and a taxpayer makes an election under 
section 1400Z-2(c), then the basis of the investment is equal to fair 
market value on the date that the investment is sold or exchanged. 
Proposed Sec.  1.1400Z2(c)-1(b)(2)(ii)(A)(1) applied the basis 
adjustment rule in section 1400Z-2(c) to the disposition of assets by a 
QOF partnership. Under general Federal income tax principles, the fair 
market value of property will generally be equal to the actual sales 
price of such property when a buyer and seller are unrelated. Fair 
market value under section 1400Z-2(c) is consistent with these 
principles. Therefore, in a disposition of assets of a QOF to an 
unrelated party where the taxpayer makes a valid election under section 
1400Z-2(c), the relevant fair market value of the assets generally 
would be the sale price. In a disposition of assets to a related party, 
the fair market value for purposes of section 1400Z-2(c) would be 
determined with consideration of the principles of section 482.

B. Application of Section 1400Z-2(c) Election to Certain Gain

    Commenters asked whether taxpayers may make an election under 
section 1400Z-2(c) with respect to section 301(c)(3) gain or section 
731 gain on a qualifying investment. The Treasury Department and the 
IRS have determined that an election under section 1400Z-2(c) should be 
available for gain resulting from section 301(c)(3), section 731(a), 
section 1059(a)(2), or section 1368(b)(2) or (c)(3) on a qualifying 
investment because such gain is treated as gain from the sale or 
exchange of property for Federal income tax purposes.

C. Inclusion Events

    As discussed in part III of this Summary of Comments and 
Explanation of Revisions, proposed Sec.  1.1400Z2(b)-1(c) provided 
rules regarding various events that trigger the inclusion of deferred 
gain under section 1400Z-2(b) and proposed Sec.  1.1400Z2(b)-1(b). 
Commenters requested guidance as to whether, and to what extent, such 
inclusion events, as well as events that occur after December 31, 2026, 
also would cause a qualifying investment to lose eligibility for the 
election under section 1400Z-2(c) and proposed Sec.  1.1400Z2(c)-1. 
Specifically, commenters asked whether an inclusion event with respect 
to gain under section 301(c)(3) would preclude an election under 
section 1400Z-2(c). See proposed Sec.  1.1400Z2(b)-1(c)(8) and related 
provisions in proposed Sec.  1.1400Z2(b)-1(c)(9) through (12).
    As discussed in part II.A.5 of this Summary of Comments and 
Explanation of Revisions, the Treasury Department and the IRS have 
determined that an inclusion event generally would cause a qualifying 
investment to lose eligibility for the election under section 1400Z-
2(c) and Sec.  1.1400Z2(c)-1. However, the Treasury Department and the 
IRS have determined that gain resulting from section 301(c)(3), section 
731(a), section 1059(a)(2), or section 1368(b)(2) or (c)(3) should not 
preclude a taxpayer from making a subsequent election under section 
1400Z-2(c) for its qualifying investment. Therefore, a QOF C 
corporation shareholder or QOF S corporation shareholder is eligible to 
make an election under section 1400Z-2(c) for a qualifying investment 
regardless of the extent to which the shareholder has received 
distributions subject to section 301(c)(3), section 1059(a)(2), or 
section 1368(b)(2) or (c)(3) with respect to such investment. 
Similarly, in the case of inclusion events under Sec.  1.1400Z2(b)-
1(c)(6)(iii) (partnership distributions) and Sec.  1.1400Z2(b)-
1(c)(7)(ii) (distributions by QOF S corporation), the section 1400Z-
2(c) election continues to be available to a partner or S corporation 
shareholder, respectively, as long as the QOF owner continues to hold a 
qualifying investment in the QOF partnership or QOF S corporation, 
despite the distribution that caused an inclusion event. The final 
regulations have been modified accordingly.
    Commenters also recommended that an ordering rule similar to 
proposed Sec.  1.1400Z2(b)-1(g)(1)(ii) be applied to the election under 
section 1400Z-2(c), so that such a basis increase would occur 
immediately before determining the results under section 301(c) and 
section 1059(a). The final regulations adopt such a rule.

D. QOF REIT Capital Gain Dividends Identified With a Date

    Proposed Sec.  1.1400Z2(c)-1(e) provided rules for QOF REITs to 
identify capital gain dividends with a date so that some shareholders 
could elect to receive the amount of such dividends tax-free under 
section 1400Z-2(c). One commenter recommended that the term ``QOF RIC'' 
be added throughout the final regulations alongside all references to 
QOF REITs to ensure that the regulations apply equally to QOF RICs and 
QOF REITs.
    The Treasury Department and the IRS understand that a Business 
Development Company (BDC) that is a RIC may qualify as a QOF. The 
Treasury Department and the IRS have determined that, if a RIC meets 
the qualifications for, and elects to be, a QOF RIC, that entity and 
its shareholders should receive the same treatment under these 
regulations as a QOF REIT and its shareholders. This change is 
reflected in the final regulations. The proportionality rule for QOF 
REITs identifying a capital gain dividend with a date in the May 2019 
proposed regulations was proposed under the authority granted to the 
Secretary under section 857(g)(2). The Treasury Department and the IRS 
apply a similar proportionality requirement to RICs (see Rev. Rul. 89-
81, 1989-1 C.B. 226), and thus have maintained the proportionality rule 
for both QOF RICs and QOF REITs identifying capital gain dividends with 
a date.

[[Page 1894]]

E. Special Rules for QOF Partnerships and QOF S Corporations

1. Section 1400Z-2(c) Election by Transferee Partnership
    The transferee partnership of a qualifying investment in a QOF 
partnership, following a section 721(a) contribution (including those 
resulting from a merger of QOF partnerships), provided there is no 
inclusion event, is eligible to make the section 1400Z-2(c) election to 
exclude from gross income gains and losses from the disposition of 
property held by a QOF (other than gains and losses from the sale of 
inventory in the ordinary course of a business), so long as the 10-year 
holding period requirement is satisfied. See Sec.  1.1400Z2(b)-
1(d)(1)(ii) (transferee partnership has a tacked holding period). The 
final regulations clarify this rule and provide reporting requirements 
for the transferee partnership in making the section 1400Z-2(c) 
election.
2. Basis Adjustment Amount on the Sale of a Qualifying Investment
    Proposed Sec.  1.1400Z2(c)-1(b)(2)(i) provided that, if a taxpayer 
sells or exchanges a qualifying investment in a QOF partnership that 
has been held for at least 10 years, and the taxpayer makes the 
election described in section 1400Z-2(c), the basis of the partnership 
interest is adjusted to an amount equal to the fair market value of the 
interest, including debt. The Treasury Department and the IRS received 
comments asking for clarification of the phrase ``including debt'' in 
the proposed rule. Specifically, commenters requested a rule that more 
clearly states that the basis of the partnership interest is adjusted 
to an amount equal to the net fair market value of the QOF partnership 
interest plus the partner's share of debt. One commenter suggested that 
a ``gross fair market value'' rule would encourage QOF partnerships to 
borrow money and distribute the proceeds, which could increase debt 
within QOZs while reducing cash amounts held by QOF partnerships, 
potentially exacerbating the plight of the economically distressed 
communities. In addition, several commenters asked for clarification 
that the fair market value of the QOF partnership interest cannot be 
less than the partner's allocable share of non-recourse debt, 
consistent with section 7701(g).
    The Treasury Department and the IRS agree with the commenters that 
clarification is needed. Accordingly, the final regulations clarify 
that the basis of the partnership interest is adjusted to an amount 
equal to its net fair market value, plus the partner's share of 
partnership debt relating to that interest, so that the partner would 
recognize no gain or loss on a sale or exchange of the qualifying QOF 
partnership interest after at least 10 years. The final regulations 
also state that the fair market value cannot be less than the partner's 
allocable share of non-recourse debt. In addition, the final 
regulations note that, in the case of a sale or exchange of qualifying 
S corporation shares, the basis is adjusted to an amount equal to the 
fair market value of the shares immediately prior to the sale or 
exchange.
3. Adjustment to Basis of QOF Partnership Assets on Sale of a 
Qualifying Investment
    Proposed Sec.  1.1400Z2(c)-1(b)(2)(i) provided that, if a 
taxpayer's basis is adjusted under section 1400Z-2(c), the bases of the 
QOF partnership assets also are adjusted immediately prior to the sale 
or exchange. The adjustment is calculated in a manner similar to a 
section 743(b) adjustment as if the transferor partner had purchased 
its interest in the QOF partnership for an amount of cash equal to the 
fair market value of the partnership interest immediately prior to the 
sale or exchange, assuming that a valid section 754 election had been 
in place. The Treasury Department and the IRS received comments asking 
for clarification that (i) the assets of lower-tier partnerships also 
should be adjusted pursuant to this rule, (ii) no actual section 754 
election is required, and (iii) generally applicable guidance issued 
pursuant to sections 743(b) and 754 applies in this context.
    The Treasury Department and the IRS agree with the commenters that 
clarification is needed. Accordingly, the final regulations clarify 
that the adjustment applies to any partnerships directly or indirectly 
owned, solely through one or more partnerships (tiered partnerships), 
by the QOF partnership, whether or not an actual section 754 election 
is in place for any of the partnerships. Guidance issued pursuant to 
sections 743(b) and 754 applies as it would outside of the context of 
section 1400Z-2. Further, because section 1400Z-2(c) is designed to 
result in no gain or loss to the transferor QOF partner, the final 
regulations provide that, to the extent the existing rules of sections 
743(b) and 755 operate in a manner that results in recognition of gain 
or loss on the transaction, the basis adjustments are to be made to the 
extent necessary to eliminate any such gain or loss.
4. Sales or Exchanges of Property by QOF Partnerships and QOF S 
Corporations
    The May 2019 proposed regulations provided that, if a QOF 
partnership or QOF S corporation disposes of qualified opportunity zone 
property after a taxpayer is treated as holding its qualifying 
investment in the QOF partnership or QOF S corporation for 10 years, 
the taxpayer may make an election to exclude from gross income some or 
all of the capital gain arising from the disposition. The Treasury 
Department and the IRS received comments requesting that, in addition 
to capital gain from the sales of qualified opportunity zone property 
by a QOF, capital gain from the sales of property by a qualified 
opportunity zone business that is held in partnership form should be 
eligible for exclusion as long as the qualifying investment in the QOF 
has been held for 10 years. The final regulations adopt this 
recommendation for QOF partnerships and QOF S corporations.
    Commenters also requested that all types of gains and losses, 
including gains and losses from the sales of inventory, section 1231 
gains and losses, and depreciation recapture, be eligible for exclusion 
under this special election for QOF partnerships and QOF S 
corporations. Other commenters suggested that the exclusion election 
should apply to all gains and losses of QOF partnerships or QOF S 
corporations other than gains and losses from the sales of inventory in 
the ordinary course of business. The final regulations adopt the 
recommendation to exclude ordinary course inventory sales from the 
exclusion election.
    The final regulations set forth two requirements for the QOF 
partnership or QOF S corporation and the taxpayer when the taxpayer 
wishes to make an election to exclude gains and losses upon sales of 
assets other than inventory sold in the ordinary course of a trade or 
business by the QOF. First, the taxpayer must make the election for 
each taxable year in which it wishes to exclude the QOF's gains and 
losses from all sales and exchanges of assets. This election may be 
made regardless of whether the taxpayer has made an election for any 
prior taxable year. The election will apply to all gains and losses, 
other than gains and losses from sales of inventory in the ordinary 
course of business, of the QOF partnership or QOF S corporation for 
that taxable year, including any gains and losses from a lower-tier 
partnership. The election must be made by the taxpayer on the 
applicable form filed with its Federal

[[Page 1895]]

tax return for the year in which the sale or exchange occurs.
    The second requirement is designed to eliminate future section 
1400Z-2 benefits attributable to the reinvestment of proceeds from 
asset sales for which gain and loss is not recognized under section 
1400Z-2. Under this provision, and solely for purposes of determining 
the amount of a QOF owner's qualifying investment and non-qualifying 
investment, the QOF is treated as distributing to each electing QOF 
owner its share of net proceeds from the asset sales on the last day of 
the QOF's tax year. For a QOF S corporation, such deemed distributions 
and recontributions will have no Federal income tax consequence other 
than the adjustment of the respective values of qualifying and non-
qualifying investments in a QOF S corporation. For example, such deemed 
distributions will have no impact on an accumulated adjustments account 
of a QOF S corporation, and will not be treated as a disproportionate 
distribution of a QOF S corporation.
    For a QOF partner that holds a mixed-funds investment, any 
distribution will be allocated to the separate interests of the QOF 
partner pursuant to Sec.  1.1400Z2(b)-1(c)(6)(iv)(B). This rule 
provides that any distribution will be allocated proportionately 
between the qualifying and non-qualifying investments of the partner. 
Immediately after the deemed distribution, the distributee QOF owner is 
treated as recontributing the amount received in exchange for a non-
qualifying investment.
    In determining the post-contribution qualifying investment and non-
qualifying investment of a QOF partnership, the QOF partnership is 
required to value each interest based on the underlying value of the 
partnership's assets, determined in accordance with the principles of 
Sec.  1.704-1(b)(2)(iv) at the end of its taxable year. For this 
purpose, the amount of the net proceeds from an asset sale is equal to 
the amount realized from the sale, less any indebtedness included in 
the amount realized that would constitute a qualified liability under 
Sec.  1.707-5(a)(6) if property subject to the debt had been 
contributed to a lower-tier partnership. An actual distribution of 
sales proceeds within 90 days of that asset sale will reduce the amount 
of the deemed distribution and deemed recontribution.
    In determining the post-contribution qualifying investment and non-
qualifying investment of a QOF S corporation, the QOF S corporation is 
required to value each interest based on the underlying value of the 
QOF S corporation's assets. For this purpose, the amount of the net 
proceeds from an asset sale is equal to the amount realized from the 
sale, less any indebtedness included in the amount realized that would 
constitute a qualified liability under the principles of Sec.  1.707-
5(a)(6). An actual distribution of sales proceeds within 90 days of 
that asset sale will reduce the amount of the deemed distribution and 
deemed recontribution.

F. Controlled Foreign Corporations

    A commenter requested that a United States shareholder investor in 
a QOF that is a controlled foreign corporation (CFC) organized in a 
U.S. territory be permitted to make section 1400Z-2(c) elections with 
respect to assets sold by the CFC, thereby eliminating any subpart F 
income or tested income resulting from these transactions. The 
commenter analogized this treatment to rules in proposed Sec.  
1.1400Z2(c)-1(b)(2)(ii) providing that, in certain cases, the owners of 
a QOF partnership or QOF S corporation can make a section 1400Z-2(c) 
election with respect to their distributive or pro rata shares of 
capital gain from the QOF's disposition of assets.
    However, the rules for income inclusions with respect to CFCs are 
not analogous to those for partnerships or S corporations. Unlike 
partnerships and S corporations, CFCs are not treated as flow-through 
entities for purposes of the Code. Additionally, in contrast with 
partnerships and S corporations, only certain U.S. taxpayer owners of 
CFCs (United States shareholders) are required to have current income 
inclusions with respect to CFCs, and these United States shareholders 
are required to currently include in gross income only certain income 
earned by a CFC (for example, subpart F income). These rules effectuate 
the policies underlying the subpart F and global intangible low-taxed 
income under section 951A(a) (GILTI) regimes--to prevent United States 
shareholders from deferring or eliminating U.S. tax on certain income 
by earning such income through CFCs. Such policies generally are not 
applicable to partnerships and S corporations, which generally are 
treated as flow-through entities for purposes of the Code. See H.R. 
Rep. No. 1447 at 57-58 (1962); S. Rep. No. 1881 at 78-80 (1962); S. 
Comm. on the Budget, Reconciliation Recommendations Pursuant to H. Con. 
Res. 71, S. Print No. 115-20, at 370 (2017).
    As opaque entities, CFCs are more analogous to domestic C 
corporations than to partnerships or S corporations because the income 
of CFCs and domestic C corporations may be subject to U.S. taxation 
when earned (at the United States shareholder-level in the case of a 
CFC) and also when distributed as a dividend to U.S. taxpayer 
shareholders. This result with respect to domestic C corporations is 
not changed by section 1400Z-2, which does not permit a shareholder of 
a domestic QOF C corporation to make a section 1400Z-2(c) election with 
respect to either the QOF C corporation's capital gains from sales of 
assets or dividends distributed to such shareholder, unless section 
1059(a)(2) applies to such dividends. Allowing this benefit for United 
States shareholders of QOFs that are CFCs organized in a U.S. territory 
would thus provide an unwarranted advantage to shareholders of QOF C 
corporations organized under the laws of U.S. territories compared to 
shareholders of QOF C corporations organized under the laws of the 50 
states or the District of Columbia. The Treasury Department and the IRS 
have determined that there is no statutory or policy basis for such 
disparate treatment. Accordingly, the comment is not adopted. A comment 
with respect to QOFs that are passive foreign investment companies 
(within the meaning of section 1297(a)) is rejected for similar 
reasons.

G. Permitting Elections Through December 31, 2047

    The October 2018 proposed regulations preserved the ability of 
taxpayers to make an election under section 1400Z-2(c) until December 
31, 2047. The Treasury Department and the IRS requested comments on 
whether some other period would better align with taxpayers' economic 
interests and the purposes of the statute, and whether alternative 
approaches would be appropriate. For example, the preamble to the 
October 2018 proposed regulations noted the possibility of allowing for 
an automatic basis step-up immediately before the end of 2047. The 
Treasury Department and the IRS will continue to consider the 
appropriateness of such an approach, including ways to address how best 
to value investments in QOFs absent a sale or exchange between 
unrelated persons by December 31, 2047.

V. Comments on and Changes To Proposed Sec.  1.1400Z2(d)-1

    Section 1400Z-2(d) sets forth requirements that an entity 
classified for Federal income tax purposes as a partnership or 
corporation must satisfy to qualify as a QOF or as a qualified

[[Page 1896]]

opportunity zone business that is owned, in whole or in part, by one or 
more QOFs.
    Section 1400Z-2(d)(1) defines a QOF as a partnership or corporation 
that (i) is organized for the purpose of investing in ``qualified 
opportunity zone property'' (other than another qualified opportunity 
fund), and (ii) must hold at least 90 percent of its assets in 
qualified opportunity zone property, determined by the average of the 
percentage of qualified opportunity zone property held in the entity as 
measured on two semiannual testing dates (90-percent investment 
standard). Section 1400Z-2(d)(2) defines the term ``qualified 
opportunity zone property'' to mean property directly held by a QOF 
that consists of (i) stock in a corporation that is qualified 
opportunity zone stock, (ii) partnership interests that are qualified 
opportunity zone partnership interests, or (iii) tangible property that 
is qualified opportunity zone business property.
    A QOF's directly held interest in a partnership or corporation will 
be treated as a qualified opportunity zone partnership interest or 
qualified opportunity zone stock, and thus qualified opportunity zone 
property, for purposes of the 90-percent investment standard if the 
interest or stock satisfies the requirements set forth in section 
1400Z-2(d)(2)(B) or (C), as applicable. First, the QOF must have 
acquired the interest or stock from the partnership or corporation, 
respectively, solely in exchange for cash after December 31, 2017. 
Second, at the time of issuance of the interest or stock, as well as 
during substantially all of the QOF's holding period for such interest 
or stock, the entity must qualify as a ``qualified opportunity zone 
business'' (or, if newly formed, must have been organized for such 
purpose).
    Section 1400Z-2(d)(2)(D) provides that tangible property will be 
treated as qualified opportunity zone business property if the tangible 
property is used in a trade or business of the QOF and satisfies three 
general requirements. First, the QOF must have acquired the tangible 
property after December 31, 2017 (post-2017 acquired tangible property) 
from a person that is not related (as defined in section 179(d)(2), and 
modified by section 1400Z-2(e)(2)) and not a member of the same 
controlled group (as defined in section 179(d)(2)(B) and (d)(7)) in a 
transaction resulting in the QOF holding the tangible property with 
other than a transferred basis (within the meaning of section 
7701(a)(43)) or with a section 1014 basis (post-2017 acquisition 
requirement). Second, the original use of the post-2017 acquired 
tangible property in the QOZ must begin with the QOF (original use 
requirement), or the QOF must substantially improve the post-2017 
acquired tangible property (substantial improvement requirement). 
Third, during substantially all of the QOF's holding period for such 
post-2017 acquired tangible property, substantially all of the use of 
post-2017 acquired tangible property has been in a QOZ. Under section 
1400Z-2(d)(2)(D)(ii), the substantial improvement requirement is met 
only if, during any 30-month period beginning after the date of 
acquisition of the post-2017 acquired tangible property, there are 
``additions to basis with respect to such property'' held by the QOF 
that, in the aggregate, exceed the adjusted basis of the post-2017 
acquired tangible property held by the QOF as of the beginning of that 
30-month period.
    Section 1400Z-2(d)(3)(A) defines the term ``qualified opportunity 
zone business'' as a trade or business (other than an enumerated ``sin 
business'' under section 144(c)(6)(B)) that meets each of the following 
two requirements. First, substantially all of the tangible property 
owned or leased in connection with the trade or business must be 
qualified opportunity zone business property. See section 1400Z-
2(d)(3)(A)(i). Second, the trade or business must satisfy the following 
requirements provided in paragraphs (2), (4), and (8) of section 
1397C(b): (i) At least 50 percent of the total gross income of such 
entity must be derived from the active conduct of the trade or business 
in the QOZ (50-percent gross income requirement); (ii) a substantial 
portion of the intangible property of such entity must be used in the 
active conduct of the trade or business in the QOZ; and (iii) less than 
five percent of the average of the aggregate unadjusted bases of the 
property of such entity must be attributable to nonqualified financial 
property (NQFP and five-percent NQFP limitation, respectively). See 
section 1400Z-2(d)(3)(A)(ii).
    Proposed Sec.  1.1400Z2(d)-1, introduced in the October 2018 
proposed regulations and expanded in the May 2019 proposed regulations, 
provided guidance for applying each of the provisions of section 1400Z-
2(d). In general, the proposed regulations addressed (i) QOF self-
certification procedures, (ii) valuation methods for determining 
satisfaction of the 90-percent investment standard, (iii) how various 
types of property can qualify as qualified opportunity zone property, 
including qualified opportunity zone business property, and (iv) how 
trades or businesses can satisfy the requirements for qualifying as 
qualified opportunity zone businesses. The Treasury Department and the 
IRS have received numerous comments regarding the proposed rules set 
forth in proposed Sec.  1.1400Z2(d)-1. The remainder of this part V 
discusses those comments in the order of the rules set forth in 
proposed Sec.  1.1400Z2(d)-1 and describes the changes in the final 
regulations in response to those comments.

A. Certification of an Entity as a QOF

1. Consideration of Revisions to QOF Self-Certification Requirements
    Section 1400Z-2(e)(4)(A) directs the Treasury Department and the 
IRS 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, 
proposed Sec.  1.1400Z2(d)-1(a)(1) generally permits any taxpayer that 
is a corporation or partnership for Federal income tax purposes to 
self-certify as a QOF, provided that the entity is eligible to self-
certify. Proposed Sec.  1.1400Z2(d)-1(a)(1)(i) permits the Commissioner 
of Internal Revenue (Commissioner) to determine the time, form, and 
manner of the self-certification in IRS forms and instructions or 
guidance published in the Internal Revenue Bulletin.
    In this regard, the Commissioner has determined that self-
certification must be reported annually on a timely filed Form 8996. 
Form 8996 requires the taxpayer to certify that, for the first period 
during which an entity will certify as a QOF, the QOF must include in 
its organizing documents (1) a statement of the purpose of investing in 
qualified opportunity zone property (as required by section 1400Z-
2(d)(1)) by the end of the first QOF year, and (2) a description of the 
qualified opportunity zone business that a QOF expects to engage in, 
either directly or indirectly through a lower-tier operating entity.
    The Treasury Department and the IRS received several comments 
regarding the certification process outlined in the proposed 
regulations. Several commenters requested that the requirements set 
forth in Form 8996 be incorporated into the final regulations. Other 
commenters recommended that the final regulations require individuals 
who manage the QOFs (fund managers) to certify that they have not been 
indicted or convicted of fraud, embezzlement, or theft, similar to 
requirements under section 45D of the Code for the New Markets Tax 
Credit program. One commenter recommended the use of licensing 
procedures for fund managers similar to those used in the

[[Page 1897]]

Small Business Investment Company (SBIC) licensure program administered 
by the Small Business Administration. Other commenters recommended that 
QOF certification require the QOF to receive a letter of support from 
the local government of the QOZ in which the QOF will operate.
    Several commenters also recommended that the final regulations 
require a taxpayer to identify, at the time of QOF certification, the 
QOF's intended community development outcomes and objectives. For 
example, one commenter requested that, as part of the QOF certification 
process, a QOF must certify that the QOF will create quality jobs for 
low-income individuals, develop affordable housing, and achieve other 
beneficial community outcomes. To facilitate the ability of a QOF to 
make such certification, one commenter suggested that the final 
regulations provide a safe harbor for certification for a QOF that 
undergoes an independent, third-party verification (similar to the 
SBIC's annual third-party impact assessment) to establish that the QOF 
meets the needs of the community, fund managers, and investors.
    The Treasury Department and the IRS appreciate the commenters' 
recommendations regarding QOF certification. In developing the proposed 
regulations, as well as Form 8996, the Treasury Department and the IRS 
intended to strike a balance between providing taxpayers with a 
flexible and efficient process for organizing QOFs, while ensuring that 
investments in such vehicles will be properly directed toward the 
economic development of low-income communities. The suggested 
recommendations, while potentially helpful for directing such 
investment and limiting abuse, likely would present numerous obstacles 
for potential QOF investors and ultimately reduce, rather than 
increase, the total amount of investment in low-income communities. As 
a result, the final regulations do not adopt the commenters' 
recommendations. However, the Treasury Department and the IRS will 
consider these comments in the event that additional guidance on QOF 
certification is warranted.
2. Consideration of Indian Tribal Governments and Corporations as 
Eligible Entities To Certify as QOFs
    Several commenters requested that Indian tribal governments and 
corporations organized under Indian tribal laws should be included in 
the definition of entities eligible to be a QOF. Proposed Sec.  
1.1400Z2(d)-1(e)(1) provided that, if an entity is not organized in one 
of the 50 states, the District of Columbia, or the U.S. territories, it 
is ineligible to be a QOF. Similarly, proposed Sec.  1.1400Z2(d)-
1(e)(2) provided that, if an entity is not organized in one of the 50 
states, the District of Columbia, or the U.S. territories, an equity 
interest in the entity is neither qualified opportunity zone stock nor 
a qualified opportunity zone partnership interest. The Treasury 
Department and the IRS have determined that, for purposes of both 
proposed Sec.  1.1400Z2(d)-1(e)(1) and (2), an entity ``organized in'' 
one of the 50 states includes an entity organized under the law of a 
Federally recognized Indian tribe if the entity's domicile is located 
in one of the 50 states or the District of Columbia. Such entity 
satisfies the requirement in section 1400Z-2(d)(2)(B)(i) and (C) that 
qualified opportunity zone stock be stock in a domestic corporation, 
and a qualified opportunity zone partnership interest be an interest in 
a domestic partnership. See section 7701(a)(4) (defining the term 
``domestic'').
    The Treasury Department and the IRS appreciate the sovereignty of 
Indian tribal governments. However, an entity eligible to be a QOF must 
be subject to Federal income tax, including the penalty imposed by 
section 1400Z-2(f)(1) where a QOF fails to meet the 90-percent 
investment standard, regardless of the laws under which the entity is 
established or organized. No individual who participated in the 
Consultation disagreed with the position that an entity organized under 
the law of an Indian tribal government is eligible to be a QOF, if the 
entity's domicile is located in one of the 50 states or the District of 
Columbia, but that such entity would be subject to Federal income tax. 
Accordingly, the Treasury Department and IRS affirm these positions and 
incorporate a reference to entities organized under the law of an 
Indian tribal government in the definition of the term ``eligible 
entity.''
3. QOF Decertification Rules and Federal Income Tax Consequences
    In the October 2018 proposed regulations, the Treasury Department 
and the IRS announced an intention to publish additional guidance 
regarding QOF decertification. See 83 FR 54283 (September 29, 2018). 
Comments were received on this topic, including comments requesting a 
mechanism to permit a QOF to self-decertify, as well as comments 
requesting guidance on the ability of the IRS to decertify a QOF. The 
Treasury Department and the IRS have included in the final regulations 
a provision to allow a QOF to self-decertify. This rule specifies that 
self-decertification becomes effective at the beginning of the month 
following the month specified by the taxpayer. The month specified by 
the taxpayer must not be earlier than the month in which the taxpayer 
files its self-decertification. For example, if a QOF wishes to 
decertify on May, the earliest date that the QOF could be decertified 
would be June 1st, provided that all applicable procedures were 
followed.
    The Treasury Department and the IRS are developing additional 
instructions regarding QOF self-decertification including instructions 
regarding the time, form, and manner of QOF self-decertification. 
Additionally, the Treasury Department and the IRS continue to consider 
the circumstances under which involuntary decertification of a QOF 
would be warranted, and intend to propose guidance regarding those 
circumstances. As noted in part III.A. of this Summary of Comments and 
Explanation of Revisions, the final regulations include a rule 
providing that the decertification of a QOF, whether voluntary or 
involuntary, is an inclusion event for eligible taxpayers that hold a 
qualifying investment in that QOF. See Sec.  1.1400Z2(b)-1(c)(15).
4. Entities That Are Not QOFs During the First Month of Their Taxable 
Year
    Under proposed Sec.  1.1400Z2(d)-1(a)(2), an entity may become a 
QOF during a month that is not the first month of the QOF's taxable 
year. Several commenters suggested that the Treasury Department and the 
IRS provide additional detail and clarification regarding this proposed 
rule. One commenter suggested that the final regulations permit QOFs to 
select as the QOF's first six-month period testing date either (i) the 
corresponding day of the month that is six months after the date of 
certification, or (ii) the last day of a month that is not more than 
six months after that certification date. Another commenter requested 
confirmation that the term ``month'' means a period of time between the 
same dates in successive calendar months in order to provide a 
consistent measuring period. A commenter also asserted that the first 
six-month period testing date should fall on the last day of that first 
six-month period, even if that period ends later than the end of the 
taxable year. The Treasury Department and the IRS will consider adding 
clarifying language to the Instructions to the Form 8996, ``Qualified 
Opportunity Fund,'' to address these comments.

[[Page 1898]]

5. Qualification of Existing Entities as QOFs or Qualified Opportunity 
Zone Businesses
    Section 1400Z-2(d)(1) provides, in relevant part, that a QOF is 
``any investment vehicle which is organized as a corporation or a 
partnership for the purpose of investing in qualified opportunity zone 
property.'' Accordingly, the statute does not indicate whether such 
partnership or corporation must be newly formed or could be a 
preexisting entity. Likewise, neither the definition of the term 
``qualified opportunity zone partnership interest'' nor the definition 
of the term ``qualified opportunity zone stock'' explicitly states that 
the partnership or corporation may be a preexisting entity. See section 
1400Z-2(d)(2)(B)(i), (C). Several commenters have requested 
confirmation as to whether existing entities could qualify as QOFs or 
qualified opportunity zone businesses. In addition, one commenter 
inquired as to whether preexisting entities could use an adjusted tax 
basis for valuing assets purchased before 2018 to improve the ability 
for such entities to qualify as QOFs.
    The Treasury Department and the IRS have addressed these comments 
in the final regulations. The final regulations confirm that 
preexisting entities are not barred from qualifying as QOFs or 
qualified opportunity zone businesses. Like newly formed partnerships 
and corporations, however, the final regulations require preexisting 
entities to satisfy all requirements applicable to QOFs under section 
1400Z-2 and the section 1400Z-2 regulations.
    To value assets acquired prior to 2018, the final regulations 
provide that preexisting entities must use either (i) the applicable 
financial statement valuation method set forth in Sec.  1.1400Z2(d)-
1(b)(3) of the final regulations, if the QOF has an applicable 
financial statement within the meaning of Sec.  1.475(a)-4(h) (AFS), or 
(ii) the alternative valuation method set forth in Sec.  1.1400Z2(d)-
1(b)(4) of the final regulations. Under the applicable financial 
statement valuation method, the value of each asset that is owned or 
leased by a QOF is the value of that asset as reported on the QOF's AFS 
for the relevant reporting period (rather than the adjusted tax basis 
of the asset). Under the alternative valuation method for purchased 
assets, a QOF must use the QOF's unadjusted cost basis of the asset 
under section 1012, section 1013 (with regards to inventory), or its 
fair market value. See part V.B of this Summary of Comments and 
Explanation of Revisions (providing additional discussion regarding the 
valuation of assets for purposes of the 90-percent investment 
standard).
6. Clarification Regarding Entities That May Appraise Property
    A commenter requested clarification regarding which entities may 
appraise property required to be valued for purposes of section 1400Z-
2(d), including for purposes of determining compliance with the 90-
percent investment standard. The Treasury Department and the IRS 
decline to provide additional guidance on appraisals in the final 
regulations. However, the Treasury Department and the IRS note that 
entities that may appraise property for valuation purposes under 
section 1400Z-2 and the section 1400Z-2 regulations are the same 
entities that may appraise property for AFS purposes.

B. Valuation of Assets for Purposes of the 90-Percent Investment 
Standard

1. Comments Regarding Determination Dates, Includable Assets, and Safe 
Harbors
    Section 1400Z-2(d)(1) provides that a QOF must maintain an average 
of 90 percent of its assets in qualified opportunity zone property, 
measured on both the last day of the first six-month period and on the 
last day of the taxable year (that is, the 90-percent investment 
standard). Section 1400Z-2(f)(1) provides that, if a QOF fails to 
maintain the 90-percent investment standard, the QOF must pay a penalty 
for each month that the QOF fails to meet that standard. Proposed Sec.  
1.1400Z2(d)-1(b) provided that, to meet the requirements of the 90-
percent investment standard, a QOF may value its assets on a semiannual 
basis using (i) the AFS valuation method, if the QOF has an AFS, or 
(ii) the alternative valuation method.
    The Treasury Department and the IRS received several comments 
regarding the application of the 90-percent investment standard. For 
example, a commenter requested confirmation that the 90-percent 
investment standard is determined for each year of the QOF's existence. 
Another commenter suggested that the final regulations make explicit 
that the 90-percent investment standard will be considered to have been 
fully satisfied for any year if the QOF meets the 90-percent investment 
standard on at least two semiannual testing dates. The Treasury 
Department and the IRS agree with the commenters that the proposed 
rules should be clarified. As a result, the final regulations make 
clear that a QOF may determine whether the 90-percent investment 
standard is satisfied by valuing its assets on the semiannual testing 
dates as provided by section 1400Z-2(d)(1).
    Several commenters also suggested that the final regulations 
provide greater clarity regarding the assets of a QOF taken into 
account for determining whether the 90-percent investment standard is 
satisfied. Commenters inquired as to whether selling commissions, 
offering expenses, deferred gain, investments in intangible property, 
and financial accounting depreciation are included or excluded in that 
valuation calculation. The Treasury Department and the IRS confirm that 
all of a QOF's assets cognizable for Federal income tax purposes are 
required to be valued on each semiannual testing date in determining 
whether the 90-percent investment standard is satisfied. However, mere 
expenses arising from organizing a QOF or day-to-day operations with 
regard thereto (such as selling commissions, organization expenses, 
offering expenses, and similar expenses) do not result in any QOF asset 
cognizable for Federal income tax purposes and therefore are not taken 
into account to any extent in determining satisfaction of the 90-
percent investment standard.
    Two commenters suggested that the Treasury Department and the IRS 
should include in the final regulations a grace period for the QOF's 
first year to meet the 90-percent investment standard. The Treasury 
Department and the IRS have determined that the statutory text of 
section 1400Z-2 does not permit adoption of the commenters' suggestion, 
but rather requires that the 90-percent investment standard be met for 
each taxable year of the QOF's existence. As a result, the final 
regulations do not incorporate this suggestion.
    In addition, a commenter recommended that, if a qualified 
opportunity zone business qualifies on each relevant testing date, then 
that entity should be treated also as qualifying during the periods 
between each relevant testing date. The Treasury Department and the IRS 
agree that if an entity satisfies all of the requirements of a 
qualified opportunity zone business determined as of the end of the 
entity's taxable year, the entity qualifies as a qualified opportunity 
zone business for the entire taxable year of the entity. However, a QOF 
and an entity whose equity the QOF owns may have different taxable 
years, making it difficult to determine whether the entity qualifies as 
a qualified opportunity zone business of the QOF on a semiannual basis 
based

[[Page 1899]]

on the QOF's taxable year pursuant to section 1400Z-2(d)(1). 
Accordingly, the Treasury Department and the IRS have provided a safe 
harbor rule for determining on the two semiannual testing dates of a 
QOF whether an entity is a qualified opportunity zone business for at 
least 90 percent of the cumulative holding period beginning on the 
first date the QOF's self-certification is effective and the end of the 
entity's most recent taxable year ending on or before a semiannual 
testing date of the QOF for purposes of the 90-percent investment 
standard.
    Finally, the Treasury Department and the IRS note that, if a QOF 
operates a business through an entity that is transparent for Federal 
income tax purposes, the transparent entity is not treated as a 
qualified opportunity zone business in which the QOF has invested. Such 
transparent entities include a qualified subchapter S subsidiary (as 
defined in section 1361(b)(3)(B)), a grantor trust, or an entity 
disregarded as separate from the QOF under Sec.  301.7701-3. For 
Federal income tax purposes, the assets of the transparent entity are 
treated as assets of the QOF, and therefore are taken into account for 
determining whether the QOF satisfies the 90-percent investment 
standard. The 70-percent tangible property standard for qualified 
opportunity zone businesses set forth in Sec.  1.1400Z2(d)-1(d)(1)(i) 
(70-percent tangible property standard) is not relevant with respect to 
the assets directly held by a transparent entity owned by a QOF.
2. Ability of a QOF With an AFS To Use the Alternative Valuation Method
    Proposed Sec.  1.1400Z2(d)-1(b)(2) provided that a QOF may utilize 
the AFS valuation method to value each asset owned or leased by the QOF 
for purposes of determining compliance with the 90-percent investment 
standard. Under the AFS valuation method, the value of each asset owned 
or leased by the QOF equals the value of that asset as reported on the 
QOF's AFS for the relevant reporting period. Proposed Sec.  
1.1400Z2(d)-1(b)(2)(ii) clarified that a QOF may select the AFS 
valuation to value an asset leased by the QOF only if the AFS of the 
QOF (1) is prepared according to U.S. generally accepted accounting 
principles (GAAP) and (2) requires an assignment of value to the lease 
of the asset.
    A commenter recommended that the final regulations allow a QOF to 
elect to use unadjusted cost basis to value tangible assets (that is, 
the alternative valuation method), regardless of whether the QOF has an 
AFS. The Treasury Department and the IRS note that the proposed 
regulations would accommodate the commenter's request without change. 
Specifically, under the proposed regulations and these final 
regulations, a QOF with an AFS may use the alternative valuation 
method.
3. Alternative Valuation Method
a. Valuation of Intangible Assets With a Tax Basis Not Based on Cost
    Under the alternative valuation method set forth in proposed Sec.  
1.1400Z2(d)-1(b)(3), the value of each asset that is owned by a QOF is 
the QOF's unadjusted cost basis of the asset under section 1012 or 
section 1013 (with regard to inventory). One commenter considered the 
application of the alternative valuation method to partnership 
interests with a tax basis not based on cost. The commenter agreed that 
the alternative valuation method generally provided an appropriate 
valuation methodology with regard to property that has been acquired by 
purchase, but questioned whether that method provided an appropriate 
means to value a partnership interest.
    The Treasury Department and the IRS agree that applying the 
alternative valuation method to partnership interests, as well as other 
intangible assets with a tax basis not based on cost, would be 
inconsistent with the intent and purpose of the statute. As a result, 
the final regulations reflect the commenter's observation and provide 
that the alternative valuation method may be used to value only assets 
owned by a QOF that are acquired by purchase or constructed for fair 
market value. In such instances, the QOF's unadjusted cost basis of the 
asset is determined under section 1012 or section 1013 (with regard to 
inventory). The final regulations also provide that the value of each 
asset owned by a QOF that is not purchased or constructed for fair 
market value equals the asset's fair market value. A QOF determines 
that fair market value on the last day of the first six-month period of 
the taxable year and on the last day of the taxable year.
b. Valuation of Assets Leased by a QOF
    Proposed Sec.  1.1400Z2(d)-1(b)(3)(iii)(A) provided that the value 
of each asset that is leased by a QOF is equal to the present value of 
the leased asset. The ``present value'' of such leased asset is (i) 
equal to the sum of the present values of each payment under the lease 
for the asset, and (ii) calculated at the time at which the QOF enters 
into the lease for the asset. See proposed Sec.  1.1400Z2(d)-
1(b)(3)(iii)(C)(1), (2). Once calculated, that present value is used as 
the value for the asset by the QOF for all testing dates for purposes 
of the 90-percent investment standard. See proposed Sec.  1.1400Z2(d)-
1(b)(3)(iii)(C)(3). To determine the present value of the lease 
payments, the proposed regulations provided that the discount rate is 
the applicable Federal rate (AFR) under section 1274(d)(1). See 
proposed Sec.  1.1400Z2(d)-1(b)(3)(iii)(B) (present value determined 
under section 1274(d)(1) by substituting the term ``lease'' for ``debt 
instrument''). The final regulations clarify the rules to be used to 
determine the AFR for a particular lease, and provide that the short-
term AFR must be used. The Treasury Department and the IRS have 
determined that use of the short-term AFR will provide a simple and 
objective rule for taxpayers and practitioners.
    Prior to the publication of the May 2019 proposed regulations, the 
Treasury Department and the IRS received comments requesting that the 
final regulations provide flexibility regarding the valuation of 
leases. For example, one commenter requested that the final regulations 
permit QOFs to use a type of basis other than the basis used for GAAP 
(for example, cost basis under section 1012). This comment was 
particularly relevant to Indian tribal governments, which typically 
rely upon leases. Another commenter had suggested that QOFs and 
qualified opportunity zone businesses should be able to elect to use 
Federal income tax basis to determine the value of assets for these 
purposes. The commenter reasoned that the value of the operating lease, 
as a non-qualifying asset, would be $0 and would not affect the 90-
percent investment standard.
    The Treasury Department and the IRS have determined that the 
alternative valuation method for leased assets, as set forth in 
proposed Sec.  1.1400Z2(d)-1(b)(3), addresses the concerns raised by 
these commenters. In addition, the Treasury Department and the IRS note 
that no participant of the Consultation requested additional guidance 
regarding these issues. Therefore, proposed Sec.  1.1400Z2(d)-1(b)(3) 
has not been modified as a result of those comments.
    With regard to the 90-percent investment standard, a commenter 
suggested that the Treasury Department and the IRS consider a valuation 
method for leases that are negotiated at arms-length under section 482. 
This valuation method would value the lease (i) as having a value of $0 
regardless of whether the QOF has an AFS, or (ii) at the unadjusted 
cost basis of the lease, similar to purchased property. Another 
commenter requested that the value of leased property be excluded from 
the

[[Page 1900]]

numerator and denominator of the fraction-based test underlying the 90-
percent investment standard, while the value of substantial 
improvements to leased property should be included. Another commenter 
suggested that leased property should be valued at the lease's fair 
market value.
    The Treasury Department and the IRS have determined that the 
proposed regulations provided a comprehensive method to value leased 
property to satisfy the 90-percent investment standard. While the 
commenters' recommended rules would provide value in certain instances, 
the Treasury Department and the IRS have concluded that such rules 
would inject significant complexity into the final regulations that 
would outweigh any potential resulting benefits. As a result, the final 
regulations retain the method provided in the proposed regulations with 
some clarifications. For example, the term of a lease that is being 
valued for purposes of the 90-percent investment standard includes 
periods during which the lessee may extend the lease at a pre-defined 
rent. The terms of a pre-defined market rate rent must follow the 
criteria set forth under section 482 with a rebuttable presumption that 
terms of a lease between unrelated parties is market rate.
4. Option To Disregard Recently Contributed Property to a QOF for 
Purposes of the 90-Percent Investment Standard
    Under proposed Sec.  1.1400Z2(d)-1(b)(4), a QOF may choose to 
determine compliance with the 90-percent investment standard by 
excluding certain eligible property from both the numerator and 
denominator of the fraction-based test underlying that standard. Such 
excluded amount of property must satisfy each of the following 
criteria: (1) The amount of contributed property was received by the 
QOF partnership or the QOF corporation solely in exchange for an 
interest in the partnership or stock in the corporation; (2) that 
contribution or exchange occurred not more than six months before the 
date of the test from which the amount of property is excluded; and (3) 
between the date of that contribution or exchange and the date of the 
underlying asset test, the amount of property was held continuously in 
cash, cash equivalents, or debt instruments with a term of 18 months or 
less. Finally, proposed Sec.  1.1400Z2(d)-1(b)(4) provided that a QOF 
need not be consistent from one semiannual test to another in whether 
it avails itself of this option.
    While commenters largely agreed with the approach set forth in 
proposed Sec.  1.1400Z2(d)-1(b)(4), many commenters suggested 
significant revisions. For instance, commenters suggested that the 
permitted six-month period (that is, the period between the date of 
contribution or exchange and the testing date) should be extended to a 
12-month period, starting on the date of the contribution or exchange, 
to facilitate increased investments into beneficial qualified 
opportunity zone property. Another commenter recommended that the final 
regulations provide QOFs with a 31-month period to deploy capital into 
a qualified opportunity zone property, and thereby provide QOFs with a 
rule similar to the 31-month working capital safe harbor (as defined in 
part V.O of this Summary of Comments and Explanation of Revisions) for 
qualified opportunity zone businesses.
    The Treasury Department and the IRS have considered each of these 
recommendations and have concluded that their adoption would achieve 
results inconsistent with the purposes of section 1400Z-2. In 
particular, the Treasury Department and the IRS have determined that 
the commenters' recommended rules would permit the holding of capital 
for extended periods of time without deployment into qualifying 
investments, and ultimately into QOZs. A delay of such capital 
investment would reduce, rather than increase, investments in QOZs and 
thereby delay the type of economic growth for which section 1400Z-2 was 
enacted to achieve.
    One commenter suggested that a QOF should control, by election, the 
decision to disregard recently contributed property. Under the 
commenter's approach, a QOF could either disregard the recently 
contributed property, or upon an election, include the property in both 
the numerator and the denominator of the fraction-based test underlying 
the 90-percent investment standard. However, if the QOF elects to 
disregard the property, the commenter argued that both the numerator 
and the denominator of the fraction-based test would be zero, resulting 
in an undefined mathematical result. In the alternative, the commenter 
suggested that the Treasury Department and the IRS should treat 
recently contributed property as qualified opportunity zone property 
only if, and to the extent that, such property is invested in qualified 
opportunity zone property before the next QOF testing date following 
that contribution.
    The Treasury Department and the IRS have determined that the option 
to disregard recently contributed property provides a sufficiently 
expansive rule set to address the concerns raised by the commenter, 
namely that by excluding recently contributed property from both the 
numerator and denominator, the resulting fraction may be undefined. The 
commenter's solution to allow a QOF to elect to disregard property, 
although potentially helpful to taxpayers in certain cases, would 
significantly increase the complexity of the mechanics for determining 
compliance with the 90-percent investment standard. Moreover, the 
commenter presumes that a QOF would have no other property to include 
in the denominator, which would allow a mathematically correct result. 
Further, the alternative suggested by the commenter is similar to the 
proposed rule and would result in the same outcome. Accordingly, the 
final regulations do not incorporate the commenter's suggestions. 
Because several commenters requested flexibility in timing of 
investments, the final regulations provide that a QOF has until the 
fifth business day after the contribution of the property to exchange 
such property into cash, cash equivalents, or debt instruments with a 
term of 18 months or less.
    In addition, one commenter suggested that, with regard to periods 
during which the previously described contributed property is 
disregarded, the Treasury Department and the IRS should require that 
the capital be held in mission-driven institutions such as Community 
Development Financial Institutions (CDFIs), low-income credit unions, 
or minority-owned depository institutions. While the Treasury 
Department and the IRS appreciate the policy objectives underlying this 
recommendation, section 1400Z-2 does not provide sufficient authority 
to incorporate this recommendation into the final regulations.
5. Wind-Down Period Safe Harbor for Applying 90-Percent Investment 
Standard to Dissolving QOFs
    For purposes of applying the 90-percent investment standard, two 
commenters requested that the final regulations provide a wind-down 
safe harbor period that would precede the start of the QOF's 
dissolution phase. The commenters reasoned that during a QOF wind-down 
period which the commenters suggested could last for up to two years, 
QOFs would hold larger amounts of non-qualifying property because the 
dissolving QOF typically would dispose of business assets (that is, 
qualified opportunity zone business property) in exchange for cash or 
other non-qualifying property. The

[[Page 1901]]

commenter contended that the policy rationale for a wind-down period 
safe harbor for QOF dissolutions would parallel the policy rationale 
for proposed safe harbor provisions that facilitate the development and 
operation by QOFs of start-up businesses.
    The Treasury Department and the IRS acknowledge the policy 
arguments set forth by the commenter. However, the final regulations do 
not adopt the commenter's recommendation. In particular, the Treasury 
Department and the IRS note that section 1400Z-2 was enacted to 
encourage the development of operating businesses in QOZs and thereby 
increase the economic development of the communities located in those 
designated census tracts. Safe harbors provided by the proposed and 
final regulations to facilitate the success of start-up businesses in 
QOZs advances the achievement of those purposes. A QOF wind-down safe 
harbor for purposes of the 90-percent investment standard, however, 
potentially would encourage the opposite effect-that is, QOF 
dissolutions and disinvestment from QOZs.

C. Consideration of Synthetic Equity as Qualified Opportunity Zone 
Stock or Partnership Interest

    Under proposed Sec.  1.1400Z2(d)-1(c), qualified opportunity zone 
stock and a qualified opportunity zone partnership interest generally 
must satisfy three requirements. First, such stock or partnership 
interest must be stock in a corporation or an interest in a partnership 
that is acquired by a QOF after December 31, 2017 from the corporation 
or the partnership solely in exchange for cash. See proposed Sec.  
1.1400Z2(d)-1(c)(2)(i)(A) (regarding qualified opportunity zone stock), 
(c)(3)(i) (regarding qualified opportunity zone partnership interests). 
Second, at the time of acquisition, the corporation whose stock was 
acquired, or the partnership whose interest was acquired, must either 
be a qualified opportunity zone business, or in the process of becoming 
a qualified opportunity zone business. See proposed Sec.  1.1400Z2(d)-
1(c)(2)(i)(B) (regarding qualified opportunity zone stock), (c)(3)(ii) 
(regarding qualified opportunity zone partnership interests). Third, 
during substantially all of the QOF's holding period for the stock or 
partnership interest, the corporation or partnership must qualify as a 
qualified opportunity zone business. See proposed Sec.  1.1400Z2(d)-
1(c)(2)(i)(C) (regarding qualified opportunity zone stock), (c)(3)(iii) 
(regarding qualified opportunity zone partnership interests).
    The Treasury Department and the IRS received comments recommending 
that the final regulations include in the definition of the term 
``qualified opportunity zone stock'' any interest constituting 
synthetic equity under section 409(p)(6)(C) or an employee stock option 
plan. The synthetic equity definitions recommended by the commenters 
include an expansive range of interests, some of which would require 
potentially complex rules to ensure their proper application in the 
section 1400Z-2 regulations. The Treasury Department and the IRS 
continue to consider synthetic equity for purposes of the definitions 
of ``qualified opportunity zone stock'' and ``qualified opportunity 
zone partnership interest,'' but have determined that specific rules to 
address synthetic equity would add inappropriate complexity to the 
final regulations. As a result, the final regulations do not 
incorporate the commenters' recommendation.

D. Qualified Opportunity Zone Business Property Purchased by QOF or 
Qualified Opportunity Zone Business

    Under proposed Sec.  1.1400Z2(d)-1(c)(4)(i)(A) and (d)(2)(i)(A), 
property that is purchased (as defined in section 179(d)(2)) by a QOF 
or a qualified opportunity zone business from an unrelated party (as 
defined in section 1400Z-2(e)(2)) qualifies as ``qualified opportunity 
zone business property,'' provided that the property satisfies all 
other requirements under section 1400Z-2(d)(2)(D)(i).
1. Qualification of Property Constructed by an Eligible Entity
    The Treasury Department and the IRS received several comments 
requesting that the final regulations expand the definition of the term 
``qualified opportunity zone business property'' to include an eligible 
entity's self-constructed property. One commenter recommended that the 
final regulations treat construction costs of such self-constructed 
property as part of the property's purchase price. To determine the 
acquisition date for each testing period, one commenter suggested that 
the final regulations utilize the approach provided under former 
section 168(k)(2) and Sec.  1.168(k)-1(b)(4)(iii). Former section 
168(k)(2)E)(i) and Sec.  1.168(k)-1(b)(4)(iii) provided that if a 
taxpayer manufactures, constructs or produces property for use in its 
trade or business (or for its production of income), the property will 
be treated as acquired when the taxpayer begins manufacturing, 
constructing or producing the property. Under Sec.  1.168(k)-
1(b)(4)(iii), manufacturing, construction or production of the property 
begins when physical work of a significant nature begins. Another 
commenter suggested that, if an eligible entity's self-constructed 
property is not to be included as purchased property, (i) the 
incorporation of non-qualifying property into new construction should 
not taint the new property, and (ii) that new property should be 
treated as a separate asset under section 1400Z-2(d)(2)(D)(i)(III).
    The Treasury Department and the IRS have determined that tangible 
property is not disqualified from constituting qualified opportunity 
zone business property solely because the property is manufactured, 
constructed, or produced, rather than purchased, by the eligible 
entity. However, to qualify as qualified opportunity zone business 
property, such tangible property must be manufactured, constructed, or 
produced by the eligible entity with the intent to use the property in 
the trade or business of the eligible entity in a QOZ. In addition, the 
materials and supplies used for the construction of the qualified 
opportunity zone business property must be qualified opportunity zone 
business property. Self-constructed property must otherwise meet the 
requirements of section 1400Z-2(d)(2)(D)(i).
    For purposes of the 90-percent investment standard and the 70-
percent tangible property standard, an eligible entity must determine 
the date on which such self-constructed property will be treated as 
acquired. The Treasury Department and the IRS agree with the prior 
commenter that applying a standard similar to former section 168 and 
the regulations thereunder make logical sense. Thus, the final 
regulations provide that, for purposes of the 90-percent investment 
standard and the 70-percent tangible property standard, self-
constructed property will be treated as acquired on the date physical 
work of a significant nature begins. Physical work of a significant 
nature does not include preliminary activities such as planning or 
designing, securing financing, exploring or researching, and will 
depend on a facts and circumstances analysis. The final regulations 
also provide a safe harbor to determine when physical work of a 
significant nature begins. An eligible entity may choose the date on 
which the eligible entity paid or incurs more than 10 percent of the 
total cost of the property, excluding the cost of any land and 
preliminary activities such as planning and designing, securing 
financing, exploring or researching.

[[Page 1902]]

2. Qualification of Property Contributed to a QOF
    Several commenters suggested that property contributed to a QOF, 
and used in the QOF's trade or business, should be treated as qualified 
opportunity zone business property. Under section 1400Z-
2(d)(2)(D)(i)(I), to qualify as qualified opportunity zone business 
property, the property must be purchased from an unrelated party. 
Property contributed by an entity to a QOF, while potentially used in 
the QOF's trade or business, will not be considered qualified 
opportunity zone business property because the QOF has not purchased, 
leased, or self-constructed the contributed property. Because the 
commenters' suggestion would not be consistent with the text of section 
1400Z-2(d)(2)(D)(i)(I), the final regulations do not adopt it.
3. Qualification of Property Purchased Before Statutory Deadline
    A commenter asserted that, by requiring the purchase of property to 
have occurred after December 31, 2017, the proposed regulations will 
irrationally exclude owners of property purchased on or before that 
date from the benefits of section 1400Z-2. Another commenter raised 
similar concerns, and requested that the final regulations treat as 
qualified opportunity zone business property otherwise qualifying 
property acquired by a QOF or qualified opportunity zone business prior 
to the publication date of the October 2018 proposed regulations. While 
the Treasury Department and the IRS are sympathetic to the concerns 
expressed by these commenters, the text of section 1400Z-2(d) does not 
provide authority to allow property purchased on or before December 31, 
2017, to be treated as qualified opportunity zone business property.
    One commenter requested confirmation that contractual rights to 
real property (including easements, land leases, timber deeds, 
agricultural leases, and water rights) qualify as an acquisition by 
purchase, and therefore could qualify as qualified opportunity zone 
business property. The Treasury Department and the IRS acknowledge the 
common usage of these types of arrangements, particularly in rural 
industries. While the text of section 1400Z-2 requires qualified 
opportunity zone business property to be purchased or leased, the 
Treasury Department and the IRS note that contractual rights may 
qualify as leases under the rules discussed in part V.E of this Summary 
of Comments and Explanation of Revisions. If such contractual rights do 
not meet the requirements of either purchased or leased property, 
however, the final regulations provide that the contractual rights will 
not qualify as qualified opportunity zone property.
4. Qualification of Property Based on Factors Not Consistent With 
Section 1400Z-2
    For purposes of determining whether property qualifies as qualified 
opportunity zone business property, the text of section 1400Z-
2(d)(2)(D)(i) sets forth requirements regarding the property's 
acquisition, location, and use. The Treasury Department and the IRS 
have received comments requesting that the final regulations provide 
exceptions to those statutory requirements. For example, a commenter 
requested that the final regulations provide rules that focus on the 
use of the subject property at the time the property is acquired, but 
exclude any consideration regarding the location of the property. 
Similarly, another commenter suggested that the final regulations 
should provide an exception to allow residents of a QOZ to treat 
previously purchased property as qualified opportunity zone business 
property. Commenters also have suggested that property owned by 
residents of a QOZ, as well as land, should be treated as completely 
exempt from the post-2017 acquisition requirement.
    The Treasury Department and the IRS appreciate the commenters' 
recommendations. However, each of these suggested rules would conflict 
with the statutorily imposed acquisition, location, and use 
requirements set forth in section 1400Z-2(d)(2)(D)(i). As a result, the 
final regulations do not adopt the commenters' recommendations.
5. Qualification of Property Purchased From Related Persons
    Section 1400Z-2(d)(2)(D)(iii) limits the purchase of qualified 
opportunity zone property to purchases from parties who are not related 
parties, as that term is defined in section 1400Z-2(e)(2). Proposed 
Sec.  1.1400Z2(d)-1(c)(4)(i)(A) and (d)(2)(i)(A) provide that property 
must be acquired by a QOF or qualified opportunity zone business from a 
person that is not related under section 1400Z-2(e)(2). Under that 
statutory provision, persons are related to each other for purposes of 
section 1400Z-2 if such persons are described in section 267(b) or 
707(b)(1), determined by substituting ``20 percent'' for ``50 percent'' 
each place the phrase ``50 percent'' occurs in those sections. See 
section 1400Z-2(e)(2).
    The Treasury Department and the IRS received numerous comments 
requesting that the final regulations treat property purchased from a 
related person (under section 1400Z-2(e)(2)) as qualified opportunity 
zone business property. To prevent potential abuse that could arise 
from such related-party transactions, one commenter suggested that the 
final regulations should require purchases between related parties to 
be negotiated at arm's length. Other commenters recommended that the 
final regulations allow otherwise qualifying purchases by a QOF or 
qualified opportunity zone business to be carried out with (i) 
businesses or partnerships that owned property located in a QOZ prior 
to the QOZ's designation, and (ii) residents of a QOZ prior to such 
time. The Treasury Department and the IRS note that the text of section 
1400Z-2, as described above, does not permit property purchased from a 
related party to qualify as qualified opportunity zone property, and 
therefore decline to adopt these comments.
    Another commenter requested that the final regulations provide 
clarification as to whether any sponsorship arrangement with a sponsor, 
who is a QOF investor, would establish relatedness included in the 
definition of ``related person'' under section 1400Z-2(e)(2). The 
Treasury Department and the IRS have determined that (i) specific rules 
to address sponsorship agreements would introduce significant, 
additional complexity into the final regulations, and (ii) the proposed 
regulations provide adequate guidance to address the commenter's 
request. As a result, the final regulations do not incorporate specific 
rules to address sponsorship agreements.
    The final regulations, however, have added rules to address the 
qualification of property purchased in certain ``sponsor-like'' 
arrangements as qualified opportunity zone business property. With 
regard to these arrangements, the final regulations provide that, in 
the case of real property that is purchased by a QOF or qualified 
opportunity zone business, if at the time of the purchase there was a 
plan, intent, or expectation for the real property to be repurchased by 
the seller of the real property for an amount of consideration other 
than the fair market value of the real property, the purchased real 
property is not qualified opportunity zone business property. Under 
this rule, the ``fair market value of the real property'' refers to the 
fair market value of that property at the time of the repurchase by the 
seller.

[[Page 1903]]

E. Qualified Opportunity Zone Business Property Leased by QOF or 
Qualified Opportunity Zone Business

    Proposed Sec.  1.1400Z2(d)-1(c)(4)(i)(B) and (d)(2)(i)(B) provided 
that a QOF or qualified opportunity zone business may treat leased 
tangible property as qualified opportunity zone business property for 
purposes of satisfying the 90-percent investment standard and the 70-
percent tangible property standard. To qualify, the leased tangible 
property must satisfy the following two general requirements: First, 
analogous to owned tangible property, leased tangible property must be 
acquired under a lease entered into after December 31, 2017. Second, 
and also similar to owned tangible property, substantially all of the 
use of the leased tangible property must be located within a QOZ during 
substantially all of the period for which the business leases the 
property.
1. General Comments Requesting Additional Rules and Clarifications
    The Treasury Department and the IRS received several comments 
agreeing with the rules addressing leased tangible property set forth 
in the May 2019 proposed regulations. However, many commenters 
requested that the Treasury Department and the IRS further clarify 
whether certain types of leased property qualify as qualified 
opportunity zone business property. Similarly, other commenters 
recommended that the final regulations provide additional detailed 
rules and examples, and include definitions for leases, lease-like 
arrangements, and licenses for purposes of determining whether such 
instruments qualify as qualified opportunity zone property.
    As described further in this part V.E of the Summary of Comments 
and Explanation of Revisions, the Treasury Department and the IRS have 
provided additional details and examples in the final regulations to 
respond to the commenters' concerns and recommendations. For example, 
the final regulations exempt State and local governments, as well as 
Indian tribal governments, from the market-rate requirement for leased 
tangible property that otherwise must be satisfied to qualify as 
qualified opportunity zone business property. In addition, the final 
regulations provide rules that permit certain short-term leased 
property to lessors located outside of a QOZ to be counted as qualified 
opportunity zone business property for purposes of satisfying the 70-
percent use test. The final regulations also contain additional 
examples to clarify the application of the rules regarding leased 
tangible property.
2. Qualification of Tangible Property Subject to an Existing Lease
    Section 1400Z-2(d)(2)(D)(i)(I) requires tangible property to be 
purchased after December 31, 2017, which the May 2019 proposed 
regulations followed in requiring that leased tangible property be 
acquired under a lease entered into after December 31, 2017. One 
commenter requested that the final regulations treat an existing lease 
of property the same as a new lease of property for purposes of 
determining whether the property subject to the existing lease is 
qualified opportunity zone business property. The Treasury Department 
and the IRS note that the leased tangible property rules were included 
in the May 2019 proposed regulations to provide parity among diverse 
business models (for example, parity between business models that 
utilize purchased tangible property and those that utilize leased 
tangible property). To achieve that parity, the Treasury Department and 
the IRS have determined that in general acquisitions of tangible 
property by purchase or lease should be treated consistently. In 
addition, the Treasury Department and the IRS note that section 1400Z-2 
requires the acquisition of such property to occur after December 31, 
2017. Therefore, the final regulations confirm that property subject to 
an existing lease will not constitute qualified opportunity zone 
business property unless the lease was entered into on or after 
December 31, 2017.
3. Requirement That the Terms of Lease Must Be Market Rate Between 
Parties
    Proposed Sec.  1.1400Z2(d)-1(c)(4)(i)(B)(2) and (d)(2)(i)(B)(2) 
provided that, to qualify as qualified opportunity zone business 
property, the terms of a lease must be market rate at the time at which 
the lease was entered into (market-rate lease requirement). For this 
purpose, whether a lease is market rate (that is, whether the terms of 
the lease reflect common, arms-length market pricing in the locale that 
includes the QOZ) is determined in accordance with the regulations 
under section 482. This limitation operates to ensure that all of the 
terms of the lease are market rate. The proposed regulations applied 
the market-rate lease requirement to leases between unrelated parties 
and related parties.
    The Treasury Department and the IRS received multiple comments 
regarding the market-rate lease requirement. For example, many 
commenters requested that the final regulations not apply the market-
rate lease requirement to leases between unrelated parties. Rather, 
these commenters recommended that the final regulations provide a 
presumption that such unrelated-party leases are arms-length. The 
Treasury Department and the IRS agree with the commenters' 
recommendation. Accordingly, the final regulations provide that there 
will be a rebuttable presumption that, with regard to leases between 
unrelated parties, the terms of the lease were market rate (that is, 
the lease satisfies the market-rate lease requirement).
    In addition, the Treasury Department and the IRS received several 
comments requesting that the final regulations exempt from the market-
rate lease requirement leases between an unrelated party and a state or 
local government. Commenters explained that such leases are subject to 
numerous requirements and other special rules. The Treasury Department 
and the IRS agree with the commenters, and have determined that, based 
on the same rationale, Indian tribal governments likewise should be 
exempt from the market-rate lease requirement. As a result, the final 
regulations provide that, for purposes of satisfying the market-rate 
lease requirement, tangible property acquired by lease from a state or 
local government, or an Indian tribal government, is not considered 
tangible property acquired by lease from a related party.
    Another commenter suggested that the final regulations replace the 
market-rate lease requirement with a requirement that a subject lease 
must have reasonable terms. This commenter, however, acknowledged that 
a ``reasonableness'' standard likely would inject additional 
uncertainty into the final regulations. The Treasury Department and the 
IRS appreciate the commenter's suggestion and agree that a 
``reasonableness'' standard would pose additional uncertainty for 
taxpayers in determining whether the terms of a subject lease are 
reasonable. Moreover, the Treasury Department and the IRS believe that 
such a standard would be too complex to administer. As a result, the 
final regulations do not adopt the commenter's suggestion.
4. Plan, Intent, or Expectation of QOF or Qualified Opportunity Zone 
Business To Purchase Leased Real Property
    Proposed Sec.  1.1400Z2(d)-1(c)(4)(i)(E) and (d)(2)(i)(E) provided 
an anti-abuse rule to prevent the use of leases to circumvent the 
substantial improvement requirement for purchases by QOFs or qualified 
opportunity zone businesses of real property (other than unimproved 
land). If, at the time a QOF or qualified

[[Page 1904]]

opportunity zone business enters into a lease for real property (other 
than unimproved land), there was a plan, intent, or expectation for the 
QOF or qualified opportunity zone business to purchase the real 
property for an amount of consideration other than the fair market 
value of the land (as determined at the time of the purchase without 
regard to any prior lease payments) the leased real property does not 
qualify as qualified opportunity zone business property at any time.
    A commenter suggested that the Treasury Department and the IRS 
should consider eliminating from this anti-abuse rule the reference to 
a plan, intent, or expectation to purchase the leased property. Rather, 
the commenter asserted that, even if the QOF or qualified opportunity 
zone business had such ``plan, intent, or expectation,'' the anti-abuse 
rule should not be applied if there were a fixed purchase price option, 
consistent with general Federal income tax principles governing the 
distinction between a lease and a sale, with a strike price not less 
than a specified amount of the fair market value at the time the option 
is entered into.
    The Treasury Department and the IRS have considered the commenter's 
suggestion and have determined that such a rule might enable QOFs and 
qualified opportunity zone businesses to circumvent the substantial 
improvement requirement because leased property from an unrelated party 
is not required to be substantially improved. Thus, the final 
regulations do not reflect this suggestion.

F. Treatment of Inventory for Purposes of Determining Substantial Use 
in QOZ

    Under section 1400Z-2(d)(2)(D)(i)(III), the term ``qualified 
opportunity zone business property'' refers to tangible property used 
in a trade or business of a QOF or qualified opportunity zone business 
if, during substantially all of the holding period of the QOF or 
qualified opportunity zone business for such property, substantially 
all of the use of such property was in a QOZ. Prior to the publication 
of the May 2019 proposed regulations, commenters inquired how inventory 
would be treated for purposes of determining whether substantially all 
of the tangible property is used in the QOZ. To address those 
questions, the May 2019 proposed regulations provided a safe harbor 
that inventory would not fail to qualify as qualified opportunity zone 
business property simply because the inventory is in transit outside 
the QOZ due to transport (i) from a vendor to a facility of the trade 
or business that is in a QOZ, or (ii) from a facility of the trade or 
business that is in a QOZ to customers outside the QOZ (inventory 
transit safe harbor). See proposed Sec.  1.1400Z2(d)-1(c)(4)(iii) 
(setting forth the inventory transit safe harbor).
1. Inventory as Qualified Opportunity Zone Business Property and 
Application of 90-Percent Investment Standard and 70-Percent Tangible 
Property Standard
    As part of the May 2019 proposed regulations, the Treasury 
Department and the IRS requested comments as to whether inventory, 
including raw materials, should be excluded from both the numerator and 
denominator of the fraction used to determine compliance with the 90-
percent investment standard and the 70-percent tangible property 
standard. In response, some commenters recommended that the final 
regulations exclude inventory from the 90-percent investment standard 
and the 70-percent tangible property standard. These commenters based 
that recommendation upon their conclusion that inventory should never 
be treated as qualified opportunity zone business property because such 
inventory (i) is a transitory asset, (ii) does not add value to the 
QOZ, and (iii) does not meet the requirements for either the original 
use or substantial improvement requirement. Other commenters agreed 
that inventory should be excluded from the 70-percent tangible property 
standard, emphasizing that any requirement that taxpayers measure 
inventory would be significantly burdensome.
    Several additional commenters, however, recommended that the final 
regulations treat inventory, in a limited manner, as qualified 
opportunity zone business property. These commenters suggested that 
taxpayers should be allowed to elect on an annual basis whether to 
exclude inventory from the numerator and denominator for purposes of 
the 90-percent investment standard and the 70-percent tangible property 
standard. Another commenter contended that inventory should be limited 
to a certain percentage of total qualified opportunity zone property, 
suggesting that 15 or 20 percent of such total property would provide a 
reasonable maximum.
    The Treasury Department and the IRS also received numerous requests 
that the final regulations provide additional detail and clarity 
regarding the general application of section 1400Z-2 to inventory. Like 
the commenters described previously, these commenters noted that the 
proposed regulations did not specify whether inventory is properly 
includable in the numerator of the 70-percent tangible property 
standard or the 90-percent investment standard. These commenters also 
highlighted that the proposed regulations did not clarify whether 
inventory must be original use property or substantially improved 
property.
    The Treasury Department and the IRS acknowledge the concerns raised 
by these commenters and agree that additional rules regarding the 
treatment of inventory would be appropriate. As a result, the final 
regulations provide that, for purposes of determining compliance with 
the 90-percent investment standard and the 70-percent tangible property 
standard, a QOF or qualified opportunity zone business may choose to 
(i) include inventory in both the numerator and the denominator, or 
(ii) exclude inventory entirety from both the numerator and the 
denominator. The final regulations also provide that, once a QOF or 
qualified opportunity zone business makes such choice, the QOF or 
qualified opportunity zone business must apply that choice consistently 
with respect to all semiannual tests during the holding period in which 
the QOF, or the qualified opportunity zone business of the QOF, holds 
the inventory. The Treasury Department and the IRS have determined that 
these rules will provide appropriate flexibility for QOFs and qualified 
opportunity zone businesses, as well as certainty regarding the 
application of the 90-percent investment standard and the 70-percent 
tangible property standard.
2. Comments Regarding Application of 90-Percent Investment Standard to 
Inventory in Transit
    Commenters also expressed concern that inventory in transit on the 
last day of the taxable year of a QOF would be counted against the QOF 
when determining whether the QOF has met the 90-percent investment 
standard. Several commenters recommended that inventory in transit, 
either from the vendor or to the ultimate customer, be excluded from 
the numerator and denominator for purposes of the 90-percent investment 
standard, but should qualify for the 70-percent use test. Another 
commenter suggested that the location of inventory in transit should be 
taken into account in determining whether the inventory is qualified 
opportunity zone business property. One commenter generally agreed with 
the approach of the May 2019 proposed regulations with regard to 
inventory in transit, but requested clarification that (i) the distance 
traveled during the course of the transit, or (ii) the manner of the 
transit, does not affect application of the inventory transit safe 
harbor. The

[[Page 1905]]

commenter also requested clarification as to whether the inventory 
transit safe harbor covers instances in which the inventory is 
warehoused briefly (that is, for less than 30 days) in a location 
outside of the QOZ while in the process of transit.
    The Treasury Department and the IRS appreciate the commenters' 
concerns regarding the manner by which transported inventory is treated 
for purposes of applying the 90-percent investment standard. To provide 
certainty for QOFs as well as qualified opportunity zone businesses on 
this matter, the final regulations set forth a rule that provides that 
(i) the distance traveled in the course of the transit, and (ii) the 
fact that the inventory is briefly warehoused while in transit, does 
not affect the application of the inventory transit safe harbor. The 
Treasury Department and the IRS intend for these provisions to 
complement the inventory transit safe harbor, which the final 
regulations adopt in full.

G. Definition of ``Substantially All'' for Purposes of Qualified 
Opportunity Zone Property and Qualified Opportunity Zone Business 
Determinations

    The definitions of the terms ``qualified opportunity zone 
property'' and ``qualified opportunity zone business'' incorporate 
several ``substantially all'' requirements. For example, with regard to 
(1) qualified opportunity zone stock, (2) qualified opportunity zone 
partnership interests, and (3) qualified opportunity zone business 
property, to qualify as qualified opportunity zone property, the 
corporation or partnership must have qualified as a qualified 
opportunity zone business, and the qualified opportunity zone business 
property must have been used in a QOZ, during ``substantially all'' of 
the QOF's holding period of such stock, interest, or business, as 
appropriate. See section 1400Z-2(d)(2)(B)(i)(III) (regarding qualified 
opportunity zone stock); section 1400Z-2(d)(2)(C)(iii) (regarding 
qualified opportunity zone partnership interests); section 1400Z-
2(d)(2)(D)(i)(III) (regarding qualified opportunity zone businesses). 
In this holding period context, the May 2019 proposed regulations 
defined ``substantially all'' of a QOF's holding period as 90 percent 
of the total holding period of the QOF. See proposed Sec.  1.1400Z2(d)-
1(c)(5).
    In addition to QOF holding period requirements, the term 
``substantially all'' appears in a ``use'' context. Specifically, 
tangible property used in a trade or business of a QOF or in a 
qualified opportunity zone business will not qualify as qualified 
opportunity zone business property unless ``substantially all'' of the 
use of such tangible property was within the geographic boundaries of a 
QOZ. See section 1400Z-2(d)(2)(D)(i)(III), (3)(A)(i). In this ``use'' 
context, the May 2019 proposed regulations defined ``substantially 
all'' of the use of tangible property in a QOZ by a trade or business 
of a QOF, or by a qualified opportunity zone business, as 70 percent of 
the total use of such tangible property. See proposed Sec.  
1.1400Z2(d)-1(c)(6), (d)(2)(iv).
    Lastly, the term ``substantially all'' appears in the context of 
the portion of a business's tangible property that must be qualified 
opportunity zone business property in order for the business to qualify 
as a qualified opportunity zone business. Specifically, a trade or 
business qualifies as a qualified opportunity zone business only if 
(among the satisfaction of other requirements) ``substantially all'' of 
the tangible property owned or leased by the taxpayer for the trade or 
business is qualified opportunity zone business property. See section 
1400Z-2(d)(3)(A)(i). For this determination of whether the trade or 
business owns or leases a sufficient amount of qualified opportunity 
zone business property, the October 2018 proposed regulations defined 
``substantially all'' as an amount equal to 70 percent of the total 
amount of tangible property owned or leased by the trade or business 
(70-percent tangible property standard). See proposed Sec.  
1.1400Z2(d)-1(d)(3).
    As discussed in the respective preambles to the October 2018 and 
May 2019 proposed regulations, the Treasury Department and the IRS 
provided a higher threshold in the holding period context to preserve 
the integrity of the statute and ensure that investors focus their 
investments within the geographic borders of QOZs. Therefore, the term 
``substantially all,'' as used in the holding period context, was 
defined in the proposed regulations as 90 percent of the QOF's total 
holding period. The Treasury Department and the IRS determined that a 
percentage threshold higher than, for example 70 percent, was warranted 
because taxpayers can more easily control and determine the period for 
which they hold property. In addition, given the lower 70-percent 
thresholds for testing both the use of tangible property in the QOZ and 
the amount of owned and leased tangible property of a qualified 
opportunity zone business that must be qualified opportunity zone 
business property, applying a 70-percent threshold in the holding 
period context could result in an unacceptably low percentage of a 
qualified opportunity zone business's tangible property being used in a 
QOZ.
    The Treasury Department and the IRS, however, recognized that the 
operations of certain types of businesses may extend beyond the census 
tract boundaries that define QOZs. Accordingly, the ``substantially 
all'' thresholds provided by the proposed regulations with regard to 
required amounts and use of tangible property owned or leased by a 
trade or business were set to a 70-percent standard. The Treasury 
Department and the IRS determined that a 70-percent standard would 
appropriately tie the ability of investors in QOFs to receive 
preferential capital gains treatment to a consequential amount of 
tangible property being used by the underlying business within a QOZ. 
Importantly, the Treasury Department and the IRS also determined that a 
70-percent standard would provide businesses with an appropriate degree 
of flexibility to conduct their day-to-day operations, and therefore 
avoid significantly distorting or otherwise limiting the introduction 
of new businesses and investment in QOZs.
1. Consideration of Uniform 90-Percent ``Substantially All'' Standard
    Commenters have suggested that the term ``substantially all'' 
should be interpreted as requiring a 90-percent standard with regard to 
each instance in which the term is used in section 1400Z-2. As 
described previously, the Treasury Department and the IRS have 
determined that the policy considerations underlying each use of the 
term ``substantially all'' are not uniform, and therefore a uniform 
standard would fail to effectuate such policies in all cases. For 
example, the Treasury Department and the IRS established the 70-percent 
tangible property standard and 70-percent use test to provide 
``substantially all'' requirements for qualified opportunity zone 
businesses that, while substantial, would ensure that a diverse 
spectrum of businesses would be able to operate in QOZs. However, the 
Treasury Department and the IRS selected a higher 90-percent threshold 
regarding holding periods of QOFs (under the 90-percent investment 
standard) to encourage long-term direct or indirect investments in 
those qualified opportunity zone businesses. In addition, due to the 
compound application of the 90-percent threshold, the 70-percent 
tangible property standard, and the 70-percent use test, the Treasury 
Department and the IRS sought to ensure that each percentage

[[Page 1906]]

requirement, when taken together, would remain significant.
    Another commenter that advocated for a uniform 90-percent standard 
specifically contended that the 70-percent use test presented an 
inappropriately low threshold to ensure that acceptable amounts of new 
economic activity are introduced in QOZs. The Treasury Department and 
the IRS appreciate the commenter's perspective, but have determined 
that a 70-percent standard achieves an appropriate balance between 
providing proper flexibility to potential investors in QOZs and 
limiting the potential for abuse. A 90-percent use threshold would pose 
a much stricter standard than the proposed 70-percent standard, and 
potentially would discourage investment in QOZs. As a result, the final 
regulations retain the 70-percent use test.
    Several commenters recommended that, solely with regard to real 
estate businesses, the final regulations should adopt a threshold of 90 
percent for the substantially all use test. The Treasury Department and 
the IRS have determined that such industry-specific rules would (i) not 
be consistent with section 1400Z-2 or its underlying policy, and (ii) 
present administratively burdensome tracking requirements under which 
taxpayers, as well as the IRS, would need to apply different rules for 
different types of businesses. As a result, the final regulations do 
not adopt this recommendation.
2. Clarification Regarding the Measurement of ``Use'' for the 70-
Percent Use Test
    Several commenters requested clarification regarding the scope of 
the term ``use'' under section 1400Z-2(d)(2)(D)(i)(III). Similarly, 
other commenters requested that the final regulations clarify the 
meaning of the term ``use'' with regard to qualified opportunity zone 
property located both inside, and outside the geographic borders of a 
QOZ. Taken together, commenters generally requested easily applicable 
metrics for determining compliance with the 70-percent use test that 
are responsive to the practical realities of businesses that utilize a 
range of tangible property in addition to real estate.
    The Treasury Department and the IRS agree with the commenters that 
guidance regarding the meaning and application of the term ``use'' 
would be significantly helpful to taxpayers. As a result, the final 
regulations provide that tangible property of a trade or business is 
counted for purposes of satisfying the 70-percent use test (qualified 
tangible property) to the extent the tangible property is (1) located 
within the geographic borders of a QOZ, and (2) in connection with the 
ordinary conduct of the trade or business, utilized in the QOZ in the 
performance of an activity of the trade or business that contributes to 
the generation of gross income for the trade or business. The final 
regulations explicitly provide that this determination is based upon 
the amount of time during which the use of the subject tangible 
property meets those two requirements.
3. Application of 70-Percent Use Test to Mobile Tangible Property
    The Treasury Department and the IRS received several comments 
regarding the application of the 70-percent use test to mobile tangible 
property that a trade or business might utilize both inside and outside 
a QOZ or in multiple QOZs. Commenters noted that many trades or 
businesses rely on delivery vehicles, construction equipment, service 
trucks and other types of mobile tangible property to generate gross 
income. Ordinarily, such trades or businesses will deploy mobile 
tangible property without regard to QOZ boundaries, at times utilizing 
the property inside a QOZ, while at other times utilizing the property 
outside of a QOZ. As a result, these commenters requested that the 
final regulations articulate standards or safe harbors for determining 
whether a mobile tangible property satisfies the 70-percent use test to 
qualify as qualified opportunity zone business property.
    The Treasury Department and the IRS appreciate the concerns raised 
by these commenters. To provide standards that more effectively respond 
to the day-to-day customary operation of trades or businesses, the 
final regulations set forth specific rules clarifying the application 
of the 70-percent use test to mobile tangible property. The Treasury 
Department and the IRS have drafted these rules to strike an 
appropriate balance between allowing flexibility for business 
development and ensuring that such business development primarily 
benefits low-income communities comprising QOZs.
    For example, the final regulations provide a safe harbor for 
tangible property utilized in rendering services both inside and 
outside the geographic borders of a QOZ. Under this safe harbor, a 
limited amount of such tangible property may be excluded from the 
general time of use calculation underlying the 70-percent use test. 
Specifically, the safe harbor permits up to 20 percent of the tangible 
property of a trade or business to be treated as satisfying the 70-
percent tangible property standard if the tangible property is utilized 
in activities both inside and outside of the geographic borders of a 
QOZ, and if (i) the trade or business has an office or other fixed 
location located within a qualified opportunity zone (QOZ office), and 
(ii) the tangible property is operated by employees of the trade or 
business who regularly use a QOZ office of the trade or business in the 
course of carrying out their duties, and are managed directly, 
actively, and substantially on a day-to-day basis by one or more 
employees of the trade or business at a QOZ office. In addition, in 
order to qualify for the safe harbor, the tangible property must not be 
operated exclusively outside of the geographic borders of a qualified 
opportunity zone for a period longer than 14 consecutive days for the 
generation of gross income for the trade or business.
    In addition, the final regulations provide a similar safe harbor 
for short-term leased tangible property. Under this rule, tangible 
property leased by a trade or business located within the geographic 
borders of a QOZ to a lessee that utilizes the tangible property at a 
location outside of a QOZ is qualified tangible property if the 
following two requirements are satisfied. First, consistent with the 
normal, usual, or customary conduct of the trade or business, the 
tangible property must be parked or otherwise stored at a location 
within a QOZ when the tangible property is not subject to a lease to a 
customer of the trade or business. Second, the lease duration of the 
tangible property (including any extensions) must not exceed 30 
consecutive days. This special leased tangible property rule, however, 
is not subject to a limitation similar to the 20-percent limitation 
with regard to non-leased mobile tangible property due to the highly 
mobile nature of tangible property typically leased to customers by 
leasing businesses.
4. Use of Tangible Property in Multiple QOZs Aggregated for the 70-
Percent Use Test
    The Treasury Department and the IRS have received comments 
recommending that the final regulations clarify the manner in which use 
of tangible property is measured if such use occurs in multiple QOZs. 
To respond to these comments, the final regulations specifically 
provide that, if tangible property is used in one or more QOZs, 
satisfaction of the 70-percent use test is determined by aggregating 
the number of days the tangible property in each QOZ is utilized. The 
Treasury

[[Page 1907]]

Department the IRS have determined that the policy underlying the 70-
percent use test would be effectuated through the introduction of new 
economic activity into any low-income community designated as a QOZ, 
regardless of specific designation.
    A commenter highlighted potential confusion caused by circular 
language in proposed Sec.  1.1400Z2(d)-1(c)(9)(i)(A). In general, 
proposed Sec.  1.1400Z2(d)-1(c)(9) described the fraction by which the 
70-percent use test is calculated. Proposed Sec.  1.1400Z2(d)-
1(c)(9)(i)(A) referred to the value of qualified opportunity zone 
business property that meets the requirements of Sec.  1.1400Z2(d)-
1(c)(4)(i)(A)-(C), (E), and (F). The commenter noted that this 
reference results in a circular analysis because qualified opportunity 
zone business property is the item calculated by the previously 
described fraction, and proposed Sec.  1.1400Z2(d)-1(c)(4)(i)(D) sets 
forth the ``substantially all'' test for use in a QOZ. In other words, 
the 70-percent use fraction must be calculated before one can determine 
whether property qualifies as qualified opportunity zone business 
property.
    The Treasury Department and the IRS appreciate the commenter's 
point. The final regulations set forth a significantly revised 
calculation for determining satisfaction of the 70-percent use test 
that does not implicate the issue raised by the commenter. In addition, 
the final regulations clarify that the use of tangible property in a 
QOZ is determined on an asset-by-asset basis. See part V.G. of this 
Summary of Comments and Explanation of Revisions.
5. Application of Holding Period Requirements Under Section 1400Z-2
    The Treasury Department and the IRS received numerous requests for 
clarification regarding the manner by which QOFs can meet the holding 
period requirements under section 1400Z-2(d)(2)(B)(i)(III) and 
(d)(2)(C)(iii) (90-percent qualified opportunity zone property holding 
period) and QOFs and qualified opportunity zone businesses can meet the 
holding period requirement under section 1400Z-2(d)(2)(D)(i)(III) (90-
percent qualified opportunity zone business property holding period). 
For example, several commenters suggested that QOFs and qualified 
opportunity zone businesses should test for satisfaction of the two 90-
percent holding period requirements only at the end of their holding 
period for the property. One commenter recommended that the final 
regulations provide QOFs with an election to test for satisfaction of 
the 90-percent holding period requirement based on either (i) the 
taxpayer's actual holding period as of a testing date, or (ii) the 
taxpayer's projected holding period. See V.B.1. of this Summary of 
Comments and Explanation of Revisions.
    The Treasury Department and the IRS agree that the rules for 
determining satisfaction of the 90-percent qualified opportunity zone 
property holding period requirement and 90-percent qualified 
opportunity zone business property holding period requirement should be 
clarified. Accordingly, the final regulations provide that the 
determination of whether the two 90-percent holding period requirements 
are satisfied is made on a semiannual basis, based on the cumulative 
amount of time the QOF or qualified opportunity zone business has held 
the property.
    Stock or partnership interests will satisfy the 90-percent 
qualified opportunity zone property holding period requirement if 
during 90-percent of the QOF's holding period for the stock or 
partnership interest, beginning on the date that it's self-
certification as a QOF is effective and ending on the relevant 
semiannual testing date, the corporation or partnership qualified as a 
qualified opportunity zone business. Similarly, tangible property will 
satisfy the 90-percent qualified opportunity zone business property 
holding period requirement only if the tangible property satisfied the 
70-percent use test for at least 90 percent of the period during which 
the QOF or qualified opportunity zone business has held such property. 
As noted in part V.B.1. of this Summary of Comments and Explanation of 
Revisions, the determination of whether an eligible entity engaged in a 
trade or business qualified as a qualified opportunity zone business is 
determined at the end of the entity's taxable year but a QOF has 
semiannual testing dates on which it must determine if the entity was a 
qualified opportunity zone business for 90 percent of the QOF's holding 
period of the equity of the entity. Because status as a qualified 
opportunity zone business is defined with respect to an entity's 
taxable year, taxpayers may encounter difficulties when a QOF's 
semiannual testing date falls before the end of the entity's taxable 
year. The final regulations therefore provide a safe harbor for 
purposes of complying with the 90-percent holding period test. Under 
the safe harbor, the QOF may limit the period tested to the period that 
starts with the beginning of the QOF's status as a QOF and lasts until 
the last day of the entity's latest taxable year and ends on or before 
the relevant testing date.
    To determine whether qualified opportunity zone business property 
meets the statutory holding period requirements, a QOF or qualified 
opportunity zone business must measure the use of the property on a 
semiannual basis, on the same testing dates as the 90-percent 
investment standard. (If QOFs with diverse taxable years invest in the 
same qualified opportunity zone business, the business may have to 
measure use of the property semiannually for each investing QOF). The 
purposes of section 1400Z-2 and the section 1400Z-2 regulations are to 
provide specified tax benefits to owners of QOFs to encourage the 
making of longer-term investments of new capital, through QOFs and 
qualified opportunity zone businesses, into one or more QOZs and to 
increase the economic growth therein. The Treasury Department and the 
IRS have determined that, if the final regulations were to permit QOFs 
or qualified opportunity zone businesses to use a projected holding 
period, or to measure the holding period only at the end of their 
holding period in the property, the previously described policy goals 
of section 1400Z-2 would be compromised. In addition, such approaches 
would pose administrative difficulties for the IRS in administering 
holding period requirements in instances in which a period of ownership 
extends beyond the statute of limitations for assessing the QOF.
6. Consideration of Cure Periods and Other Relief Regarding Application 
of 90-Percent Investment Standard
    Commenters noted that, under the proposed regulations, no relief 
was available to a QOF that discovered that the entity in which it 
invested failed to qualify as a qualified opportunity zone business. 
Several commenters emphasized that the 90-percent investment standard 
posed a high threshold with severe consequences for a trade or business 
that failed to qualify as a qualified opportunity zone business for a 
testing date. As an example, one commenter described a scenario in 
which an entity qualified as a qualified opportunity zone business 
during one year, but failed to satisfy the 90-percent qualified 
opportunity zone property holding period during the next year, and 
therefore lost any potential to satisfy the 90-percent qualified 
opportunity zone property holding period for that stock or partnership 
interest in later years--regardless of whether the otherwise compliant 
trade or business permanently cured the defect that lead to the second-
year failure. As a result, commenters recommended various ``grace 
periods'' during which an entity

[[Page 1908]]

would be treated as a qualified opportunity zone business even if the 
entity failed one or more requirements under section 1400Z-2.
    The Treasury Department and the IRS agree that entities should be 
afforded appropriate relief to cure a defect that prevents 
qualification as a qualified opportunity zone business for purposes of 
the 90-percent qualified opportunity zone property holding period, 
without penalty to the investing QOF under section 1400Z-2(f). 
Accordingly, the final regulations provide a six-month period for an 
entity in which a QOF has invested to cure a defect that caused the 
entity to fail to qualify as a qualified opportunity zone business. The 
six-month cure period corresponds to both the testing periods for both 
the qualified opportunity zone business and the QOF as required in 
sections 1400Z-2(d)(1) and (3). The final regulations provide that 
during that six-month cure period, the QOF can treat the interest held 
in the entity as qualified opportunity zone property. Upon the 
conclusion of the six-month cure period, if the entity again fails to 
qualify as a qualified opportunity zone business, the QOF must 
determine if the QOF meets the 90-percent investment standard, taking 
into account its ownership in the non-qualifying entity. If the QOF 
fails to meet the 90-percent investment standard, the final regulations 
provide that the QOF must determine the penalty applicable to each 
month in which the QOF failed to meet the 90-percent investment 
standard, including each month during and prior to the six-month cure 
period. The final regulations specify that a qualified opportunity zone 
business can utilize a six-month cure period only once.
    The Treasury Department and the IRS note that, in addition to this 
six-month cure period, a QOF can assert a defense of reasonable cause 
under section 1400Z-2(f)(3) if the QOF becomes subject to a penalty for 
failure to satisfy the 90-percent investment standard. Specifically, 
section 1400Z-2(f)(3) provides that no penalty may be imposed for 
failure to meet the 90-percent investment standard ``if it is shown 
that such failure is due to reasonable cause.'' The Treasury Department 
and the IRS view this relief under the statute, as well as the six-
month cure period provided by the final regulations, as sufficient 
relief to address the commenters' concerns.
    One commenter suggested that the Treasury Department and the IRS 
consider whether the 90-percent qualified opportunity zone property 
holding period should be tolled due to circumstances beyond the control 
of the QOF or qualified opportunity zone business. The Treasury 
Department and the IRS note that section 1400Z-2(f)(3) provides that a 
QOF can assert a defense of reasonable cause if the QOF becomes subject 
to the penalty for failure to maintain the 90-percent investment 
standard. Based on the existence of this statutory relief, the Treasury 
Department and the IRS have determined that a QOF possesses appropriate 
recourse (that is, a reasonable cause defense) with regard to 
circumstances beyond the QOF's control.
H. Original Use of Tangible Property Acquired by Purchase
    Section 1400Z-2(d)(2)(D) requires either that the original use of 
qualified opportunity zone business property in the QOZ commences with 
the QOF or qualified opportunity zone business or that the QOF or 
qualified opportunity zone business substantially improve the property. 
Similar requirements are also found in other sections of the Code. 
Under the now-repealed statutory frameworks of both section 1400B 
(related to the DC Zone) and section 1400F (related to Renewal 
Communities), qualified property for purposes of those provisions was 
required to have its original use in a zone or to meet the requirements 
of substantial improvement as defined under those provisions. Following 
the publication of the October 2018 proposed regulations, the Treasury 
Department and the IRS received numerous questions and comments on the 
meaning of ``original use.'' Several commenters requested confirmation 
as to whether (i) tangible property could be previously used property, 
rather than solely new property; (ii) property previously placed in 
service in the QOZ for one use, but subsequently placed in service for 
a different use by an acquirer, could qualify as original use; and 
(iii) property previously used in the QOZ could be placed in service in 
the same QOZ by an acquiring, unrelated taxpayer.
    After carefully considering the comments and questions received 
regarding the October 2018 proposed regulations, the May 2019 proposed 
regulations generally provided that the ``original use'' of tangible 
property acquired by purchase by any person commences on the date on 
which that person or a prior person (i) first places the property in 
service in the QOZ for purposes of depreciation or amortization, or 
(ii) first uses the property in the QOZ in a manner that would allow 
depreciation or amortization if that person were the property's owner. 
Therefore, tangible property located in the QOZ that has been 
depreciated or amortized by a taxpayer other than the QOF or qualified 
opportunity zone business would not satisfy the original use 
requirement of section 1400Z-2(d)(2)(D)(i)(II) under the May 2019 
proposed regulations. Conversely, tangible property, other than land, 
located in the QOZ that has not yet been depreciated or amortized by a 
taxpayer other than the QOF or qualified opportunity zone business 
would satisfy the original use requirement of section 1400Z-
2(d)(2)(D)(i)(II) under those proposed regulations. The May 2019 
proposed regulations also clarified that used tangible property will 
satisfy the original use requirement for a QOZ so long as the property 
has not been previously used in the QOZ (that is, has not previously 
been used within that QOZ in a manner that would have allowed it to be 
depreciated or amortized, by any taxpayer).
1. Reliance on Certificate of Occupancy for ``Original Use'' 
Determination
    Several commenters of the May 2019 proposed regulations recommended 
that the final regulations permit taxpayers to rely on certificates of 
occupancy for determining whether a property satisfies the original use 
requirement. For example, commenters suggested that, if a certificate 
of occupancy has not been received for property consisting of a 
structure, the property has not been used prior to the issuance of the 
certificate and therefore potentially could satisfy the original use 
requirement. Another commenter requested that the final regulations 
treat real property as meeting the original use requirement if the 
property receives a certificate of occupancy following a certain number 
of years without a certificate. Another commenter suggested that, 
similar to the rules under Sec. Sec.  1.46-3(d)(2), 1.150-2(c), and 
1.179-4(e), the final regulations permit QOFs and qualified opportunity 
zone businesses to elect to have ``original use'' measured from the 
date on which (i) the property is placed into service, or (ii) the 
certificate of occupancy is granted under local law.

[[Page 1909]]

    The Treasury Department and the IRS appreciate the commenters' 
objective to increase certainty regarding ``original use'' 
determinations. However, the Treasury Department and the IRS note that 
standards applicable to certificates of occupancy vary by jurisdiction 
and therefore fail to provide a uniform standard. In addition, the 
processes for obtaining a certificate of occupancy vary significantly 
based on jurisdiction and likely would introduce additional complexity 
and uncertainty. As a result, the final regulations do not adopt the 
commenters' recommendation.
2. Consideration of Treating Acquired Non-Business Property or Newly 
Rezoned Property as ``Original Use'' Property
    Several commenters recommended that the final regulations clarify 
that property previously used for non-business purposes may be treated 
as ``original use'' property in a QOZ upon its acquisition. For 
support, these commenters emphasized that such property would not have 
been depreciated or amortized. Similarly, one commenter requested that 
the final regulations provide a special rule that real property located 
in an area newly rezoned pursuant to a local government's master plan 
be treated as ``original use property'' because the local government's 
rezoning would fundamentally change the real property's use. Other 
commenters contended that no previously used property in a QOZ should 
qualify as satisfying the original use requirement regardless of 
whether, for example, the property had been depreciated or amortized.
    The Treasury Department and the IRS have considered each of the 
arguments set forth by the commenters and have concluded that acquired 
property previously used in a QOZ does not satisfy the original use 
requirement. A rule treating historically used property in a QOZ as 
``original use'' property because such property's prior use was 
nonbusiness in nature or classified differently under a local 
government's master plan would fail to sufficiently encourage the 
introduction of new capital investments into QOZs. Accordingly, the 
final regulations retain the rules set forth in the proposed 
regulations that a property's ``original use'' commences on the date on 
which the property is first (i) placed into service in the QOZ and is 
depreciated or amortized, or (ii) used in a manner that would allow 
depreciation or amortization.
3. Consideration of Safe Harbor Based on Belief That Property Was Not 
Placed Into Service
    One commenter requested that the Treasury Department and the IRS 
provide a safe harbor to treat property acquired by a taxpayer as 
satisfying the original use requirement if the taxpayer believed that 
the property had not yet been placed into service. The commenter 
contended that, if such taxpayer held that belief, the acquired 
property should be treated as ``original use'' property even if the 
taxpayer subsequently discovers that the property actually had been 
placed in service shortly before its acquisition. The Treasury 
Department and the IRS decline to adopt this comment because the 
purposes of section 1400Z-2 and the section 1400Z-2 regulations are to 
provide specified tax benefits to owners of QOFs to encourage the 
making of longer-term investments, through QOFs and qualified 
opportunity zone businesses, of new capital in one or more QOZs and to 
increase the economic growth of such QOZs. The Treasury Department and 
the IRS have determined that the commenter's recommended safe harbor 
would not help achieve those goals.
4. Consideration of Newly Constructed Buildings Acquired Prior To Being 
Placed Into Service
    A commenter requested clarification regarding whether a building 
that is newly constructed and sold to a purchaser meets the original 
use requirement with respect to the purchaser. The commenter noted that 
potential QOF investors intend to invest in QOZs by acquiring newly 
constructed buildings for their trades or businesses that, prior to 
acquisition, have not been placed into service for purposes of 
depreciation. In such circumstances, the commenter noted that potential 
QOF investors have expressed uncertainty regarding the application of 
the original use requirement.
    The Treasury Department and the IRS appreciate the commenter's 
concern and have determined that such newly constructed buildings 
satisfy the original use requirement. The construction of new buildings 
in economically disadvantaged communities, which are acquired for the 
purpose of introducing new businesses into such communities, clearly 
achieves the policy goals underlying section 1400Z-2 and should be 
encouraged. Accordingly, the final regulations provide an example that 
provides certainty with regard to the acquisition of such newly 
constructed buildings.
5. Qualification of Demolished Property, Overwhelmingly Improved 
Property, and Property Improvements as ``Original Use'' Property
    One commenter requested that the final regulations provide that an 
improvement made to non-qualified property used in a QOZ satisfies the 
original use requirement. The commenter reasoned that such treatment 
would be appropriate because, under the May 2019 proposed regulations, 
improvements made by a lessee to leased property are treated as 
separate property for purposes of section 1400Z-2(d)(2)(D)(i) and 
therefore as satisfying the original use requirement. The Treasury 
Department and the IRS appreciate the argument raised by the commenter, 
but have determined that the administrative burdens that would arise 
for taxpayers and the IRS from tracking improvements made to such non-
qualified property would significantly exceed those arising from the 
tracking of lessee improvements. As a result, the final regulations do 
not adopt the commenter's recommendation.
    A commenter also requested that the final regulations treat 
tangible property that has not been purchased, but has been 
overwhelmingly improved, as ``original use'' property. Section 1400Z-
2(d)(2)(D)(i)(I) requires that property must be acquired after December 
31, 2017 to qualify as qualified opportunity zone business property. 
While a QOZ would benefit from the overwhelming improvement of 
currently owned property located within the QOZ, such improvement does 
not satisfy the statutory requirement set forth in section 1400Z-
2(d)(2)(D)(i)(I). Therefore, the final regulations do not incorporate 
the commenter's recommendation.
    Another commenter requested that the Treasury Department and the 
IRS confirm that newly constructed real property, or substantially 
improved property, that otherwise meets the requirements of section 
1400Z-2(d)(2)(D), will not fail to qualify as qualified opportunity 
zone business property solely because the property is constructed upon 
leased land. The Treasury Department and the IRS note that land, 
including leased land, does not need to be substantially improved 
within the meaning of section 1400Z-2(d)(2)(D)(i)(II) and 1400Z-
2(d)(2)(D)(ii). Cf. Sec.  1400Z2(d)-1(c)(7)(iv)(B) and (d)(4)(iv)(B). 
Accordingly, if property otherwise qualifies as qualified opportunity 
zone business property, the fact that the property is constructed on 
leased land will not disqualify the

[[Page 1910]]

property from being treated as qualified opportunity zone business 
property.
6. Treatment of Property That Qualifies for Certain Low-Income Housing 
Credits
    A commenter requested that the final regulations address the 
application of credits provided under section 42(a) of the Code for 
investment in certain low-income housing buildings (section 42 
credits). Specifically, the commenter requested that the final 
regulations provide that a property that qualifies for section 42 
credits be treated as satisfying the original use requirement. The 
Treasury Department and the IRS continue to consider the combining of 
other tax incentives (including credits) with the benefits provided by 
section 1400Z-2. As a result, the final regulations do not incorporate 
the commenter's request.
7. Application of Original Use Requirement to Leased Tangible Property
    A commenter recommended that the final regulations require that 
leased tangible property located in a QOZ be (i) originally used in the 
QOZ, and (ii) substantially improved. The Treasury Department and the 
IRS note that, under the proposed regulations, improvements made by a 
lessee to leased property satisfy the original use requirement and are 
considered purchased property to the extent of the unadjusted cost 
basis of those improvements (as under section 1012). However, the 
proposed regulations do not set forth any requirement that leased 
property be substantially improved. After considering the commenter's 
analysis, the Treasury Department and the IRS have determined that a 
rule requiring both original use and substantial improvement with 
regard to leased tangible property would be inconsistent with section 
1400Z-2 and unnecessary.
8. Vacancy Period for Original Use Requirement
    In the May 2019 proposed regulations, the Treasury Department and 
the IRS proposed that, where a building or other structure has been 
vacant for at least five years prior to being purchased by a QOF or 
qualified opportunity zone business, the purchased building or 
structure will satisfy the original use requirement. Specifically, the 
May 2019 proposed regulations provided that, if property has been 
unused or vacant for an uninterrupted period of at least five years, 
original use in the QOZ commences on the date after that period when 
any person first so uses or places the property in service in the QOZ. 
See proposed Sec.  1.1400Z2(d)-1(c)(4)(i)(B)(6), (c)(7)(i), 
(d)(2)(i)(B)(6). The Treasury Department and the IRS requested comments 
regarding that proposed approach, including the length of the vacancy 
period and how such a standard might be administered and enforced.
a. Duration of Vacancy Period Required To Satisfy Original Use 
Requirement
    The Treasury Department and the IRS received several comments 
regarding the five-year vacancy requirement set forth in the May 2019 
proposed regulations. While some commenters expressed approval, others 
contended that a five-year vacancy period would be inappropriately 
long. Commenters also recommended vacancy periods in excess of five 
years, contending that any shorter vacancy period would increase the 
number of vacant properties exempt from the substantial improvement 
requirement, and therefore decrease the overall magnitude of property 
development in QOZs. One commenter requested that the final regulations 
include, in addition to a five-year vacancy requirement, safeguards to 
reduce the incentive for taxpayers to vacate buildings for tax 
benefits.
    In particular, several commenters suggested that the final 
regulations provide a vacancy period threshold similar to the threshold 
provided in Sec.  1.1394-1(h), which requires a vacancy period of ``at 
least one-year.'' See Sec.  1.1394-1(h) (setting forth an original use 
requirement for purposes of qualified zone property under section 
1397D, with regard to the issuance of enterprise zone facility bonds 
under section 1394). However, numerous commenters disagreed with that 
approach, contending that the vacancy period required under Sec.  
1.1394-1(h) responds to a different policy objective than the section 
1400Z-2 policy objective of increasing new economic development in 
QOZs. These commenters also contended that a one-year vacancy period 
would constitute an unacceptably weak standard that potentially would 
encourage owners of property in QOZs to attempt to artificially satisfy 
the vacancy requirement by ceasing occupation of a property for one 
year.
    Commenters also recommended rules consisting of multiple vacancy 
periods to accommodate different types of situations involving vacant 
buildings. For example, a commenter recommended that the final 
regulations require (i) a vacancy period spanning not less than two 
years, or (ii) a five-year vacancy period, if less than 25 percent of 
the rentable square footage of the subject property is rented or 
occupied. Another commenter, while expressing general approval 
regarding the five-year vacancy period requirement, suggested that 
properties already vacant for at least one year at the time of QOZ 
designation should qualify as vacant.
    The Treasury Department and the IRS appreciate the commenters' 
suggestions and recommendations, and have modified the proposed five-
year vacancy requirement to better effectuate the policy of section 
1400Z-2. Accordingly, the final regulations provide a special one-year 
vacancy requirement for property that was vacant prior to and on the 
date of publication of the QOZ designation notice that listed the 
designation of the QOZ in which the property is located, and through 
the date on which the property was purchased by an eligible entity. The 
Treasury Department and the IRS have determined that a shorter vacancy 
period for property vacant at the time of their QOZ designation is 
appropriate because (i) such buildings do not present the same 
potential for abuse (for example, causing a building to be vacant for 
one year to convert the building to ``original use'' property), and 
(ii) the infusion of capital investments into vacant property that 
contributed to the QOZ's designation would achieve a core policy 
objective of section 1400Z-2.
    With respect to property not vacant as of the time of such QOZ 
designation notice but that later become vacant, the final regulations 
require the property to be vacant continuously for at least three 
years. The Treasury Department and the IRS agree that a one-year 
vacancy requirement similar to that imposed under Sec.  1.1394-1(h) 
would spur capital investment into needed areas. However, a three-year 
vacancy period for property that was not vacant at the time of QOZ 
designation will more effectively facilitate such investment while 
alleviating concerns that QOFs and qualified opportunity zone 
businesses would intentionally cease occupying property to convert 
otherwise used property into ``original use'' property.
b. Buildings Located on Brownfield Sites Qualify as ``Original Use'' 
Property
    The Department of the Treasury and the IRS have received several 
comments regarding the application of section 1400Z-2 and the section 
1400Z-2 regulations to brownfield site redevelopment. A ``brownfield 
site'' comprises ``real property, the expansion, redevelopment, or 
reuse of which may be complicated by the presence or potential presence 
of a hazardous substance, pollutant, or contaminant.'' Comprehensive

[[Page 1911]]

Environmental Response, Compensation and Liability Act of 1980, section 
101(39) (42 U.S.C. 9601(39)). The Environmental Protection Agency has 
defined these sites as ``abandoned, idled or under-used industrial and 
commercial facilities where expansion or redevelopment is complicated 
by real or perceived environmental contamination.'' 60 FR 49276 
(September 22, 1995). Cleaning up and reinvesting in these properties 
increases local tax bases, facilitates job growth, utilizes existing 
infrastructure, takes development pressures off of undeveloped, open 
land, and both improves and protects the environment.
    Commenters have recommended that the final regulations contain 
rules to facilitate brownfield redevelopment, particularly rules to 
provide that the real property composing the brownfield site be treated 
as ``original'' use property under section 1400Z-2(d)(2)(D)(i)(II). One 
commenter contended that, because of the degree of contamination 
present in brownfield sites, remediation and construction periods for 
these properties generally extend beyond 30 months. The Treasury 
Department and the IRS agree with this observation, and have included 
rules in the final regulations to adopt the commenters' recommendation. 
Specifically, the final regulations provide that all real property 
composing a brownfield site, including land and structures located 
thereon, will be treated as satisfying the original use requirement of 
section 1400Z-2(d)(2)(D)(i)(II). To alleviate concerns that the 
property purchased will not be remediated, the final regulations also 
provide that the eligible entity must make investments in the 
brownfield site to ensure that the site meets basic safety standards 
for human health and the environment. The final regulations also make 
clear that remediation of contaminated land is taken into account for 
determining if the land has been more than minimally improved, and that 
the QOF or qualified opportunity zone business must make investments 
into the brownfield site to improve its safety and environmental 
standards.
c. Clarification of the Term ``Vacant'' for Purposes of Applying the 
Vacant Property Rules
    The Treasury Department and the IRS received multiple suggestions 
to clarify the meaning of the term ``vacant''. One commenter suggested 
that the definition of the term should be modified to add the phrase 
``substantially unused or substantially vacant.'' For this purpose, the 
commenter recommended that the term ``substantially vacant'' be defined 
to require that greater than 70 percent of the square footage of the 
subject building be unoccupied.
    In addition, commenters suggested that the final regulations define 
the term ``vacant'' in a manner similar to the term under Sec.  1.1394-
1(h). Accordingly, these commenters requested that the final 
regulations include a provision disregarding de minimis, incidental 
uses of property. See Sec.  1.1394-1(h) (providing that ``de minimis 
incidental uses of property, such as renting the side of a building for 
a billboard, are disregarded''). Another commenter suggested that the 
definition of ``vacant'' be revised to allow for clearly delineated 
portions of a larger property to be treated as vacant after five years 
of uninterrupted vacancy, even if the rest of the larger property had 
not been unoccupied.
    One commenter also suggested that property that had involuntarily 
transferred to local government control be included in the definition 
of the term ``vacant.'' This commenter emphasized that local 
governments often acquire brownfield sites and other blighted 
properties through tax delinquency, abandonment, bankruptcy, and other 
similar events. As a result, many local governments hold large 
inventories of vacant properties with varying histories of use. The 
commenter contended that a bright-line treatment of such properties as 
``vacant'' for purposes of the original use requirement will eliminate 
burdens regarding the determination of historical use and, importantly, 
expedite capital investment in properties located in distressed 
communities.
    Several commenters suggested that the final regulations set forth a 
vacancy definition that relies upon vacant property determinations 
carried out by Federal, state, and local governmental authorities 
(including, for example, a local government waiver process to 
demonstrate vacancy). Commenters also suggested that a vacancy 
definition similarly could rely upon vacant property determinations by 
public utilities. In addition, some commenters contended that a vacancy 
definition should take into account a spectrum of factors, including 
the structure of the subject property and the length of time during 
which the property's structure had been significantly damaged or 
otherwise decrepit.
    The Treasury Department and the IRS agree that the final 
regulations should provide a definition for the term ``vacant'' for 
purposes of Sec.  1.1400Z2(d)-1. Under the final regulations, real 
property, including land and buildings, is considered to be in a state 
of vacancy if the property is ``significantly unused.'' A building or 
land will be considered to be ``significantly unused'' under the final 
regulations if more than 80 percent of the building or land, as 
measured by the square footage of useable space, is not being used.
    In addition, the Treasury Department and the IRS appreciate that a 
bright-line test for ``vacancy'' would facilitate the ability for local 
governments to increase capital investment in underused property and 
increase economic activity in their respective communities. As a 
result, the final regulations provide that an eligible entity that 
purchases real property from a local government that the local 
government holds as the result of an involuntary transfer (including 
through abandonment, bankruptcy, foreclosure, or receivership) may 
treat all property composing the real property (including the land and 
structures thereon) as satisfying the original use requirement of 
section 1400Z-2(d)(2)(D)(i)(II).
d. Requests To Require All Vacant Buildings To Be Substantially 
Improved
    Multiple commenters recommended that the final regulations provide 
that no building, regardless of occupancy, be treated as satisfying the 
original use requirement. One commenter also suggested that the final 
regulations (i) require all vacant buildings to be substantially 
improved, and (ii) not permit such buildings to be treated as 
originally used in a QOZ by a QOF or qualified opportunity zone 
business. The Treasury Department and the IRS appreciate the 
commenters' recommendations and suggestions, and agree that the 
improvement of all buildings acquired by a QOF or qualified opportunity 
zone businesses would significantly benefit the QOZs in which such 
buildings are located. However, the Treasury Department and the IRS 
have determined that, by permitting certain buildings to satisfy the 
original use requirement, the final regulations will encourage a larger 
aggregate amount of long-term investments in economically distressed 
communities nationwide.

I. Substantial Improvement of Qualified Opportunity Zone Business 
Property

1. Consideration of Asset-by-Asset Approach and Alternative Approaches
    In the May 2019 proposed regulations, the Treasury Department and 
the IRS requested comments regarding the relative strengths and 
weakness of determining ``substantial improvement'' based on an asset-
by-asset approach, as compared to asset aggregation and similar 
approaches. See 84 FR 18655

[[Page 1912]]

(May 1, 2019). Taxpayers and practitioners have provided numerous 
responses, several of which articulated examples of difficulty in 
applying an asset-by-asset approach--particularly within the context of 
building renovation.
    Many of these commenters requested that the final regulations adopt 
an aggregate approach to determining ``substantial improvement,'' or 
otherwise permit taxpayers to elect such an approach. Similarly, other 
commenters requested that the final regulations permit asset 
aggregation based on (i) asset location within a QOZ, or (ii) whether 
the assets were acquired as part of the same transaction or business 
decision. In contrast, a commenter suggested that the final regulations 
adopt an approach similar to the ``integrated unit approach'' of Sec.  
1.1250-1(a)(2)(ii). See Sec.  1.1250-1(a)(2)(ii) (providing for example 
that, ``if two or more buildings or structures on a single tract or 
parcel (or contiguous tracts or parcels) of land are operated as an 
integrated unit (as evidenced by their actual operation, management, 
financing, and accounting), they may be treated as a single item of 
section 1250 property'').
    The Treasury Department and the IRS also received several 
recommendations to retain the asset-by-asset approach set forth in the 
May 2019 proposed regulations. Commenters that made these suggestions 
generally argued that ``substantially all'' determinations based on an 
asset aggregation approach would encourage businesses to target 
investments narrowly in rigidly defined areas, thereby preventing a 
broader disbursement of capital investment. Such commenters also 
emphasized that, by requiring the basis of each discrete asset to be 
doubled in value, the proposed regulations will ensure a minimum level 
of investment for each qualified asset. Because the asset-by-asset 
approach of the May 2019 proposed regulations prohibits a taxpayer from 
using any excess capital investment in a qualified asset to satisfy the 
``doubling of basis'' requirement for a different asset, commenters 
noted that the total capital investments by a taxpayer often will 
exceed a doubling of the aggregate basis of all of the taxpayer's 
qualified assets.
    Based on the strengths and weaknesses of each of these various 
approaches, the Treasury Department and the IRS have concluded that 
permitting asset aggregation to a limited extent is appropriate for 
carrying out ``substantial improvement'' determinations. Accordingly, 
for example, the final regulations set forth an asset aggregation 
approach for determining whether a non-original use asset (such as a 
preexisting building) has been substantially improved. Under the 
approach adopted by the final regulations, QOFs and qualified 
opportunity zone businesses can take into account purchased original 
use assets that otherwise would qualify as qualified opportunity zone 
business property if the purchased assets (i) are used in the same 
trade or business in the QOZ (or a contiguous QOZ) for which the non-
original use asset is used, and (ii) improve the functionality of the 
non-original use assets in the same QOZ (or a contiguous QOZ). In the 
case of purchased non-original use real property, the final regulations 
require that the purchased property must be improved by more than an 
insubstantial amount. Finally, if an eligible entity chooses to use 
this approach, the purchased property will not be treated as original 
use property, and instead, the basis of that purchased property will be 
taken into account in determining whether the additions to the basis of 
the non-original use property satisfy the requirements of sections 
1400Z-2(d)(2)(D)(i)(II) and 1400Z-2(d)(2)(D)(ii).
    For example, if a QOF purchases and intends to substantially 
improve a hotel, the QOF may include ``original use'' purchased assets 
in the basis of the purchased hotel to meet the substantial improvement 
requirement if those purchased assets are integrally linked to the 
functionality of the hotel business. These ``original use'' purchased 
assets could include mattresses, linens, furniture, electronic 
equipment, or any other tangible property. However, for purposes of the 
substantial improvement requirement, the QOF may not include in the 
basis of that hotel an apartment building purchased by the QOF that is 
operated in a trade or business separate from the hotel business.
2. Aggregation of Certain Buildings To Be Treated as Single Property
    The final regulations also provide that, for purposes of applying 
the substantial improvement requirement, certain buildings can be 
aggregated and treated as a single item of property, as that term is 
used in section 1400Z-2(d)(2)(D)(ii) (single property). Specifically, 
with respect to two or more buildings located within a QOZ or a single 
series of contiguous QOZs (eligible building group) that are treated as 
a single property, the amount of basis required to be added to those 
buildings will equal the total amount of basis calculated by adding the 
basis of each such building comprising the single property and 
additions to the basis of each building comprising the single property 
are aggregated to determine satisfaction of the substantial improvement 
requirement.
    To clarify which buildings may be treated as a single property, the 
final regulations address eligible building groups located entirely 
within a parcel of land described in a single deed, as well as groups 
spanning contiguous parcels of land described in separate deeds. First, 
a QOF or QOZ business may treat all buildings that compose an eligible 
building group and that are located entirely within the geographic 
borders of a parcel of land described in a single deed as a single 
property. In addition, a QOF or QOZ business may treat all buildings 
composing an eligible building group that are located entirely within 
the geographic borders of contiguous parcels of land described in 
separate deeds as a single property to the extent each building is 
operated as part of one or more trades or businesses that meet the 
following three requirements: (1) The buildings must be operated 
exclusively by the QOF or by the qualified opportunity zone business; 
(2) the buildings must share facilities or share significant 
centralized business elements, such as personnel, accounting, legal, 
manufacturing, purchasing, human resources, or information technology 
resources; and (3) the buildings must be operated in coordination with, 
or reliance upon, one or more of the trades or businesses (for example, 
supply chain interdependencies or mixed-use facilities).
3. Inclusion of Substantial Improvement Requirement on Form 8996
    A commenter recommended that the Form 8996 be revised to 
incorporate the substantial improvement requirement. The Treasury 
Department and the IRS appreciate the commenter's suggestion and will 
consider this recommendation during the annual review of Form 8996.
4. Items Includable in Basis of Property for Substantial Improvement 
Requirement
    The Treasury Department and the IRS received multiple comments 
requesting that the final regulations clarify what items are includable 
in a property's basis for purposes of the substantial improvement 
requirement. These commenters emphasized that, while section 1400Z-
2(d)(2)(D)(ii) requires a QOF or a qualified opportunity zone business 
to make additions to the basis of a subject property that exceed an 
amount equal to the initial adjusted basis of that property within a 
30-month

[[Page 1913]]

period, the statute does not specify what items are properly includable 
in that basis. Several of the commenters recommended safe harbors and 
other simplifying rules to limit complexity and increase taxpayer 
certainty regarding the application of the substantial improvement 
requirement.
a. Consideration of Safe Harbor for ``Value Add'' Real Estate Projects
    One commenter recommended that the final regulations include a safe 
harbor for ``value-add'' real estate projects, which ordinarily entail 
significant renovation or redevelopment of a real property to 
significantly increase the price-point of the property. The commenter 
asserted that a property renovated through a value-add project should 
be treated as automatically satisfying the substantial improvement 
requirement due to the significant magnitude of the project. The 
commenter reasoned that, because a value-add project results in a 
transformative modification to the QOZ property, the QOF or qualified 
opportunity zone business should be relieved from undertaking a 
granular analysis and confirmation of project costs for purposes of 
satisfying the substantial improvement requirement. The commenter also 
requested that the final regulations express a general policy that the 
IRS will not challenge a decision by a QOF or qualified opportunity 
zone business to capitalize expenses into basis.
    The Treasury Department and the IRS acknowledge that the 
commenter's recommendation would facilitate the conduct of value-add 
projects in QOZs. However, the Treasury Department and the IRS have 
concluded that value-add projects are similar to other types of 
property renovation projects for which no special safe harbor is 
provided. As a result, the Treasury Department and the IRS have 
determined that no special safe harbor is warranted for value-add 
projects in QOZs, and the final regulations do not incorporate the 
commenter's recommendation.
b. Clarification Regarding Property Previously Placed in Service
    A commenter requested that the final regulations confirm that 
additions to basis of property for purposes of the substantial 
improvement requirement do not include property previously placed in 
service. Under section 1400Z-2, and as reflected in the proposed 
regulations, property already placed in service can meet the 
substantial improvement requirement if the property was not placed in 
service by the QOF. Therefore, the final regulations do not adopt the 
commenter's request.
c. Calculation of Basis by Reference to Pre-Depreciation Adjusted Cost 
Basis
    A commenter requested that, for purposes of the substantial 
improvement requirement, the final regulations permit a QOF or 
qualified opportunity zone business to calculate the basis of the 
subject property by reference to the property's pre-depreciation 
adjusted cost basis. Similarly, another commenter suggested that the 
term ``adjusted basis'' be defined as cost under section 1012. In 
addition, a commenter requested that the final regulations confirm that 
depreciation is not taken into account in determining if a property 
satisfies the substantial improvement requirement.
    The Treasury Department and the IRS disagree with the suggestion 
that, for determining compliance with the substantial improvement 
requirement, taxpayers must use section 1012 cost basis for determining 
the adjusted basis of the property. Section 1400Z-2(d)(2)(D)(ii) 
provides that adjusted basis, not cost basis under section 1012, is the 
appropriate standard to determine if property has been substantially 
improved during the 30-month substantial improvement period. Therefore, 
the final regulations provide that, property has been substantially 
improved when the additions to basis of the property in the hands of 
the QOF exceed an amount equal to the adjusted basis of such property 
at the beginning of such 30-month substantial improvement period in the 
hands of the QOF. The basis, and any additions thereto, are measured on 
the testing dates set forth in section 1400Z-2(d)(1). See part V.O.1.d 
of this Summary of Comments and Explanation of Revisions.
d. Effect of Certain Improvements on Requirements for Qualified 
Opportunity Zone Business Property
    The Treasury Department and the IRS received comments regarding the 
effect of certain improvements on the qualification of tangible 
property as qualified opportunity zone business property. For example, 
a commenter suggested that QOFs and qualified opportunity zone 
businesses should be permitted to treat tangible property purchased 
before December 31, 2017 as qualified opportunity zone business 
property if the QOF or qualified opportunity zone business 
substantially improves the tangible property after that date. In 
addition, several commenters requested that the final regulations 
provide that costs resulting from the creation of intangibles, as well 
as other research and development costs, count for purposes of 
satisfying the Substantial Improvement Requirement.
    The Treasury Department and the IRS have determined that the text 
of section 1400Z-2 does not permit adoption of these suggestions. 
First, section 1400Z-2(d)(2)(D)(i)(I) requires that tangible property 
be acquired after December 31, 2017 to qualify as qualified opportunity 
zone business property. In addition, section 1400Z-2(d)(2)(D)(i)(II) 
requires that substantially improved property must be tangible property 
based on the reference in that provision to section 1400Z-
2(d)(2)(D)(i). Accordingly, the final regulations do not incorporate 
the commenters' recommendations.
5. Clarification of Activities and Expenses That Count as Substantial 
Improvements
    The Treasury Department and the IRS have received several comments 
requesting clarification as to whether certain activities and expenses 
count as substantial improvements for purposes of the substantial 
improvement requirement. In particular, commenters requested 
clarification as to whether ``substantial improvements'' to property 
include (i) equipment installed in a building and used in a trade or 
business, (ii) demolition costs, (iii) reasonable capitalized fees for 
development, (iv) required permits, (v) necessary infrastructure, (vi) 
brownfield site assessment and remediation, (vii) professional fees, 
and (viii) necessary site preparation costs (including remediation and 
utility upgrades). These commenters also requested that the final 
regulations provide additional rules to address the applicability of 
these items with regard to the substantial improvement requirement.
    The Treasury Department and the IRS note that the text of section 
1400Z-2(d)(2)(D)(ii) provides that any cost added to the basis of a 
property improved during the 30-month improvement period will be 
included in determining satisfaction of the substantial improvement 
requirement. As a result, each activity or expense described by the 
commenter will be included in such determination if the cost adds to 
the basis of the subject property. In addition, the Treasury Department 
and the IRS agree that certain expenses with regard to tangible 
property (such as ``betterment'' expenses under Sec.  1.263(a)-
3(j)(1)(i)) are included in the calculation of basis of that property 
for purposes of the substantial improvement requirement, even if those 
expenses are properly chargeable under the Code to the basis

[[Page 1914]]

of the land on which the property is located (which does not need to be 
doubled). As a result, the final regulations permit all capitalized 
costs with respect to the cost of residential rental property to be 
taken into account for determining satisfaction of the substantial 
improvement requirement.
6. Requests for Extensions and Safe Harbors Regarding 30-Month 
Substantial Improvement Period
    The Treasury Department and the IRS have received several comments 
regarding the 30-month substantial improvement period set forth in 
section 1400Z-2(d)(2)(D)(ii), which provides the period during which a 
QOF or qualified opportunity zone business can improve acquired 
tangible property to satisfy the substantial improvement requirement. 
In particular, many commenters recommended that the final regulations 
extend this period to a period not exceeding 60 months in the event 
that (i) the QOF or qualified opportunity zone business encounters a 
delay not within the entity's control, (ii) the land on which the 
property rests requires significant preparation or remediation, or 
(iii) the scale of the project appropriately requires such extended 
period. Another commenter suggested that the final regulations provide 
a phase-based safe harbor, similar to that set forth in Sec.  1.148-
7(e)(1), that would allow a taxpayer to satisfy the substantial 
improvement requirement if the QOF or qualified opportunity zone 
business expended (i) at least 10 percent of the total invested funds 
within 8 months, (ii) at least 50 percent of the total funds within 16 
months, (iii) at least 75 percent of the total funds within 24 months, 
and (iv) 100 percent of the total funds within 30 months.
    The Treasury Department and the IRS note that the commenters' 
suggestions conflict with the statutory text of section 1400Z-
2(d)(2)(D)(ii). That provision explicitly requires that (i) 
improvements be made to tangible property during the 30-month period 
beginning after the date of acquisition of such property, and (ii) the 
measurement for ``substantial improvement'' be based on additions to 
the basis of the subject tangible property, rather than the percentage 
of expended funds. As a result, the final regulations do not adopt the 
commenters' recommended extensions or safe harbors.
7. Safe Harbor for 90-Percent Investment Standard During 30-Month 
Substantial Improvement Period
    One commenter suggested that a QOF or qualified opportunity zone 
business should be deemed to have met the 90-percent investment 
standard throughout the 30-month substantial improvement period. The 
Treasury Department and the IRS appreciate the commenter's 
recommendation and have revised the final regulations to address, in 
large part, the commenter's concern. The final regulations provide 
that, during the 30-month substantial improvement period, eligible 
tangible property in the process of being improved but not yet placed 
into service or used in the trade or business of the QOF or qualified 
opportunity zone business is treated as satisfying the original use 
requirement and substantial improvement requirement. For property to be 
eligible for this safe harbor, there must be a reasonable expectation 
that, not later than the conclusion of the 30-month substantial 
improvement period, the property will be used in a QOZ as part of the 
trade or business of the QOF or qualified opportunity zone business, as 
appropriate. The Treasury Department and the IRS, however, note that a 
QOF's satisfaction of the 90-percent investment standard will be 
measured with regard to all of the QOF's qualified opportunity zone 
property, not just the property being substantially improved.
8. Clarification Regarding Interaction With Substantial Rehabilitation 
Rules
    The Treasury Department and the IRS received a request that the 
final regulations clarify the interaction between the substantial 
improvement requirement and the substantial rehabilitation rules under 
section 42. See section 42(e)(3) (setting forth a minimum expenditure 
threshold that must be satisfied for rehabilitation expenditures to be 
considered sufficient to constitute a rehabilitation project eligible 
for a section 42 credit). The commenter recommended that, with regard 
to projects carried out in conjunction with section 42 credits, the 30-
month substantial improvement period should be subject to the rules for 
substantial rehabilitation under section 42(e). The Treasury Department 
and the IRS continue to consider the interaction of rules governing 
other tax incentives (including credits) with section 1400Z-2 and the 
regulations under section 1400Z-2. As a result, the final regulations 
do not incorporate the commenter's request.
9. Qualification of Land Used for Agriculture or Renewable Energy
    The Treasury Department and the IRS received multiple comments 
regarding the qualification of land used for agriculture or renewable 
energy as qualified opportunity zone business property. To ease 
difficulties in determining qualification, one commenter suggested that 
the final regulations include an option to permit the use of specific 
metrics to calculate the increase of economic activity on unimproved 
land used for agriculture (for example, specific metrics to calculate 
increased economic activity that arises from a conversion of 
agricultural property from pasture to row crops). The commenter stated 
that such clarification would be useful for farmers. Another commenter 
recommended that the final regulations treat land used in agricultural 
activities the same as other tangible business property. Similarly, a 
commenter requested that the final regulations provide a safe harbor to 
alleviate difficulties in determining satisfaction of the substantial 
improvement requirement with regard to farming and biofuel businesses.
    The Treasury Department and the IRS acknowledge that complex and 
fact-specific questions can arise when applying qualified opportunity 
zone business requirements to agricultural and renewable energy 
businesses. However, such complexities result in large part from the 
flexibility that the Treasury Department and the IRS intended to 
instill in those requirements to facilitate the inclusion of diverse 
ranges of businesses in QOZs. To preserve that flexibility, and reduce 
additional complexity that would result from business-specific rules 
and exceptions, the final regulations do not incorporate the 
commenters' suggestions.
10. Application of Substantial Improvement Requirement to Land and 
Buildings Located Thereon
    As provided in Rev. Rul. 2018-29, 2018 I.R.B 45, and the May 2019 
proposed regulations, if land that is within a QOZ is acquired by 
purchase in accordance with section 1400Z-2(d)(2)(D)(i)(I), the 
requirement under section 1400Z-2(d)(2)(D)(i)(II) that the original use 
of tangible property in the QOZ commence with a QOF is not applicable 
to the land, whether the land is improved or unimproved. See proposed 
Sec.  1.1400Z2(d)-1(c)(8)(ii)(B), (d)(4)(ii)(B). Likewise, unimproved 
land located within a QOZ and acquired by purchase in accordance with 
section 1400Z-2(d)(2)(D)(i)(I) is not required to be substantially 
improved within the meaning of section 1400Z-2(d)(2)(D)(i)(II) and 
(d)(2)(D)(ii). The May 2019 proposed regulations, however, provided 
that a QOF or qualified opportunity zone business may not rely on these 
rules if the land is unimproved or minimally improved

[[Page 1915]]

and the QOF or the qualified opportunity zone business purchases the 
land with an expectation, an intention, or a view not to improve the 
land by more than an insubstantial amount within 30 months after the 
date of purchase (insubstantial improvement exception). See proposed 
Sec.  1.1400Z2(d)-1(f).
a. General Applicability of Substantial Improvement Requirement to Land
    The Treasury Department and the IRS received numerous comments 
regarding the proposed application of the substantial improvement 
requirement to land. While commenters expressed general approval 
regarding this proposed approach, several commenters disagreed or 
otherwise suggested revisions or clarifications. For example, multiple 
commenters requested that the final regulations clarify that unimproved 
land is treated as qualified opportunity zone business property. 
Another commenter requested clarification as to whether land held in 
conjunction with substantially improved property could be treated as 
qualified opportunity zone business property even if the land was not 
acquired through a capital contribution or substantially improved. With 
regard to these requests for clarification, the Treasury Department and 
the IRS note that land does not need to meet the original use 
requirement or the substantial improvement requirement to be treated as 
qualified opportunity zone business property. However, land must meet 
all other relevant requirements under section 1400Z-2(d)(2)(D) and the 
section 1400Z-2 regulations.
    In addition, commenters recommended that the final regulations 
subject unimproved land to the substantial improvement requirement to 
ensure that the land will be used productively to encourage economic 
growth in the QOZ in which it is located. The Treasury Department and 
the IRS acknowledge the commenters' recommendations and agree that an 
integral policy of section 1400Z-2 is to encourage the making of 
longer-term investments of new capital into QOZs to enhance economic 
growth and development. However, the Treasury Department and the IRS 
continue to appreciate that ``land is a crucial business asset for 
numerous types of operating trades or businesses aside from real estate 
development, and the degree to which it is necessary or useful for 
taxpayers seeking to grow their businesses to improve the land that 
their businesses depend on will vary greatly by region, industry, and 
particular business.'' 84 FR 18652, 18655 (May 1, 2019). Therefore, the 
Treasury Department and the IRS have concluded that the imposition of a 
substantial improvement requirement on all types of trades or 
businesses for land used in such trades or businesses ``may encourage 
noneconomic, tax-motivated business decisions, or otherwise effectively 
prevent many businesses from benefitting under the opportunity zone 
provisions'' and ``would inject a significant degree of additional 
complexity'' into the final regulations. Id.
b. Eligibility of Naturally Occurring Structures for Substantial 
Improvement
    A commenter requested that the final regulations clarify that 
naturally occurring structures are eligible for substantial improvement 
(including any preservation expenses incurred). The commenter contended 
that the substantial improvement requirement should be determined based 
on the aggregate expenditure made to improve such natural structures. 
In addition, the commenter requested that, with regard to trades or 
businesses in which the value of the land substantially exceeds any 
building thereon, the rationale of Rev. Rul. 2018-29 should apply 
without regard to the value of buildings constructed on the land 
relative to the value of the land (i) provided that the buildings were 
substantially improved, and (ii) taking into account improvements to 
natural structures on the land. The commenter also noted that 
``naturally occurring structures'' should include vegetation (including 
trees and other plants) and water sources (including ponds and 
wetlands).
    The Treasury Department and the IRS appreciate the commenter's 
request for clarity, but note that the proposed regulations did not 
subject land to the substantial improvement requirement. As provided in 
the October 2018 proposed regulations, the Treasury Department and the 
IRS have determined that ``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.'' 83 FR 54279 (October 29, 2018). However, 
the Treasury Department and the IRS agree with the commenter that 
expenditures to improve land and any naturally occurring structures 
located thereon can be taken into account for purposes of the 
requirement that land be improved by more than an insubstantial amount 
under the final regulations.
c. Application of Substantial Improvement Requirement to Land Expected 
To Be Only Insubstantially Improved
    As described previously, proposed Sec.  1.1400Z2(d)-1(f) prohibits 
a QOF or qualified opportunity zone business, in certain instances, 
from relying on rules that except land from the substantial improvement 
requirement. Specifically, such exception does not apply if (i) the 
subject land is unimproved or minimally improved, and (ii) the QOF or 
qualified opportunity zone business purchased the land with an 
expectation not to improve the land by more than an insubstantial 
amount (insubstantial improvement exception). See proposed Sec.  
1.1400Z2(d)-1(f). This rule helps ensure that the QOZ in which such 
land is located receives an appropriate amount of capital investment 
from QOF investors.
    The Treasury Department and the IRS received several comments and 
recommendations regarding the proposed insubstantial improvement 
exception. For example, one commenter recommended that the final 
regulations adopt a two-part test, which would require that (i) the 
subject land be used as a material income-producing factor in the 
section 162 trade or business conducted by the purchaser, and (ii) the 
use of the land be in a different trade or business than the use in the 
hands of the seller, or the purchaser make more than insubstantial 
improvements to the land. Another commenter requested clarification 
that the insubstantial improvement exception be revised to permit 
improvements to be completed after the 30-month substantial improvement 
period. In addition, a commenter requested that the final regulations 
provide that capital investments of at least 20 percent of the total 
cost basis of the subject land made within a 30-month period beginning 
on the acquisition date be deemed to have improved the land by more 
than an insubstantial amount.
    The Treasury Department and the IRS acknowledge that the 
commenters' recommendations would provide additional flexibility for 
investors that acquire unimproved land located within a QOZ. However, 
the Treasury Department and the IRS have determined that the 
commenters' suggested rules likely would reduce overall capital 
investments in low-income communities by either (i) introducing 
significant additional complexity into the final regulations, or (ii) 
relaxing the timing requirements for capital investment for an 
inappropriate duration. As a result, the final

[[Page 1916]]

regulations do not adopt the commenters' recommendations.
    Commenters also recommended that the final regulations limit the 
application of the insubstantial improvement exception solely to land 
the value of which is small in relation to the value of the structures 
on the land. One commenter argued that, with regard to a circumstance 
in which the value of the subject land on which a structure is located 
significantly exceeds the value of the structure, substantially 
improving only the structure should not be considered a genuine 
economic investment in the real property as an aggregate. Similarly, 
multiple commenters requested that the final regulations provide 
additional detail for determining the amount of capital improvement 
necessary to exceed an ``insubstantial amount'', including percentage 
thresholds that would provide a clear amount that needs to be improved. 
Such threshold amounts ranged from 20 percent to 33 percent.
    The Treasury Department and the IRS appreciate the logic of 
comparing the value of the land to the value of any structures on the 
land when considering the proposed insubstantial improvement exception 
for land. However, a rule that makes a distinction between high-value 
land and low-value land properties would disadvantage investors who 
planned to make investments in QOZs with higher land value relative to 
the existing structures on that land. A disproportionate relationship 
between land value and structure value may exist for a variety of 
reasons, many of which do not warrant separate treatment. Moreover, a 
rule that includes the basis of land in the substantial improvement 
calculation could make development prohibitively expensive for some 
QOFs and qualified opportunity zone businesses. Accordingly, the final 
regulations do not distinguish between real property with high or low 
value land in relation to the structures built upon that land in the 
application of the exception to substantial improvement.
    The Treasury Department and the IRS agree with the commenters that 
QOFs and qualified opportunity zone businesses should improve land by 
more than an insubstantial amount. The Treasury Department and the IRS, 
however, decline to assign a specific percentage threshold to the 
concept of insubstantial improvement because an appropriate amount of 
improvement for a particular parcel of land is a highly fact dependent 
inquiry. Instead, the Treasury Department and the IRS will regard 
improvements to the land, such as an irrigation system for a farming 
business or grading of the land with a sufficient nexus to a trade or 
business of the QOF or qualified opportunity zone business, as more 
than an insubstantial amount of improvement. Further, the Treasury 
Department and the IRS view this requirement that land be more than 
insubstantially improved as clarifying the overall requirement that 
land be qualified opportunity zone business property. Thus, the 
proposed rule concerning the qualification of land as qualified 
opportunity zone business property is moved from Sec.  1.1400Z2(d)-1(f) 
to the special rules concerning land and improvements on land in Sec.  
1.1400Z2(d)-2(b)(4)(iv)(C).
d. Severability of Land From Buildings for Purposes of Applying the 
Substantial Improvement Requirement
    A commenter requested that land on which an existing building is 
located, and which is not substantially improved, be severable from the 
existing building for purposes of applying the substantial improvement 
requirement. Specifically, the commenter recommended that such land 
should be treated as qualified opportunity zone business property, if 
(i) the QOF or the qualified opportunity zone business uses or improves 
the land as part of its trade or business, and (ii) the land otherwise 
meets the tests for being qualified opportunity zone business property.
    However, as noted above, the proposed regulations did not subject 
land to the substantial improvement requirement. Instead, the land to 
which the commenter refers would qualify as qualified opportunity zone 
business property if all other requirements set forth in section 1400Z-
2 and the section 1400Z-2 regulations are satisfied (including the 
insubstantial improvement exception). For these reasons, as well as the 
rationale for the insubstantial improvement exception described in part 
V.J.10.c of this Summary of Comments and Explanation of Revisions, the 
final regulations do not adopt the commenter's recommendation.
11. Speculative Land Purchasing
    Several commenters requested that the final regulations provide 
more stringent rules to prevent the acquisition of land for speculative 
investment, as well as increased substantial improvement standards with 
regard to land. These commenters also requested that the final 
regulations clarify that land does not need to be improved more than an 
insubstantial amount if (i) the use of the land is integral to the 
business, and (ii) the land is reasonably expected to generate economic 
activity that was not reasonably expected prior to its purchase. Other 
commenters requested that land have a minimum level of improvement to 
be considered qualified opportunity zone business property. One 
commenter suggested that land should be improved by 33 percent of its 
basis. Another suggested that land that is not improved should not 
count as qualified opportunity zone business property if the value of 
the land does not exceed a certain threshold percentage of the QOF's 
assets.
    The Treasury Department and the IRS appreciate the commenters' 
concerns regarding speculative land purchasing. However, the Treasury 
Department and the IRS have determined that a bright-line standard 
would be inappropriately restrictive because the determination of 
whether such land would qualify as qualified opportunity zone business 
property would require consideration of all relevant facts and 
circumstances. See additional discussion at VII.B of this Summary of 
Comments and Explanation of Revisions. Accordingly, the final 
regulations do not adopt additional rules for speculative land 
purchasing.

J. Transactions Between Qualified Opportunity Zone Businesses

    Proposed Sec.  1.1400Z2(b)-1(c)(10)(i)(A) generally provided that 
the acquisition of a QOF corporation's assets in a qualifying section 
381 transaction is not an inclusion event if the acquiring corporation 
is a QOF within a prescribed period of time after the acquisition. See 
parts III.C and III.D of this Summary of Comments and Explanation of 
Revisions. In turn, proposed Sec.  1.1400Z2(b)-1(d)(1) and (2) provided 
that the holding period for the target QOF stock is ``tacked'' onto the 
holding period of the acquiring QOF stock, and any qualified 
opportunity zone property transferred by the transferor QOF to the 
acquiring QOF in the transaction does not lose its status as qualified 
opportunity zone property solely as a result of the transfer. In 
addition, proposed Sec.  1.1400Z2(b)-1(c)(6)(ii)(C) provided that a 
merger or consolidation of a partnership holding a qualifying 
investment, or of a partnership that holds an interest in such 
partnership solely through one or more partnerships, with another 
partnership in a transaction to which section 708(b)(2)(A) applies is 
not an inclusion event, to the extent section 721 applies. See part 
III.E.1.b of this Summary of Comments and Explanation of Revisions.
    As one commenter observed, however, the proposed regulations did 
not expressly address the merger of a qualified opportunity zone 
business

[[Page 1917]]

corporation with another qualified opportunity zone business 
corporation, or the merger of a qualified opportunity zone business 
partnership with another qualified opportunity zone business 
partnership. Thus, it is unclear whether the successor business would 
be treated as succeeding to the target business's original use of, and 
substantial improvements to, qualified opportunity zone business 
property for purposes of section 1400Z-2(d)(2)(D), and whether the 
QOF's stock or partnership interest in the successor business would be 
treated as acquired ``solely in exchange for cash'' for purposes of 
section 1400Z-2(d)(2)(B) and (C). The commenter recommended that, after 
a merger of qualified opportunity zone businesses, the original use and 
substantial improvement status of the target's property should 
continue, and the QOF's interest in the successor business should be 
considered to have been acquired solely in exchange for cash. Another 
commenter recommended more generally that, when QOFs or qualified 
opportunity zone businesses transact in qualified assets among 
themselves, those assets should retain their status as qualified 
assets, and the transferee QOF or qualified opportunity zone business 
should be afforded a new working capital safe harbor of up to 31 months 
to the extent the transferee intends to inject additional capital with 
respect to the transferred property.
    The Treasury Department and the IRS agree that, if a qualified 
opportunity zone business that is a corporation engages in a 
transaction described in section 381(a)(2) with another qualified 
opportunity zone business, or if a qualified opportunity zone business 
that is a partnership engages in a transaction described in section 
708(b)(2)(A) with another qualified opportunity zone business, the 
original use and substantial improvement status of the transferor 
business's property should continue, and the QOF's interest in the 
successor business should be considered to have been acquired solely in 
exchange for cash. The final regulations have been modified 
accordingly. See Sec. Sec.  1.1502-14Z and 1.1504-3 for special rules 
applicable to consolidated groups.
    However, the Treasury Department and the IRS do not agree that a 
successor qualified opportunity zone business or a successor QOF should 
be afforded a new 31-month working capital safe harbor because such a 
rule would be patently inconsistent with treating the entity as a 
``successor'' for other purposes, such as original use. The Treasury 
Department and the IRS also do not agree that a qualified asset should 
retain its status as such if it is transferred from one QOF or 
qualified opportunity zone business to another QOF or qualified 
opportunity zone business in a transaction not described in section 
381(a)(2) or section 708(b)(2)(A) because the transferee in such 
transactions is not a ``successor'' to the transferor.

K. Operation of Section 1397C Requirements Incorporated by Reference

1. 50-Percent Gross Income Requirement
    Section 1397C(b) sets forth eight requirements that a corporation 
or partnership must satisfy to qualify as a ``qualified business 
entity'' and therefore an ``enterprise zone business.'' Section 1400Z-
2(d)(3)(A), which describes the requirements that a trade or business 
must satisfy to qualify as a ``qualified opportunity zone business,'' 
incorporates paragraphs (2), (4), and (8) of section 1397C(b)(2). See 
section 1400Z-2(d)(3)(A)(ii). With regard to gross income, section 
1397C(b)(2) requires that ``at least 50 percent of the total gross 
income of such entity is derived from the active conduct of such 
business.''
    The Treasury Department and the IRS interpret section 1400Z-
2(d)(3)(A)(ii)'s incorporation of section 1397C(b)(2) to require that a 
corporation or partnership, in order to qualify as a qualified 
opportunity zone business, must derive at least 50 percent of its total 
gross income from the active conduct of a trade or business within 
``a'' QOZ (50-percent gross income requirement). In response to 
commenters' requests for clarification, the May 2019 proposed 
regulations provided three safe harbors and a facts-and-circumstances 
test for determining whether a trade or business in a QOZ has generated 
sufficient income to satisfy the 50-percent gross income requirement. 
The Treasury Department and the IRS requested comments regarding those 
proposed safe harbors, including suggestions for additional safe 
harbors and revisions to the proposed rules to prevent abuse.
a. Satisfaction of 50-Percent Gross Income Requirement Through 
Activities in Multiple QOZs
    The Treasury Department and the IRS have received comments 
requesting clarification that a trade or business can satisfy the 50-
percent gross income requirement by aggregating activities carried out 
by the trade or business in multiple QOZs. Specifically, commenters 
emphasized that the proposed regulations, in numerous instances, 
referenced a trade or business ``within the QOZ'' rather than ``within 
a QOZ.'' These commenters asserted that the use of the word ``the'' 
could be interpreted as requiring that 50 percent of the total gross 
income from a trade or business (as well as a startup business relying 
on an applicable safe harbor) be derived from activities carried out 
solely within a single QOZ.
    The Treasury Department and the IRS did not interpret the 50-
percent gross income requirement as requiring a trade or business to 
carry out all activities necessary to satisfy the requirement in only 
one QOZ. Give the purpose of section 1400Z-2 to encourage economic 
growth in all QOZs, the Treasury Department and the IRS intended 
taxpayers and practitioners to apply the 50-percent gross income 
requirement by aggregating all activities of a trade or business 
carried out among all QOZs in which the trade or business operates. As 
a result, the final regulations have been revised to clarify that 
intended interpretation.
b. Requirement That Activities of Trade or Business Be Carried Out in a 
QOZ
    The Treasury Department and the IRS also received comments 
suggesting that the 50-percent gross income requirement does not 
require a qualified opportunity zone business to generate 50 percent of 
its total gross income from the active conduct of its business ``in a 
qualified opportunity zone.'' As stated in the preamble of the May 2019 
proposed regulations, the phrase ``such business'' in section 
1397C(b)(2) refers to a business mentioned in the preceding sentence, 
which discusses ``a qualified business within an empowerment zone.'' 
See 84 FR 18652, 18658 (May 1, 2019). In applying section 1397C to 
section 1400Z-2, references in section 1397C to ``an empowerment zone'' 
are treated as referring to a QOZ. See id. Therefore, the final 
regulations do not adopt this comment, but rather provide that the 
corporation or partnership must derive at least 50 percent of its total 
gross income from the active conduct of a business within a QOZ.
2. Services Performed in a QOZ Based on Hours and Amounts Paid for 
Services
    The May 2019 proposed regulations provided that, if at least 50 
percent of the services performed for the trade or business are 
performed in a QOZ, based on (i) total number of hours performed by 
employees and independent contractors and employees of independent 
contractors in a QOZ (hours performed test), or (ii) amounts paid to 
employees and independent

[[Page 1918]]

contractors and employees of independent contractors in a QOZ (amounts 
paid test), then the trade or business is deemed to satisfy the 50-
percent gross income requirement. See proposed Sec.  1.1400Z2(b)-
1(d)(5)(i)(A) (setting forth the hours performed test), (d)(5)(i)(B) 
(setting forth the amounts paid test). As provided in the preamble to 
the May 2019 proposed regulations, the hours performed test is intended 
to address businesses located in a QOZ that primarily provide services. 
See 84 FR 18652, 18658 (May 1, 2019). In addition, the preamble 
explained that the amounts paid test is based upon amounts paid by the 
trade or business for services performed in the QOZ during the taxable 
year by employees and independent contractors, and employees of 
independent contractors. See id.
a. Calculations and Recordkeeping for Hours Performed and Amounts Paid 
Tests
    The Treasury Department and the IRS received comments requesting 
clarification on how to calculate and track ``hours worked'' and 
``amounts paid'' for purposes of the hours performed test and the 
amounts paid test. For example, some commenters highlighted 
difficulties in distinguishing employees from independent contractors. 
In particular, a commenter asked whether a trade or business is 
required to include hours worked by, or payments made to, third-party 
accountants, lawyers, or investment bankers in determining whether 
those safe harbors have been met. Commenters also criticized the 
inclusion of independent contractors and employees of independent 
contractors, as unreasonable for the hours performed test and amounts 
paid test because newer businesses, which may be unable to hire full 
time employees, might not be able to require independent contractors to 
work primarily in QOZs.
    The Treasury Department and the IRS appreciate the commenters' 
requests and suggestions. With regard to determining satisfaction of 
the hours performed test and amounts paid test, a majority of the 
services performed (measured by hours worked or amounts paid) must be 
provided by employees and independent contractors, and employees of 
independent contractors, in a QOZ for the trade or business. These 
calculations do not take into account hours worked by, or amounts paid 
to, independent contractors and their employees for services that are 
not performed for the qualified opportunity zone business.
    With regard to recordkeeping, the Treasury Department and the IRS 
have determined that taxpayers and practitioners should be afforded 
flexibility rather than be encumbered by rigid tracking requirements. 
However, the Treasury Department and the IRS expect qualified 
opportunity zone businesses to maintain adequate records and implement 
sound processes to track hours worked by and amounts paid to employees, 
independent contractors, and employees of independent contractors for 
purposes of the hours performed and amounts paid tests. Further, the 
classification of an employee as opposed to an independent contractor 
must be determined based upon all relevant facts and circumstances 
under the applicable common law standard and all relevant provisions of 
the Code and general principles of tax law.
b. Clarification Regarding Services Provided by Partners in a 
Partnership
    Commenters requested that the final regulations clarify that hours 
worked by, and amounts paid to, partners in a partnership that provide 
services to the partnership's trade or business count towards 
satisfying the hours performed test and amounts paid test. In 
particular, these commenters emphasized that such partners constitute 
neither employees nor independent contractors of the subject trade or 
business. As a result, the commenters noted that such hours worked, and 
amounts paid, were not specifically covered by either safe harbor.
    The Treasury Department and the IRS agree that hours worked by, and 
amounts paid to, partners in a partnership for services provided to the 
partnership's trade or business should be taken in account for the 
hours performed and amounts paid tests. Therefore, the final 
regulations adopt the commenter's suggestion. In order to ensure that 
amounts paid to partners are for services provided to the trade or 
business of the partnership, the final regulations provide that 
guaranteed payments for services (within the meaning of section 707(c)) 
to a partner are the only amounts that will be taken into account for 
the amounts paid test.
c. Clarification Regarding Services Provided by Partners in a 
Partnership
    Some commenters criticized the hours performed test and amounts 
paid test based on the commenters' view that neither test is 
sufficiently stringent. These commenters encouraged the Treasury 
Department and the IRS to combine all three safe harbors into one 
conjunctive, three-prong approach to provide a better measure of 
overall business activity occurring within a QOZ. Commenters also 
requested that the operative threshold be raised from 50 percent of 
hours worked and amounts paid to 75 percent to ensure that the 
residents of the QOZ sufficiently benefit from the economic activity 
created by the QOF investments.
    The Treasury Department and the IRS appreciate the policy concerns 
underlying the commenters' recommendations. However, the Treasury 
Department and the IRS have determined that the hours performed test 
and amounts paid test strike an appropriate balance between (i) 
ensuring economic activity is created in a QOZ (that is, by requiring 
that at least half of the services performed, determined by hours or 
amounts paid, be performed in a QOZ), and (ii) providing operating 
businesses with appropriate flexibility to expand and provide services 
outside of a QOZ. Therefore, the final regulations do not adopt these 
comments.
3. Clarification Regarding the Application of the Business Functions 
Test
    In addition to the hours performed test and the amounts paid test, 
the May 2019 proposed regulations provided a ``business functions 
test.'' Under that test, a trade or business satisfies the 50-percent 
gross income requirement if each of (i) the tangible property of the 
trade or business located in a QOZ, and (ii) the management or 
operational functions performed in the QOZ, are necessary for the 
generation of at least 50 percent of the gross income of the trade or 
business (business functions test). See proposed Sec.  1.1400Z2(b)-
1(d)(5)(i)(C) (setting forth the business functions test). The May 2019 
proposed regulations requested comments on the business functions test. 
See 84 FR 18652, 18659 (May 1, 2019).
    In response, the Treasury Department and the IRS received several 
comments requesting that the final regulations clarify the application 
of the business functions test. Many commenters emphasized that the 
business functions test fails to provide clearly the manner by which to 
determine when an asset generates income, as well as which managerial 
and operational staff are necessary for the generation of income. 
Commenters requested that the final regulations clarify (i) the meaning 
of the term ``operational functions,'' and (ii) the method for tracing 
income generated from tangible property and managerial or operational 
functions in the QOZ. Also, a commenter highlighted that

[[Page 1919]]

administrative ``back office'' functions are necessary functions for 
the generation of income, although administrative tasks may not be as 
intrinsically related to the operation of the trade or business.
    In addition, a commenter requested that the final regulations 
provide additional guidance regarding mobile workforces and portable 
assets. The commenter noted that the May 2019 proposed regulations set 
forth an example involving a business with a mobile workforce and 
portable assets that returned to the business' headquarters on a daily 
basis, but the example does not address a situation in which the 
tangible assets of the business are almost entirely located in a QOZ at 
all times, but the business is operated by a workforce which may be 
remote, mobile, or shared with other businesses. See proposed Sec.  
1.1400Z2(b)-1(d)(5)(i)(E)(1), 84 FR 18652, 18659 (May 1, 2019). The 
commenter noted that the example does not clearly indicate whether an 
employee's activities outside of a QOZ, even while performing key 
operational roles inside of a QOZ, would cause their work not to be 
treated as an ``operational function'' that is ``necessary'' for the 
generation of the business' gross income. The commenter requested that 
the final regulations describe what is meant by management or 
operational functions and whether management functions, operational 
functions, and the location of tangible property are similarly weighted 
when applying the business functions test.
    Commenters also noted that the business functions test could 
encourage businesses to bring high-skilled, high-income workers into a 
QOZ, but may not encourage businesses to create jobs for lower-skilled 
residents of the QOZ. Commenters requested additional examples 
describing what may or may not meet the business functions test, 
particularly within the context of fixed assets that are managed or 
operated by service providers, some of which are physically located 
outside of a QOZ.
    The Treasury Department and the IRS appreciate the commenters' 
request for clarity regarding the application of the business functions 
test. Based on comments received, the Treasury Department and the IRS 
have determined that the business functions test would present an 
achievable and readily applicable safe harbor for businesses that are 
headquartered in a QOZ and for which the bulk of business activity 
occurs in a QOZ. However, the Treasury Department and the IRS 
acknowledge that businesses with unconventional management and 
operational structures, as well as tangible property located both 
inside and outside of a QOZ, would benefit from additional guidance. 
For those difficult cases, the Treasury Department and the IRS continue 
to study the commenters' request for clarification regarding the 
business functions test and may consider providing additional rules and 
examples through guidance published in the Internal Revenue Bulletin.

L. Requirement To Use Substantial Portion of Intangible Property in a 
Trade or Business

    Section 1400Z-2(d)(3) provides that a qualified opportunity zone 
trade or business must satisfy the intangible property requirement set 
forth in section 1397C(b)(4). Section 1400Z-2(d)(3)'s incorporation of 
section 1397C(b)(4) requires that, with respect to any taxable year, a 
substantial portion of the intangible property of a qualified 
opportunity zone business must be used in the active conduct of a trade 
or business within the QOZ (intangible property use test). However, 
section 1397C does not provide a definition for the term ``substantial 
portion.'' To provide additional certainty for determinations regarding 
whether a substantial portion of intangible property is used in the 
active conduct of a trade or business within a QOZ, the May 2019 
proposed regulations provided that the term ``substantial portion'' 
means at least 40 percent of the intangible property of the qualified 
opportunity zone business. See proposed Sec.  1.1400Z2(b)-1(d)(5)(ii), 
84 FR 18652, 18659 (May 1, 2019).
1. Clarification Regarding Determinations of Location and ``Use'' of 
Intangible Property
    The Treasury Department and the IRS received comments requesting 
that the final regulations clarify the methods for determining the 
location and ``use'' of intangible property. Commenters contended that 
any uncertainty with regard to those determinations could discourage 
qualified opportunity zone businesses from developing and using 
intangible property. These commenters suggested that the Treasury 
Department and the IRS should consider a number of relevant factors for 
determining the location and use of intangible property, including (i) 
where a business provides services or has customers, (ii) where the 
business' tangible assets are located, (iii) how and where the business 
is marketed, and (iv) the geographic scope of the legal rights to use 
the intangible property.
    One commenter suggested that, with regard to ``use,'' a 
determination based on both gross revenue and the location in which 
such revenue is earned would be appropriate. For example, the commenter 
contended that an active trade or business that uses intangible 
property both inside and outside a QOZ should undertake a comparison of 
gross revenues derived inside the QOZ as well as outside the QOZ. Some 
commenters suggested that the final regulations adopt a rule similar to 
the safe harbors used for the 50-percent gross income test which would 
be based on the location of a business' employees or tangible property 
located within a QOZ. A commenter noted that a rule that ties ``use'' 
to tangible property or employees would help prevent abusive situations 
and ensure that economic activity occurs within a QOZ.
    Commenters also suggested methods for determining the situs of 
intangible property. Commenters noted that, for state property law 
purposes, the location of intangible property generally is treated as 
the location at which the owner of that property is located. These 
commenters asserted that such a determination might be difficult in 
situations in which a business owner has locations both inside and 
outside of a QOZ. For example, if a business has a management and 
operations headquarters in a QOZ, and a technology research and 
development facility located outside of a QOZ, commenters expressed 
uncertainty regarding how to determine or measure the location of the 
business' intangible property. Another commenter suggested that the 
final regulations provide a rule or rebuttable presumption that 
connects the situs of an intangible property to a tangible property 
located within a QOZ if the portion of tangible property that is used 
for a trade or business inside the QOZ corresponds to the portion of 
intangible property deemed to be used inside the QOZ. This commenter 
also noted that a rule providing that an intangible property's location 
depends upon a tangible property's location could undercut the 
requirement for substantial use of intangible property in the QOZ.
    The Treasury Department and the IRS appreciate the commenters' 
concerns regarding determinations of location and ``use'' of intangible 
property for purposes of applying the intangible property use test. To 
increase certainty in making such determinations, the final regulations 
provide that intangible property of a qualified opportunity zone 
business is used in the active conduct of a trade or business in a QOZ 
if the following two requirements are

[[Page 1920]]

satisfied. First, the use of the intangible property must be normal, 
usual, or customary in the conduct of the trade or business. In 
addition, the intangible property must be used in the QOZ in the 
performance of an activity of the trade or business that contributes to 
the generation of gross income for the trade or business.
2. Consideration of 40-Percent Threshold for Use of Intangible Property
    Commenters generally agreed with the 40-percent threshold for 
defining the minimum level of use necessary to satisfy the section 
1397C(b)(4) requirement that a substantial portion of intangible 
property be used in a QOZ. However, some commenters asserted that the 
threshold percentage should be increased to more effectively prevent 
abuse. Commenters highlighted the potential for abusive transactions 
involving intangible property, noting that intangible property is 
highly mobile, may appreciate significantly in value, and is not 
subject to the same restrictions that apply to tangible property under 
section 1400Z-2(d)(2)(D) (regarding qualified opportunity zone business 
property). These commenters suggested that the final regulations apply 
anti-abuse rules similar to those set forth in section 1400Z-2(d)(2)(D) 
to the use by a trade or businesses of intangible property.
    The final regulations adopt the 40-percent threshold for 
determining whether a ``substantial portion'' of the intangible 
property of a qualified opportunity zone business is used in the trade 
or business in a QOZ. After considering the concerns of commenters 
regarding potential abuses involving intangible property, the Treasury 
Department and the IRS have determined that the 40-percent threshold 
requires an appropriately substantial amount of intangible property to 
be used in a QOZ. In addition, the Treasury Department and the IRS have 
determined that a 40-percent threshold will provide appropriate 
flexibility for trades and businesses to expand and operate outside of 
a QOZ.
3. Clarification Regarding Reference to ``Such Business'' in Section 
1397C(b)(4)
    A commenter requested clarification regarding whether an 
intellectual property holding company can be a qualified opportunity 
zone business in light of section 1397C(d)(4), which excludes any trade 
or business the activities of which consist predominantly of developing 
or holding intangibles for sale or license. This commenter noted that 
section 1397C(b)(4) provides the following condition: ``a substantial 
portion of the intangible property of such entity is used in the active 
conduct of any such business.'' The commenter requested that the final 
regulations confirm whether the use of ``such business'' in section 
1397(b)(4) incorporates the qualified business definition set forth in 
section 1397C(d).
    As provided in the preamble to the May 2019 proposed regulations, 
the Treasury Department and the IRS addressed a similar question with 
regard to section 1397C(b)(2), which provides that, in order to be a 
``qualified business entity'' (in addition to other requirements found 
in section 1397C(b)) with respect to any taxable year, a corporation or 
partnership must derive at least 50 percent of its total gross income 
``from the active conduct of such business.'' See 84 FR 18652, 18658 
(May 1, 2019). As noted in that preamble, the phrase ``such business'' 
refers to a business mentioned in the preceding sentence, referring to 
section 1397C(b)(1), which discusses ``a qualified business within an 
empowerment zone.'' See id. The preamble goes on to state that for 
purposes of applying section 1400Z-2, references in section 1397C to 
``an empowerment zone'' are treated as meaning a qualified opportunity 
zone. Therefore, section 1400Z-2 does not incorporate the concept of 
``qualified business'' within an empowerment zone under section 
1397C(d), but instead reads ``such business'' in section 1397C(b)(2) 
and (4) to refer to ``a business within a qualified opportunity zone.'' 
As a result, the Treasury Department and the IRS have concluded that 
the exception set forth in section 1397C(d)(4) has no application with 
respect to the qualification of an intellectual property holding 
company as a qualified opportunity zone business.

M. Limitation on Nonqualified Financial Property of Qualified 
Opportunity Zone Business

    Section 1400Z-2(d)(3) incorporates section 1397C(b)(8), which 
limits the portion of the qualified opportunity zone business' assets 
that may be held in nonqualified financial property (NQFP) to less than 
five percent of the average of the aggregate unadjusted bases of the 
property of the entity in a taxable year (five-percent NQFP 
limitation). Section 1397C(e) defines the term ``nonqualified financial 
property'' as debt, stock, partnership interests, options, futures 
contracts, forward contracts, warrants, notional principal contracts, 
annuities, and other similar properties. However, section 1397C(e) 
excludes from that definition reasonable amounts of working capital 
held in cash, cash equivalents, or debt instruments with a term of 18 
months or less.
1. Consideration of Industry-Specific Revisions to Five-Percent NQFP 
Limitation
    The Treasury Department and the IRS received several 
recommendations that the final regulations tailor the five-percent NQFP 
limitation to provide flexibility for certain industries. For example, 
several commenters expressed a general concern that ordinary-course 
transactions in the real estate sector may be prohibited by the 
definition of NQFP. One commenter noted that the definition of NQFP may 
cover commonplace items such as leases with prepaid or front-loaded 
rent that are treated in part as loans, prepaid expenses, prepaid 
development fees, and options to acquire property. The commenter 
requested that (i) the definition of NQFP provide exceptions for the 
aforementioned items, and (ii) the five-percent NQFP limitation be 
revised to exclude commonplace real estate transactions. For support, 
the commenter asserted that the definition of NQFP creates a trap for 
the unwary and that the five-percent NQFP limitation was not intended 
to prevent qualified opportunity zone businesses from engaging in the 
ordinary-course real estate transactions that develop QOZs.
    The Treasury Department and the IRS also received comments 
requesting similar revisions to the five-percent NQFP limitation to 
accommodate other industries. For example, a commenter requested that 
insurance company general account assets be excluded from the 
definition of NQFP. The commenter emphasized that insurance companies 
are required to invest a significant portion of their assets in 
financial property to satisfy obligations to policy holders. By not 
excluding insurance companies from the five-percent NQFP limitation, 
the commenter reasoned that the section 1400Z-2 regulations would 
prevent insurance companies from being qualified opportunity zone 
businesses.
    The Treasury Department and the IRS acknowledge the concerns raised 
by the commenters. However, sections 1400Z-2(d)(3)(A)(ii) and 
1397C(b)(8) provide a clear statutory definition of NQFP and an equally 
clear limitation on the percentage of NQFP that a qualified opportunity 
zone business may own. As a result, the final regulations do not adopt 
the commenters' recommended

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revisions to the five-percent NQFP limitation.
2. Consideration of Special Rules To Facilitate the Use of Tax-Exempt 
Municipal Bonds
    Several commenters stressed the importance of adequate 
infrastructure for the economic development of a QOZ, and the critical 
role of tax-exempt municipal bonds in the financing of infrastructure 
projects. These commenters recommended that the final regulations 
provide favorable treatment for municipal bonds used to finance new or 
improve existing infrastructure projects located within a QOZ. In 
particular, these commenters recommended that the final regulations 
treat municipal bonds essentially as qualified opportunity zone 
property in which a QOF would be eligible to invest. Further, these 
commenters recommended that the final regulations treat municipal bonds 
as property that would not be treated as NQFP in the hands of an entity 
seeking to qualify as a qualified opportunity zone business. In support 
of these recommendations, a commenter highlighted that two-thirds of 
all domestic infrastructure projects are financed by municipal bonds. 
This commenter reasoned that, if the final regulations were not to 
remove municipal bonds from the definition of NQFP, infrastructure 
developments that might otherwise occur would not be financed.
    The Treasury Department and the IRS recognize the significant need 
for additional investment in public infrastructure in QOZs, and that 
expanded debt and equity tax incentives could facilitate such increased 
investment. In addition, the Treasury Department and the IRS 
acknowledge that municipal bonds provide an important source of 
financing for infrastructure projects. However, section 1400Z-2(d) does 
not contemplate direct investments in municipal bonds as qualifying 
property for QOFs. Municipal bonds, which are intangible debt 
instruments, cannot qualify under the statutory categories of qualified 
opportunity zone property because municipal bonds are neither (i) 
equity in a qualified opportunity zone business nor (ii) a tangible 
asset that is qualified opportunity zone business property. A QOF could 
make a direct equity investment in tangible property that meets the 
definition of qualified opportunity zone business property, and the 
property also may have municipal bond financing (for example, a private 
water facility financed with tax-exempt private activity bonds under 
section 142 of the Code). Further, if held by a qualified opportunity 
zone business, municipal bonds generally constitute NQFP and can 
qualify for the reasonable working capital safe harbor only in limited 
circumstances in which the bonds have a term of 18 months or less. For 
the foregoing reasons, the Treasury Department and the IRS decline to 
adopt the recommendations of these commenters regarding municipal bond 
investments.
3. Consideration of Special Rules To Facilitate Tiered Entity 
Structures
    The Treasury Department and the IRS have received several comments 
regarding the application of sections 1400Z-2(d)(3)(A)(ii) and 
1397C(b)(4) to groups of related corporations and partnerships 
structured to conduct integrated qualified opportunity zone businesses. 
In particular, several commenters expressed concern that the text of 
section 1397C(e) prohibits qualified opportunity zone businesses from 
owning operating subsidiaries due to the inclusion of stock and 
partnership interests in the statutory definition of NQFP. However, one 
commenter contended that Congress clearly intended the statute only to 
prevent qualified opportunity zone businesses from owning publicly 
traded securities that are passive investments, rather than prevent the 
ownership of operating subsidiaries. Accordingly, the commenter 
recommended that the definition of NQFP be clarified to prohibit 
actively traded personal property for purposes of Sec.  1.1092(d)-1, 
but not equity interests in operating subsidiaries.
    Similarly, other commenters requested that all requirements for a 
qualified opportunity zone business under section 1400Z-2(d)(3) 
(including the five-percent NQFP limitation) be applied to an entire 
group that conducts an integrated business. These commenters asserted 
that an entity-by-entity test would not be appropriate because such 
integrated businesses often are organized by entity-specific functions 
that, in the view of the commenters, would distort the intended 
application of the five-percent NQFP limitation. For example, an 
integrated business carried out by a holding corporation that owns all 
of the equity interests in an operating subsidiary and a treasury 
subsidiary might comply with the five-percent NQFP limitation if tested 
in the aggregate, even though the treasury subsidiary, tested on its 
own, would exceed that limitation.
    The Treasury Department and the IRS agree that section 1400Z-
2(d)(3) should be applied in a manner that permits flexibility to 
taxpayers in structuring and conducting qualified opportunity zone 
businesses. However, with regard to the five-percent NQFP limitation, 
sections 1397C(b)(8) and 1397C(e) clearly provide that (i) less than 
five percent of the average of the aggregate unadjusted bases of the 
property of the subject entity, rather than any group of related 
entities, must be attributable to NQFP, and (ii) the definition of the 
term ``nonqualified financial property'' includes stock and partnership 
interests. As a result, the final regulations do not adopt a group-
based test for purposes of the five-percent NQFP limitation.
    In addition, the final regulations do not adopt a group-based 
approach for testing the remaining requirements for a qualified 
opportunity zone business under section 1400Z-2(d)(3). The Treasury 
Department and the IRS have determined that an inconsistent application 
of the requirements for qualified opportunity zone business 
qualification would significantly increase the complexity of the final 
regulations and create potential traps for unwary taxpayers. In 
addition, the Treasury Department and the IRS note that these section 
1400Z-2(d)(3) requirements (including the five-percent NQFP limitation) 
can be applied on a group basis with regard to a qualified opportunity 
zone business that owns interests in function-specific entities 
disregarded as separate from their owner for Federal income tax 
purposes.

N. Trade or Business of a Qualified Opportunity Zone Business

1. Significance of Trade or Business Concept in Section 1400Z-2
    Section 1400Z-2(d)(2)(D)(i) and (d)(3)(A)(i) require that qualified 
opportunity zone business property be tangible property used in the 
trade or business of a QOF or qualified opportunity zone business. 
Under section 1400Z-2(d), both QOFs and qualified opportunity zone 
businesses must meet ``substantially all'' property requirements. For 
QOFs, at least 90 percent of the qualified entity's property must be 
qualified opportunity zone property, which includes qualified 
opportunity zone stock and qualified opportunity zone partnership 
interests (that is, the 90-percent investment standard). For qualified 
opportunity zone businesses, at least 70 percent of the qualified 
entity's property must be qualified opportunity zone business property 
(that is, the 70-percent tangible property standard). In addition, 
section 1400Z-2(d)(3)(A)(ii) imposes an additional requirement on 
qualified opportunity zone businesses but not on QOFs. Under this 
requirement, at least

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50 percent of the total gross income of a qualified entity must be 
derived from the active conduct of a trade or business within a QOZ 
(that is, the 50-percent gross income requirement).
2. Proposed Definition Based on a ``Trade or Business'' Under Section 
162
    The October 2018 proposed regulations contained the term ``active 
conduct of a trade or business'' in several provisions. See proposed 
Sec.  1.1400Z2(d)-1(d)(5). Following the publication of that proposal, 
the Treasury Department and the IRS received comments asking whether 
future guidance would define the phrase ``active conduct of a trade or 
business'' for purposes of section 1400Z-2. Commenters also expressed 
concern that the leasing of real property by a qualified opportunity 
zone business may not amount to the active conduct of a trade or 
business if the business has limited leasing activity.
    With regard to the term ``trade or business,'' the May 2019 
proposed regulations set forth a definition for QOFs and qualified 
opportunity zone businesses that referenced section 162 of the Code. 
See 84 FR 18652, 18659 (May 1, 2019). See also Sec.  1.1400Z2(d)-
1(c)(4)(ii) (regarding QOFs); Sec.  1.1400Z2(d)-1(d)(2)(ii) (regarding 
qualified opportunity zone businesses). Section 162(a) permits a 
deduction for ordinary and necessary expenses paid or incurred in 
carrying on a trade or business. Because neither the Code nor the 
regulations define the meaning of a ``trade or business'' under section 
162, courts have established requirements to determine the existence of 
a trade or business. The Supreme Court has set forth a two-pronged 
test, providing that, ``to be engaged in a trade or business, the 
taxpayer must be involved in the activity with continuity and 
regularity and that the taxpayer's primary purpose for engaging in the 
activity must be for income or profit.'' Commissioner v. Groetzinger, 
480 U.S. 23, 25 (1987). With respect to the requirement that the 
activity must be engaged for income or profit, the Court has expressly 
provided that section 162 qualification ``requires only an intent to 
earn an economic profit.'' Portland Golf Club v. Commissioner, 497 U.S. 
154, 164, 169 (1990) (citing Commissioner v. Groetzinger for the 
Court's observation that it ``has ruled that a taxpayer's activities 
fall within the scope of [section] 162 only if an intent to profit has 
been shown'').
3. Application of Section 162 Trade or Business Standard to Start-Up 
Businesses
    While commenters agreed that section 162 provides an appropriate 
standard for trade or business qualification under section 1400Z-
2(d)(2)(D)(i) and (d)(3)(A)(i), many noted significant uncertainties in 
applying the section 162 standard to a trade or business of a QOF or 
qualified opportunity zone business that does not expect to generate 
profits immediately. In general, these commenters have noted that QOF 
property used in a start-up business cannot qualify as qualified 
opportunity zone property unless the start-up business that utilizes 
such property qualifies as a section 162 trade or business. With regard 
to QOFs that hold an equity interest in a newly formed partnership or 
corporation organized for the purpose of being a qualified opportunity 
zone business, commenters have questioned how section 162 would apply 
if the partnership or corporation experiences a start-up phase of 
significant duration. See section 1400Z-2(d)(2)(B)(i)(II) and 
(d)(2)(C)(ii). With regard to qualified opportunity zone businesses, 
commenters similarly have expressed uncertainty regarding the 
qualification of a start-up business as a qualified opportunity zone 
business if the start-up business has not yet matured to a trade or 
business under section 162.
a. Comments Suggesting Safe Harbors for Start-Up Businesses
    To provide certainty to current and potential investors of start-up 
businesses in QOZs, commenters suggested a variety of safe harbors. 
These suggestions included (1) a grace period for a QOF to use tangible 
property in a trade or business to satisfy the 90-percent investment 
standard, as well as (2) a provision similar to that under Sec.  1.45D-
1(d)(4)(iv) in the New Markets Tax Credit regulations that treats an 
entity as engaged in the active conduct of a trade or business if, at 
the time an investment is made, there is a reasonable belief that the 
entity will generate revenues during the subsequent three-year period. 
To support the addition of a safe harbor for start-ups, commenters 
correctly noted that section 1400Z-2 contemplates the start-up phase of 
a trade or business. Sections 1400Z-2(d)(2)(B)(i)(II) and 
(d)(2)(C)(ii), as discussed previously, reference newly formed 
partnerships and corporations organized for the purpose of being a 
qualified opportunity zone business. In addition, commenters 
highlighted section 1400Z-2(d)(2)(D)(ii), which provides QOFs 30 months 
to improve tangible property acquired for use in a QOF's trade or 
business to meet the substantial improvement requirement.
b. Comments Requesting Clarifications and Simplifying Rules for Start-
Up Businesses
    Commenters also requested that the final regulations provide a 
number of clarifications or simplifying rules. For example, commenters 
requested clarification on whether the conduct of a section 162 trade 
or business must have begun by the conclusion of a working capital safe 
harbor period in situations in which the plan underlying the 
development of the trade or business contemplates the utilization of 
multiple contributions to which a working capital safe harbor would 
otherwise apply. Another commenter requested that the final regulations 
include an example to clarify that the conduct of a trade or business 
would be required only upon the conclusion of all working capital safe 
harbors carried out as components of a single integrated plan. 
Consistent with that request, commenters contended that many types of 
business ventures, to achieve qualification as a section 162 trade or 
business, require start-up periods in excess of a single 31-month 
working capital safe harbor period.
    With regard to simplifying rules, a commenter suggested that the 
final regulations treat the development of a section 162 trade or 
business as a qualifying section 162 trade or business, regardless of 
whether the operations that constitute the trade or business have 
actually begun. Other commenters requested clarification that the 
ongoing development of real estate constitutes the active conduct of a 
trade or business even if rent or other revenues are not yet being 
collected. Similarly a commenter suggested that the final regulations 
treat a QOF as engaged in a trade or business under section 162 even if 
the subject business activity had generated no income. Another 
commenter suggested that the ``active conduct'' requirements set forth 
in paragraphs (2) and (4) of section 1397C(b) should not be treated as 
applying to section 1400Z-2(d)(3)(A)(ii).
c. Creation of New 62-Month Working Capital Safe Harbor for Start-Up 
Businesses
    The Treasury Department and the IRS appreciate the commenters' 
concerns and recommendations regarding the application of the section 
162 trade or business standard to start-up businesses. To provide 
taxpayers with

[[Page 1923]]

straightforward and responsive rules, the Treasury Department and the 
IRS have created an additional 62-month safe harbor for start-up 
businesses (62-month working capital safe harbor). Unlike the 31-month 
working capital safe harbor, this start-up-focused safe harbor 
addresses each qualified opportunity zone business requirement, other 
than the ``sin business'' prohibition under section 1400Z-
2(d)(3)(A)(iii).
    As set forth in the final regulations, the 62-month working capital 
safe harbor provides that, during the maximum 62-month covered period, 
(1) NQFP in excess of the five-percent NQFP limitation will not cause a 
trade or business to fail to qualify as a qualified opportunity zone 
business, and (2) gross income earned from the trade or business will 
be counted towards satisfying the 50-percent gross income requirement 
(each of clauses (1) and (2) function in a manner similar to the 31-
month working capital safe harbor). In addition, the 62-month working 
capital safe harbor provides that, during the maximum 62-month covered 
period, (i) tangible property purchased, leased, or improved by a 
business with cash covered by a working capital safe harbor, pursuant 
to the plan submitted with respect to that safe harbor, will count 
towards satisfaction of the 70-percent tangible property standard, and 
(ii) intangible property purchased or licensed with that cash, and 
pursuant to that plan, likewise will count towards the satisfaction of 
the 40-percent intangible property use test.
    To qualify for a maximum 62-month safe harbor period, a start-up 
business must receive multiple cash infusions during its start-up 
phase. Specifically, under the 62-month working capital safe harbor, a 
start-up business can qualify for a 31-month safe harbor period with 
respect to the business' first cash infusion. Upon receipt of a 
subsequent contribution of cash (subsequent cash infusion), the 
business can both (i) extend the original 31-month safe harbor period 
that covered the initial cash infusion, and (ii) receive safe-harbor 
coverage for the subsequent cash contribution for a maximum 31-month 
period, if the business satisfies the following two conditions. First, 
the subsequent cash infusion must be independently covered by an 
additional working capital safe harbor. Second, the working capital 
safe harbor plan for the subsequent cash infusion must form an integral 
part of the working capital safe harbor plan that covered the initial 
cash infusion.
    To ensure the proper application of the 62-month working capital 
safe harbor, the final regulations also provide additional operating 
rules. For example, the final regulations make clear that, regardless 
of the number of subsequent cash infusions, the 62-month working 
capital safe harbor cannot extend past the 62 month-period beginning on 
the date of the first cash infusion covered by the safe harbor (for 
example, a subsequent cash infusion received 60 months after the date 
of the first cash infusion will be covered by the 62-month working 
capital safe harbor for only two months). In addition, the 62-month 
working capital safe harbor features a minimum investment threshold for 
each subsequent cash infusion to ensure that a de minimis subsequent 
infusion does not unlock a subsequent 31-month period for previously 
covered tangible and intangible property. The final regulations also 
provide that tangible property covered by the 62-month working capital 
safe harbor plan is not considered qualified opportunity zone business 
property for purposes of the special rule in section 1400Z-2(d)(3)(B).
4. Expansion of 30-Month Substantial Improvement Period
    The October 2018 proposed regulations provided a 30-month 
substantial improvement period of tangible property for purposes of 
applying the substantial improvement requirement. Under that proposal, 
tangible property is treated as substantially improved by a QOF or 
qualified opportunity zone business 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 or qualified 
opportunity zone business 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 or qualified opportunity zone business. See proposed Sec.  
1.1400Z2(d)-1(c)(8) (setting forth the requirement with regard to 
QOFs); proposed Sec.  1.1400Z2(d)-1(d)(4) (setting forth the 
requirement with regard to qualified opportunity zone businesses). The 
May 2019 proposed regulations provided that the term trade or business 
means a trade or business within the meaning of section 162, for both 
QOFs and qualified opportunity zone businesses, and requested comments 
on whether additional clarification or guidance was needed.
    Several commenters pointed out that the proposed regulations are 
unclear regarding the treatment of tangible property during the 30-
month substantial improvement period for a QOF and a qualified 
opportunity zone business that is not utilizing 31-month working 
capital safe harbor. Commenters noted that the proposed regulations do 
not clarify whether non-original use tangible property undergoing a 
substantial improvement process will be treated as qualified 
opportunity zone business property during the 30-month substantial 
improvement period. A commenter noted that just as startup businesses 
have difficulty satisfying the ``used in a trade or business 
requirement'' found in section 1400Z-2(d)(2)(D)(i), a QOF or qualified 
opportunity zone business generally will not be able to use tangible 
property in a section 162 trade or business during a 30-month 
substantial improvement period.
    Another commenter requested a new safe harbor for work in progress, 
applicable to both QOFs and qualified opportunity zone businesses, 
unrelated to the working capital safe harbor. The commenter noted that 
some projects do not need working capital and that, without an 
additional safe harbor, projects not utilizing the working capital safe 
harbor would fail to qualify as qualified opportunity zone business 
property during the 30-month substantial improvement period. The 
commenter requested that assets held for work in progress be treated as 
qualified opportunity zone business property for the 90-percent 
investment standard found in section 1400Z-2(d)(1) (and the property be 
treated as used in a trade or business) during the substantial 
improvement period, if certain criteria are met.
    The Treasury Department and the IRS recognize that QOFs are 
ineligible to utilize the benefits of the working capital safe harbor 
since the requirements found in paragraphs (2), (4), and (8) of section 
1397C(b) are not applicable to QOFs, and that not all qualified 
opportunity zone businesses will be able to utilize the working capital 
safe harbor for a variety of reasons. Therefore, the final regulations 
provide that for QOFs and qualified opportunity zone businesses, 
tangible property purchased, leased, or improved by a trade or business 
that is undergoing the substantial improvement process but has not been 
placed in service or used in a trade or business by the QOF or 
qualified opportunity zone business is treated as used in a trade or 
business and satisfies the requirements of section 1400Z-2(d)(2)(D)(i) 
for the 30-month substantial improvement period with respect to that 
property. In order to receive such treatment, the QOF or qualified 
opportunity zone business

[[Page 1924]]

must reasonably expect that the property will be substantially 
improved, as defined in section 1400Z-2(d)(2)(D)(ii), and used in a 
trade or business in the QOZ by the end of the 30-month substantial 
improvement period.
5. Consideration of Excluding Real Estate Speculation From the 
Definition of ``Trade or Business''
    A commenter suggested that the final regulations modify the 
definition of the term ``trade or business'' to specifically exclude 
real estate speculation. The commenter asserted that real estate 
speculation on projects carried out within QOZs presents a significant 
potential for abuse, and reasoned that a specific exclusion of real 
estate speculation from the definition of ``trade or business'' would 
eliminate such potential. The Treasury Department and the IRS 
appreciate the concern raised by the commenter, but note that the final 
regulations address real estate speculation abuse by requiring that 
land (1) be more than insubstantially improved and (2) be used in the 
trade or business of a QOF or qualified opportunity zone business. 
Accordingly, the final regulations do not adopt the commenter's 
recommendation.
6. Consideration of Triple-Net-Leases for Active Conduct a Trade or 
Business Requirement
    Proposed Sec.  1.1400Z2(d)-1(d)(5)(ii)(B)(2) provided that, solely 
for the purposes of determining whether a trade or business qualified 
as a qualified opportunity zone business, the ownership and operation, 
including leasing, of real property qualifies as an active conduct of a 
trade or business. The proposed rule, however, provided that merely 
entering into a triple-net-lease with respect to real property owned by 
a taxpayer does not constitute an active conduct of a trade or business 
by such taxpayer. See proposed Sec.  1.1400Z2(d)-1(d)(5)(ii)(B)(2) 
(second sentence). The Treasury Department and the IRS determined that, 
solely for purposes of determining qualified opportunity zone business 
qualification, triple-net-leases constitute inappropriately passive 
activities similar to holding publicly traded stock or securities.
a. Comments Suggesting Special Definitions for ``Triple-Net-Lease''
    In general, commenters requested additional guidance regarding the 
meaning of the term ``triple net lease'' for purposes of applying 
proposed Sec.  1.1400Z2(d)-1(d)(5)(ii)(B)(2). Several commenters 
suggested that the final regulations define the term ``triple-net-
lease'' as a lease in which the tenant, in addition to rent and 
utilities, pays the tenant's proportionate share of the taxes, 
insurance, maintenance, and other fees for the property leased. 
Multiple commenters recommended that a triple-net-lease of a taxpayer 
be defined to constitute an active conduct of a trade or business if 
the taxpayer meaningfully participates in the management or operations 
of the trade or business of the lessee. Similarly, another commenter 
requested that the final regulations define a triple-net-lease to 
exclude arrangements pursuant to which a taxpayer retains contractual 
responsibility for meaningful capital obligations or meaningful 
operating obligations. The commenter indicated that an obligation to 
maintain certain structural or operating systems of a building would 
qualify as a meaningful capital obligation, while obligations to 
provide cleaning or grounds-keeping services would qualify as 
meaningful operating obligations.
b. Comments Suggesting Active Trade or Business Qualification Based on 
Section 162 Case Law
    Another commenter recommended that the final regulations adopt a 
rule based on case law under section 162 to determine whether a triple-
net-lease qualifies as the active conduct of a trade or business. 
According to the commenter, the case law under section 162 allows a 
deduction for ordinary and necessary expenses paid or incurred in 
carrying on any trade or business related to a triple-net-lease if the 
landlord, or an employee, agent, or contractor of the landlord, 
performs the services related to the taxes, maintenance, insurance, and 
similar fees even though the landlord receives payment for these 
services from the tenant. Therefore, the commenter suggested that a 
triple-net-lease in which the landlord, or an employee, agent, or 
contractor of the landlord, performs these services should qualify as 
the active conduct of a trade or business, regardless of which party 
ultimately bears the cost for these services.
c. Comments Suggesting Special Rules for Active Trade or Business 
Qualification
    Commenters also recommended that the final regulations provide 
special rules for determining whether a taxpayer entering into a 
triple-net-lease with respect to real property owned by a taxpayer 
constitutes an active conduct of a trade or business by such taxpayer. 
For example, a commenter contended that a triple-net-lease qualify as 
the active conduct of a trade or business if (1) the underlying 
property meets the test under the original use requirement or the 
substantial improvement requirement, and (2) assuming all other 
requirements are met, qualifies as qualified opportunity zone business 
property. For support, the commenter highlighted the May 2019 proposed 
regulations, which provided that leased property can qualify as 
qualified opportunity zone business property to a tenant that is a QOF 
or a qualified opportunity zone business. This commenter reasoned that, 
because leased property would be qualified opportunity zone business 
property to a tenant notwithstanding the fact that the property was 
subject to a triple-net-lease, it could also be qualified opportunity 
zone business property to the landlord. Therefore, under the 
commenter's reasoning, a lessor's participation in a triple-net-lease 
could constitute the active conduct of a trade or business.
    Commenters also recommended that lessor participation in certain 
arrangements that utilize the rehabilitation tax credit under section 
47 of the Code should qualify as an active conduct of a trade or 
business. In such arrangements, a landlord owns a building that is the 
subject of a rehabilitation project. The landlord acquires the 
property, obtains permits and approvals, assembles the development 
team, raises the funds necessary to develop the property, and places 
the rehabilitated structure into service. After that initial phase, the 
landlord leases the building to a tenant, who may further lease the 
property to a subtenant. The landlord transfers the rehabilitation tax 
credits to the original tenant pursuant to section 50(d)(5). The 
commenter noted that this arrangement between the landlord and the 
original tenant may constitute a triple-net-lease. As a result, the 
commenter recommended that the final regulations adopt a rule to 
provide specifically that such arrangements constitute the active 
conduct of a trade or business.
d. Comments Suggesting Triple-Net-Leases Qualify as an Active Trade or 
Business
    However, other commenters disagreed with the premise of proposed 
Sec.  1.1400Z2(d)-1(d)(5)(ii)(B) that merely entering into a triple-
net-lease for property owned by a taxpayer does not constitute the 
active conduct of a trade or business. Several commenters noted that 
triple-net-leases cause capital to enter a QOZ and provide property for 
use in trades or businesses within the QOZ. These commenters also

[[Page 1925]]

emphasized that landlords and tenants often prefer triple-net-lease 
arrangements, as opposed to employing a separate property manager or 
agent of the landlord, because tenants often are better positioned to 
control and maintain the leased property. Accordingly, the commercial 
real estate industry widely employs triple-net-leasing.
e. Revisions to Proposed Triple-Net-Lease Rule for Active Trade or 
Business Qualification
    The Treasury Department and the IRS appreciate the comments and 
recommendations received with respect to triple-net-leases. In general, 
the final regulations confirm that merely entering into a triple-net-
lease with respect to real property owned by a taxpayer does not 
constitute the active conduct of a trade or business by such taxpayer. 
To illustrate the application of this rule, the final regulations set 
forth examples describing a triple-net-lease as a lease arrangement 
pursuant to which the tenant is responsible for all of the costs 
relating to the leased property (for example, paying all taxes, 
insurance, and maintenance expenses) in addition to paying rent. In an 
instance in which the taxpayer's sole business consists of a single 
triple-net-lease of a property, the final regulations confirm that the 
taxpayer does not carry out an active trade or business with respect to 
that property solely for purposes of section 1400Z-2(d)(3)(A).
    The Treasury Department and the IRS agree with commenters that, in 
certain cases, a taxpayer that utilizes a triple-net-lease as part of 
the taxpayer's leasing business could be treated as conducting an 
active trade or business solely for purposes of section 1400Z-
2(d)(3)(A). Accordingly, the final regulations provide an example in 
which a lessor leases a three-story mixed-use building to three 
tenants, each of which rents a single floor. In that example, (i) the 
lessor leases one floor of the building under a triple-net-lease, but 
leases the remaining two floors under leases that do not constitute 
triple-net-leases, and (ii) the employees of the lessor meaningfully 
participate in the management and operations of those two floors. As a 
result, the example provides that the lessor is treated as carrying out 
an active trade or business with respect to the entire leased building 
solely for purposes of section 1400Z-2(d)(3)(A).

O. Safe Harbor for Reasonable Amounts of Working Capital

    The October 2018 proposed regulations provided a 31-month 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 a QOZ (31-month working capital safe 
harbor). See proposed Sec.  1.1400Z2(d)-1(d)(5)(iv); 83 FR 54279, 54284 
(October 29, 2018). 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 held by the business are 
treated as reasonable in amount under sections 1397C(b)(2) and 1400Z-
2(d)(3)(A)(ii) for a period of up to 31 months. See id. To qualify, the 
qualified opportunity zone business (1) must have a written plan that 
identifies the financial property as property held for the acquisition, 
construction, or substantial improvement of tangible property in the 
QOZ, (2) must have a written schedule consistent with the ordinary 
business operations of the business that the property will be used 
within 31 months, and (3) must substantially comply with the schedule. 
See id.
    The May 2019 proposed regulations provided revisions to the 31-
month working capital safe harbor in response to comments. First, the 
May 2019 proposal modified the rule requiring a written designation for 
planned use of working capital to include the development of a trade or 
business in the QOZ as well as acquisition, construction, and/or 
substantial improvement of tangible property. See proposed Sec.  
1.1400Z2(d)-1(d)(5)(iv)(A); 84 FR 18652, 18659 (May 1, 2019). Second, 
the May 2019 proposal provided that exceeding the 31-month period does 
not violate the 31-month working capital safe harbor if the delay is 
attributable to waiting for government action the application for which 
is completed during the 31-month period. See proposed Sec.  
1.1400Z2(d)-1(d)(5)(iv)(C); 84 FR 18652, 18659 (May 1, 2019). The May 
2019 proposed regulations also clarified that a business may benefit 
from multiple overlapping or sequential applications of the working 
capital safe harbor, provided that each application independently 
satisfies all of the requirements in proposed Sec.  1.1400Z2(d)-
1(d)(5)(iv)(A) through (C) (multiple safe harbor rule). See proposed 
Sec.  1.1400Z2(d)-1(d)(5)(iv)(D).
1. Additional Guidance Regarding Reasonable Delays to Toll the 31-Month 
Working Capital Safe Harbor
    The Treasury Department and the IRS have received several comments 
and requests for additional guidance regarding delays relating to 
governmental action, as well as delays arising from a variety of other 
events. With regard to applying proposed Sec.  1.1400Z2(d)-
1(d)(5)(iv)(C), one commenter requested confirmation as to whether a 
delay attributable to governmental action, the application for which is 
completed during the 31-month period, means that (i) the governmental 
action must be pending at the end of the 31-month period or (ii) a 
waiting period for governmental action at any time ``stops the clock'' 
on the 31-month period (and therefore the waiting period is added at 
the end of the 31-month period). The commenter noted that, in certain 
instances, a governmental action might be completed predictably within 
a relatively short period of time, and therefore automatic tolling 
might provide an overly generous result. Another commenter, however, 
emphasized that the governmental permitting guidelines regarding 
natural resource projects lack predictable completion timeframes 
because such projects often require the receipt of several state and 
local permits that are subject to various timelines. As a result, this 
commenter requested that the 31-month period be tolled to accommodate 
successive permits in a circumstance in which the business has received 
the first serious of permits that initially tolled the 31-month period.
    Commenters also recommended that the final regulations provide 
that, in additional to delays resulting from governmental action, 
certain events outside of a business' control will toll the 31-month 
working capital safe harbor. For example, several commenters requested 
that events delaying the 31-month period include, among other 
occurrences, severe weather conditions, natural disasters, labor 
stoppages, financing delays, and supply shortages. Another commenter 
requested that trades or businesses receive an extension of the 31-
month period to account for delays arising from the cleanup of a 
brownfield site due because the cleanup of such a site ordinarily will 
require other lengthy regulatory approval from states and local 
governments.
    The Treasury Department and the IRS acknowledge the concerns raised 
by the commenters. In many ordinary-course instances, however, 
applicants can

[[Page 1926]]

obtain governmental permits through a routine process of predictable 
duration. The Treasury Department and the IRS continue to expect a 
qualified opportunity zone business, to the maximum extent practicable, 
to take any actions during the governmental permitting period that are 
necessary for the improvement of tangible property subject to the 31-
month working capital safe harbor. Therefore, with regard to instances 
in which governmental delay does not pose a substantial obstacle for 
improving such tangible property, a tolling of the 31-month period 
would not be appropriate.
    The Treasury Department and the IRS have determined that the 31-
month working capital safe harbor should be tolled in certain 
instances, however, and have clarified and expanded the scope of 
proposed Sec.  1.1400Z2(d)-1(d)(5)(iv)(C). In general, the final 
regulations make clear that, if a governmental permitting delay has 
caused the delay of a project covered by the 31-month working capital 
safe harbor, and no other action could be taken to improve the tangible 
property or complete the project during the permitting process, then 
the 31-month working capital safe harbor will be tolled for a duration 
equal to the permitting delay. In such case, the final regulations 
require that the permit for the governmental action was completed 
during the 31-month period. The final regulations also provide that, if 
a project that otherwise meets the requirements of the 31-month working 
capital safe harbor is located within a QOZ designated as a part of a 
Federally declared disaster area (as defined in section 165(i)(5)(A)), 
the qualified opportunity zone business may receive up to an additional 
24 months to consume its working capital assets, provided the project 
is delayed due to that disaster.
2. Clarification Regarding Overlapping or Sequential Applications of 
the 31-Month Working Capital Safe Harbor
    The Treasury Department and the IRS received several comments and 
requests for clarification regarding the multiple safe harbor rule. In 
particular, commenters questioned whether a successive application of 
the 31-month working capital safe harbor can occur for the same piece 
of tangible property, given that multiple 31-month harbor periods can 
be utilized for that same piece of tangible property. These commenters 
contended that a successive application of the 31-month working capital 
safe harbor would appropriately accommodate practical realities of 
improving tangible property in a trade or business (such as ordinary 
course-improvement projects that typically require durations in excess 
of 31 months).
    The Treasury Department and the IRS confirm that a qualified 
opportunity zone business may string together subsequent or overlapping 
working capital safe harbors with respect to the same tangible 
property. Accordingly, the final regulations specifically provide that 
a qualified opportunity zone business may choose to apply subsequent 
31-month working capital safe harbors for a maximum 62-month period 
(that is, a duration equal to two working capital safe harbor periods), 
provided that each 31-month period satisfies the requirements for 
applying a 31-month working capital safe harbor. To qualify for a 
subsequent 31-month working capital safe harbor period, (i) working 
capital subject to an expiring 31-month period must be expended in 
accordance with each requirement set forth in the section 1400Z-2 
regulations, and (ii) the subsequent infusions of working capital must 
form an integral part of the plan covered by the initial 31-month 
working capital safe harbor.
3. Treatment of Tangible Property Not Used Upon Conclusion of a 31-
Month Working Capital Safe Harbor
    Commenters also noted that, although the May 2019 proposed 
regulations expanded the 31-month working capital safe harbor to 
include the development of a trade or business, the proposal failed to 
clarify the application of the safe harbor regarding situations in 
which the qualified opportunity zone business does not use the tangible 
property in the QOZ by the end of the 31-month period. For example, 
commenters requested that the final regulations describe circumstances 
in which a business that uses a contribution of working capital during 
a 31-month period, but does not use the tangible property in a trade or 
business in the QOZ by the end of the 31-month period, may continue to 
be covered by the 31-month working capital safe harbor. These 
commenters asserted that such a business should continue to receive 
coverage by the safe harbor if, based on a consideration of the 
relevant facts and circumstances, the business diligently and 
reasonably continues to develop the trade or business and uses the 
tangible property in a trade or business in the QOZ within a reasonable 
period of time.
    Another commenter suggested that the final regulations provide a 
rebuttable assumption that all working capital that will be expended by 
the business has been expended before each testing date, including 
future tranches of working capital that, as part of the working capital 
plan, will be used to substantially improve or construct new property 
in a QOZ. Similarly, a commenter suggested that the final regulations 
provide that, if a trade or business receives serial capital 
contributions under a common written plan, the trade or business must 
use cash equal to the first capital contribution within 31 months, but 
is not required to use 70 percent of its tangible property in the QOZ 
by the end of the 31-month period associated with the first capital 
contribution. In addition, a commenter suggested that the 31-month 
working capital safe harbor be revised to provide that the 70-percent 
tangible property standard would not be applied until all working 
capital has been expended and the substantially improved (or new) 
property is placed in service by the business in the QOZ.
    The Treasury Department and the IRS appreciate the commenters' 
suggestions and requests for clarification, and have included 
additional guidance in the final regulations. In general, the final 
regulations permit a qualified opportunity zone business to treat 
tangible property for which working capital covered by the 31-month 
working capital safe harbor is expended as (i) used in the trade or 
business of the qualified opportunity zone business, and (ii) qualified 
opportunity zone business property throughout the period during which 
such working capital is covered by the safe harbor. The final 
regulations make clear that such improvements must be made pursuant to 
the written plan governing the expenditure of the working capital 
assets. In addition, the tangible property subject to such improvements 
must be used in a trade or business, within the meaning of section 162, 
of the qualified opportunity zone business by the end of the 31-month 
working capital safe harbor. The final regulations also clarify that 
unexpended amounts of working capital covered by the 31-month working 
capital safe harbor are not, following the conclusion of the final safe 
harbor period, treated as tangible property for purposes of applying 
the 70-percent tangible property standard.
4. Consideration of Special Debt-Financed Safe Harbor for QOFs and 
Qualified Opportunity Zone Businesses
    A commenter requested that the final regulations provide a new safe 
harbor to cover debt-financed work-in-progress projects that (i) would 
operate in addition to the 31-month working capital safe harbor, and 
(ii) could be

[[Page 1927]]

applied by QOFs and qualified opportunity zone businesses. For support, 
the commenter emphasized that many construction projects are debt 
financed and would not be covered by the 31-month working capital safe 
harbor during the construction period. Accordingly, the absence of a 
debt-financed safe harbor would complicate the ability to carry out 
construction projects within QOZs.
    The commenter suggested that, if certain requirements were met, the 
final regulations should provide that (i) assets held for work-in-
progress construction projects be treated as qualified opportunity zone 
business property during the construction period, and (ii) the QOF or 
qualified opportunity zone business be treated as engaged in a section 
162 trade or business. Requirements suggested by the commenter for this 
safe harbor included (1) mandatory increases to the basis of the trade 
or business in the qualified opportunity zone business property by a 
prescribed multiple during the 31-month period, (2) periodic 
certification requirements during the construction period, and (3) 
continuous and diligent construction by the trade or business until the 
completion of project and the placed-in-service date of the subject 
building. Upon such date, the commenter suggested that the final 
regulations retroactively treat (i) the work-in-progress property as 
qualified opportunity zone business property, and (ii) the trade or 
business as engaged in a section 162 trade or business beginning on the 
first day of the investment by the QOF in the trade or business and 
throughout the project's construction period.
    The Treasury Department and the IRS appreciate the commenter's 
recommendation and are sympathetic to the commenter's concern regarding 
the existing business practice of using debt to finance construction. 
However, section 1397C(e) clearly treats as NQFP any debt with a term 
greater than 18 months. Based on the text of section 1397C(e), the 
final regulations do not adopt the commenter's request to provide a 
special safe harbor for debt-financed construction projects.
5. Consequence of Failure To Qualify for a 31-Month Working Capital 
Safe Harbor
    The Treasury Department and the IRS received comments requesting 
clarification with regard to the consequences that would result if a 
trade or business fails to satisfy the requirements for a 31-month 
working capital safe harbor, including the imposition of penalties. In 
general, if a qualified opportunity zone business fails to satisfy the 
conditions for applying a 31-month working capital safe harbor, then 
the qualified opportunity zone business must satisfy the requirements 
of section 1400Z-2 and the 1400Z-2 regulations for qualifying as a 
qualified opportunity zone business in the absence of the safe harbor. 
Such failure could cause a QOF to fail to satisfy the 90-percent 
investment standard, which would result in penalties to the QOF as 
provided under section 1400Z-2 and the section 1400Z-2 regulations.
P. Real Property Straddling QOZ and Non-QOZ Census Tracts
    To determine whether a QOZ is the location of services, tangible 
property, or business functions for purposes of satisfying the 
requirements of section 1400Z-2(d)(3)(A)(ii), proposed Sec.  
1.1400Z2(d)-1(d)(5)(viii) provided that section 1397C(f) applies, 
substituting the term ``QOZ'' for the term ``empowerment zone'' in each 
instance in which the term ``empowerment zone'' appears. In addressing 
the circumstance in which a business owns real property that is located 
in more than one census tract, only one of which is a QOZ, proposed 
Sec.  1.1400Z2(d)-1(d)(5)(viii) provided that if (1) the amount of real 
property based on square footage located within the QOZ is substantial 
as compared to the amount of real property based on square footage 
outside of the QOZ (square footage test); and (2) the real property 
outside of the QOZ is contiguous to part or all of the real property 
located inside the QOZ, then all of the property is deemed to be 
located within a QOZ.
1. Consideration for Eliminating Proposed Square Footage Test
    Several commenters praised the Treasury Department and the IRS for 
allowing real property that straddles census tracts to be treated as 
located within a QOZ for purposes of determining whether the QOZ should 
be treated as the location of services, tangible property, or business 
functions. However, one commenter suggested that the proposed square 
footage test be eliminated. The commenter reasoned that only property 
located entirely within the geographic borders of a QOZ should be 
treated as within a QOZ because section 1400Z-2 was enacted to increase 
investment and business activity in QOZ, rather than non-QOZ census 
tracts. That commenter further contended that, if the proposed square 
footage test were to be finalized, at least 75 percent of the square 
footage or value of the property should be located in the QOZ, with an 
allocation of capital gains and profits to the property located within 
the QOZ.
    The Treasury Department and the IRS decline to adopt the 
commenter's recommendations. With regard to the commenter's suggestion 
to eliminate the proposed square footage test, the Treasury Department 
and the IRS note that parcels of real property commonly extend across 
census tract lines, particularly in highly populated areas. As a 
result, the Treasury Department and the IRS have determined that 
guidance addressing such situations would provide flexibility for 
potential investors in QOZs, and therefore is consistent with the 
underlying policy of section 1400Z-2. Based on the same rationale for 
providing appropriate flexibility to QOF investors and encourage 
additional investment within QOZs, the Treasury Department and the IRS 
decline to adopt the commenter's suggestion to require that at least 75 
percent of the square footage or value of the real property be located 
in the QOZ in order for real property to be treated as wholly located 
within the QOZ.
2. Clarification Regarding Applicability of the Unadjusted Cost Test
    A number of commenters noted that the preamble to the May 2019 
proposed regulations set forth an unadjusted cost test, rather than the 
square footage test, to determine whether property that straddles QOZ 
and non-QOZ census tracts would be treated as located within a QOZ 
(unadjusted cost test). See 84 FR 18652, 18658 (May 1, 2019) (setting 
forth the unadjusted cost test); proposed Sec.  1.1400Z2(d)-
1(d)(5)(viii) (setting forth the square footage test). These commenters 
highlighted the relative strengths of each of these tests, and the 
flexibility afforded by multiple approaches for taxpayers with land 
that straddles QOZ and non-QOZ census tracts. The Treasury Department 
and the IRS acknowledge that both tests would provide helpful guidance 
such taxpayers and accordingly have revised the final regulations to 
include both the square footage test and the unadjusted cost test.
3. Consideration of Revisions to the Square Footage Test and the 
Unadjusted Cost Test and Additional Safe Harbors
    The Treasury Department and the IRS received numerous comments and 
recommendations regarding the square footage test and the unadjusted 
cost basis test, including rules that would govern the application of 
such tests in certain circumstances. For example, one commenter 
suggested that, with regard to real property acquired as a single

[[Page 1928]]

parcel, the final regulations should apply the unadjusted cost test and 
set forth a presumption that unadjusted cost is allocated based on the 
area of the real property located inside, as compared to outside, the 
QOZ. In applying this presumption to buildings, however, the commenter 
suggested that the final regulations should apply the square footage 
test.
    The Treasury Department and the IRS also received several 
recommendations regarding appropriate thresholds for the safe harbor 
tests. For instance, one commenter requested that the final regulations 
provide a rule to treat real property located in a QOZ as substantial, 
as compared to real property located outside of a QOZ, if more than 50 
percent of the total square footage of real property is located inside 
of the QOZ. Another commenter suggested that the percentage of property 
located in a QOZ should be increased to at least 75 percent of the 
total square footage of the property. A third commenter suggested that 
the final regulations provide a safe harbor to treat real property 
located within a QOZ as substantial if more than 50 percent of the real 
property is located in the QOZ, as measured by square footage, 
unadjusted cost, fair market value, or other types of quantitative 
measures. The commenter indicated that such quantitative measures might 
reference the occurrence of business activities conducted on the 
portion of the real property located inside of the QOZ that are 
integral to the business activities conducted on the portion of real 
property located outside of the QOZ.
    The Treasury Department and the IRS have determined that the square 
footage test and the unadjusted cost test provide appropriate levels of 
flexibility for owners of property that straddles QOZ and non-QOZ 
census tracts. While adoption of the commenters' recommendations would 
increase the degree of guidance available to owners of such parcels, 
the Treasury Department and the IRS have concluded that the complexity 
resulting from adoption of these recommendations would outweigh their 
intended benefits. As a result, the final regulations do not adopt the 
commenters' recommendations.
4. Requested Clarification for Applying the Unadjusted Cost Test to 
Leased Property
    One commenter requested clarification in applying the unadjusted 
cost test to leased property. Under proposed Sec.  1.1400Z2(d)-
1(d)(3)(ii)(B)(3), to determine the value of tangible property owned by 
a qualified opportunity zone business for purposes of the 70-percent 
tangible property standard, the unadjusted cost basis of the property 
under section 1012 may be used. For tangible property leased by a 
qualified opportunity zone business to meet the requirements of section 
1400Z-2(d)(3)(A)(i), a taxpayer may use the methodology in proposed 
Sec.  1.1400Z2(d)-1(d)(3)(ii)(B)(4). Because the unadjusted cost of 
real property may be used to determine whether property located inside 
of a QOZ is substantial relative to property located outside of a QOZ, 
the commenter requested clarification on which method to use.
    The Treasury Department and the IRS acknowledge that such guidance 
could benefit taxpayers and practitioners in applying these rules. 
However, because the valuation methodology in proposed Sec.  
1.1400Z2(d)-1(d)(3)(ii)(B)(4) is used to value property to meet the 
statutory requirements for the 70-percent tangible property standard, 
the Treasury Department and the IRS decline to apply these 
methodologies for all purposes. Accordingly, qualified opportunity zone 
businesses may use only the square footage test or the unadjusted cost 
test, to determine if the subject property is located substantially 
within a QOZ when property straddles QOZ and non-QOZ tracts. The method 
chosen must be applied consistently throughout the holding period under 
section 1400Z-2(d)(2)(D)(iii) for such property.
5. Requested Clarification Regarding Contiguous Requirement for 
Straddle Property
    A number of commenters requested clarification regarding the 
requirement that real property located outside of a QOZ be contiguous 
to all or part of the real property located inside the QOZ. Some 
commenters requested that the contiguity requirement be relaxed in the 
following circumstances: (1) Two or more parcels of real property that 
are not contiguous because they are separated by public property, such 
as a road or a sidewalk; and (2) two or more parcels of real property 
that are not contiguous because a third-party owns a right that burdens 
the bordering area between the two tracts, such as an easement or other 
right-of-way. Similarly, commenters have recommended that the 
contiguity requirement be treated as satisfied in cases in which a 
development project that is located outside of a QOZ, but in a location 
either adjacent to or within a short distance from a QOZ.
    The Treasury Department and the IRS appreciate the commenters' 
request, and agree that the final regulations should clarify and define 
contiguous property. As a result, the final regulations provide that 
parcels or tracts of land will be considered contiguous if they possess 
common boundaries, and would be contiguous but for the interposition of 
a road, street, railroad, stream or similar property. In addition, the 
final regulations exclude from the definition of the term ``common 
boundaries'' boundaries of parcels of land that touch only at a common 
corner.
6. Extension of Straddle Safe Harbor Principles for Purposes of the 70-
Percent Use Test
    The Treasury Department and the IRS received multiple 
recommendations that the final regulations extend the principles of 
proposed Sec.  1.1400Z2(d)-1(d)(5)(viii) to determine whether real 
property is used in a QOZ for the 70-percent use test. A portion of 
these commenters requested that the extension of these principles apply 
to QOFs as well as qualified opportunity zone businesses. These 
commenters contended that QOFs and qualified opportunity zone 
businesses should be treated similarly in this context to further the 
policy of introducing new capital investment into QOZs.
    For purposes of determining whether real property qualifies as 
qualified opportunity zone business property, the Treasury Department 
and the IRS have determined that it would be appropriate to extend the 
treatment of real property that straddles QOZ and non-QOZ tracts to the 
70-percent use test. The final regulations also confirm that this 
extension of treatment applies to both qualified opportunity zone 
businesses and QOFs. The extension of this concept provides flexibility 
for trades or businesses within QOZs, and the Treasury Department and 
the IRS note that the requirements for substantiality (that is, the 
square footage and unadjusted cost tests) and contiguity will minimize 
the occurrence of abusive arrangements.
7. Requested Expansion of QOZ Definition Under Section 1400Z-2
    The Treasury Department and the IRS received a comment requesting 
that the final regulations expand the definition of a QOZ. 
Specifically, the commenter suggested that the definition of a QOZ be 
revised to include any census tract in which a development or project 
is located if (1) the relevant statistics of the census tract meet the 
criteria that were originally used to identify eligible QOZ tracts; (2) 
the development or project is located within one-quarter mile of an 
existing or proposed high-quality transit stop; or (3) the census tract 
is located

[[Page 1929]]

directly adjacent to, or within a short distance from, an existing QOZ. 
For support, the commenter contended that the process to nominate 
census tracts as QOZs may have omitted other tracts with similar 
statistical profiles that might have qualified as QOZs if the selection 
process were to have had a longer duration.
    Another commenter recommended that the final regulations expand the 
QOZ concept by treating certain projects located completely outside a 
QOZ as though such projects are located within a QOZ. Specifically, the 
commenter suggested that project components located outside of a QOZ 
that are connected or necessary to the project components located 
inside of the QOZ should be treated as if located in a QOZ. For 
support, the commenter provided examples of industries that rely on 
natural resources that might be located outside of a QOZ, and may be of 
limited portability due to their connection to certain geological or 
topographic land features.
    The Treasury Department and the IRS appreciate the commenters' 
recommendations but decline to incorporate them in the final 
regulations. With regard to the commenter's request to expand the 
definition of a QOZ, the Treasury Department and the IRS have 
determined that such recommendation is not supported by the text of 
section 1400Z-1, which sets forth the process for QOZ designation. 
Moreover, the Treasury Department and the IRS note that Rev. Proc. 
2018-16, 2018-9 I.R.B. 383, provided additional guidance to the Chief 
Executive Officers of each state regarding the manner by which certain 
population census tracts may be designated as QOZs. With regard to the 
commenter's request to expand the concept of QOZs to include certain 
projects located entirely outside of QOZs, the Treasury Department and 
the IRS have determined that the section 1400Z-2 regulations provide 
appropriate flexibility to facilitate the development of projects and 
economic activity that extend beyond the geographic boundaries of QOZs. 
The commenter's recommendation, if adopted, would exceed that degree of 
flexibility and in certain cases potentially conflict with locational 
requirements of section 1400Z-2.

Q. Application of Section 1397C Requirements and Safe Harbors to QOFs

    The October 2018 and May 2019 proposed regulations provided safe 
harbors to address requirements described in section 1397C that trades 
or businesses must satisfy to qualify as qualified opportunity zone 
businesses. These safe harbors, including the 31-month working capital 
safe harbor and the active trade or business safe harbors, did not 
specifically apply to QOFs. Several commenters requested clarification 
regarding whether such requirements described in section 1397C for 
qualified opportunity zone businesses also apply to QOFs. Many 
commenters suggested that, while QOFs should not be subject to 
statutory requirements imposed on qualified opportunity zone 
businesses, QOFs should be permitted to apply safe harbors that address 
section 1397C requirements. In addition, two commenters suggested that 
the 31-month working capital safe harbor should be made available to a 
QOF that otherwise meets the requirements for the safe harbor.
    The Treasury Department and the IRS note that the text of section 
1400Z-2 does not support the application of the section 1397C 
requirements to QOFs, but rather limits the application of those 
requirements to qualified opportunity zone businesses. Consequently, 
the Treasury Department and the IRS have concluded that any safe harbor 
made available under the proposed regulations to address a section 
1397C requirement imposed on a qualified opportunity zone business 
likewise should not be extended to QOFs. As a result, the final 
regulations do not incorporate the commenters' recommendations.

R. Consideration of QOF Reliance Rule Regarding Satisfaction of 
Qualified Opportunity Zone Business Requirements

    Commenters have requested that the final regulations provide a 
special QOF reliance rule. Such rule would provide that an entity may 
be treated as a qualified opportunity zone business for the duration of 
a QOF's ownership of the stock or partnership interest in that entity 
if, at the time the QOF acquires its interest in the trade or business, 
(i) the QOF does not have control over the trade or business and (ii) 
the QOF reasonably expects the entity will satisfy each requirements 
described in section 1400Z-2(d)(3) to qualify as a qualified 
opportunity zone business.
    The Treasury Department and the IRS note that, for stock or a 
partnership interest to be treated as qualified opportunity zone 
property and counted toward the 90-percent investment standard, the 
trade or business must meet the requirements of section 1400Z-2(d)(3). 
A QOF is responsible for ensuring that the requirements of section 
1400Z-2(d)(3) are met when reporting the value of the QOF's assets on 
Form 8996. Therefore, the Treasury Department and the IRS decline to 
accept the commenter's suggestion.

S. Certain Businesses Described in Section 144(c)(6) Not Eligible To Be 
Qualified Opportunity Zone Businesses

    Section 1400Z-2(d)(3)(A)(iii) provides that the term ``qualified 
opportunity zone business'' means a trade or business that, in addition 
to satisfying other requirements described in section 1400Z-2(d)(3)(A), 
is not a business described in section 144(c)(6)(B) (commonly referred 
to as a ``sin business''). Section 144(c)(6)(B) lists as a sin business 
any (i) 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) store the 
principal business of which is the sale of alcoholic beverages for 
consumption off premises. Section 1400Z-2(d)(1), which sets forth the 
definitional requirements for a QOF, does not prohibit QOFs from 
directly conducting section 144(c)(6)(B) sin businesses.
1. Consideration of General Application and Adoption of de minimis 
Threshold
    The Treasury Department and the IRS have received several comments 
regarding the general application of the sin business prohibition. Many 
commenters have emphasized that section 1400Z-2 explicitly prohibits 
qualified opportunity zone businesses from being a sin business, but 
sets forth no such prohibition for QOFs. These commenters also have 
noted, however, that section 1400Z-2 does not contain any specific 
provision that prohibits a qualified opportunity zone business from 
leasing property to a sin business. In addition, commenters have 
contended that a de minimis use of property in any sin business should 
not, on its own, prevent that property from qualifying as qualified 
opportunity zone business property of a QOF. Similarly, commenters 
recommended that the final regulations provide rules prohibiting a 
qualified opportunity zone business from leasing more than a de minimis 
amount of its property to a sin business. These commenters emphasized 
that section 1400Z-2(d)(3)(A)(iii) clearly conveyed Congress' intent 
that a qualified opportunity zone business should not be a sin 
business, and therefore should not be permitted to circumvent the 
substance of the sin business prohibition simply through leasing its 
property to such business.
    The Treasury Department and the IRS appreciate all of the comments

[[Page 1930]]

submitted on this issue. First, the final regulations do not extend the 
prohibition on sin businesses to the definition of a QOF because, as 
highlighted by several commenters, section 1400Z-2 explicitly prohibits 
qualified opportunity zone businesses from operating sin businesses, 
but sets forth no similar prohibition for QOFs. See section 1400Z-
2(d)(3)(A)(iii) (setting forth sin business prohibition for qualified 
opportunity zone businesses); section 1400Z-2(d)(1) (providing QOF 
definition). In addition, the Treasury Department and the IRS agree 
that section 1400Z-2 does not explicitly prohibit a qualified 
opportunity zone business from leasing its property to a sin business. 
However, the Treasury Department and the IRS have determined that the 
purpose of section 1400Z-2(d)(3)(A)(iii) is to prevent qualified 
opportunity zone businesses from operating sin businesses, which a 
qualified opportunity zone business nonetheless could carry out simply 
by leasing such property to a sin business. To ensure that the purpose 
of section 1400Z-2(d)(3)(A)(iii) is effectuated, the final regulations 
prohibit a qualified opportunity zone business from leasing more than 
five percent of its property to a sin business. The Treasury Department 
and the IRS have determined that this de minimis threshold will reduce 
the risk of a qualified opportunity zone business inadvertently 
violating the sin business prohibition.
2. Consideration of Request for Additional Detail Regarding ``Sin 
Business'' Qualification
    Commenters also requested that the final regulations provide 
additional detail regarding the spectrum of businesses covered by the 
descriptions set forth in section 144(c)(6)(B). One commenter requested 
confirmation that the ``alcoholic beverage'' restriction be limited to 
the clear meaning of a traditional ``liquor store'' that sells 
alcoholic beverages to customers for consumption off premises, but not 
to restaurants, wineries, breweries, or distilleries. Another commenter 
requested clarification that full-service spa facilities operated in 
hotels and other similar properties do not constitute prohibited sin 
businesses.
    The Treasury Department and the IRS agree with the commenters that 
additional detail regarding the qualification of a business as a ``sin 
business'' would be helpful in certain cases. However, the Treasury 
Department and the IRS have determined that the rules suggested by the 
commenters, as well as similar provisions, would inject significant 
complexity into the final regulations and likely cause additional 
uncertainty regarding the scope of the term ``sin business'' due to its 
inherently factual nature. As a result, the final regulations do not 
incorporate the commenters' recommendations.

U. Tangible Property That Ceases To Be Qualified Opportunity Zone 
Business Property

    Section 1400Z-2(d)(3)(B) provides a special rule that permits a 
qualified opportunity zone business to treat tangible property that 
ceases to be qualified opportunity zone business property as qualified 
opportunity zone business property for the lesser of five years after 
(i) the date on which such tangible property ceases to be so qualified, 
or (ii) the date on which such tangible property is no longer held by 
the qualified opportunity zone business. The phrase ``ceases to be 
qualified opportunity zone business property'' indicates that the 
tangible property must have been used in a trade or business for a 
period of time. The Treasury Department and the IRS have determined 
that tangible property must have been qualified opportunity zone 
business property used in a trade or business for at least two years.
    Therefore, the final regulations provide that a qualified 
opportunity zone business may apply section 1400Z-2(d)(3)(B) only if 
the qualified opportunity zone business property was qualified 
opportunity zone business property used by a qualified opportunity zone 
business in a QOZ for at least two years. Further, to ensure that only 
qualified opportunity zone business property used in a qualified 
opportunity zone business is eligible for the benefits of section 
1400Z-2(d)(3)(B), the final regulations provide that the 31-month 
working capital safe harbor period and the 30-month substantial 
improvement period pursuant to which tangible property may be treated 
as qualified opportunity zone business property for purposes of the 70-
percent tangible property standard, are not taken into consideration in 
determining whether property meets the requirements for eligibility 
under section 1400Z-2(d)(3)(B).

V. Exceptions Based on Location in Which an Entity Is Created, Formed 
or Organized

    The proposed regulations clarified that a QOF must be an entity 
classified as a corporation or partnership for Federal tax purposes. In 
addition, a QOF must be created or organized in one of the 50 states, 
the District of Columbia, or a U.S. territory, or organized under the 
laws of an Indian tribal government. If an entity is organized in a 
U.S. territory but not in one of the 50 states or in the District of 
Columbia, then the entity may be a QOF only if the entity is organized 
for the purpose of investing in qualified opportunity zone property 
that relates to a trade or business operated in the territory in which 
the entity is organized.
    The proposed regulations further clarified 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, that entity 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. territory, or organized 
under the laws of an Indian tribal government. If an entity is 
organized in a U.S. territory but not in one of the 50 states or in the 
District of Columbia, then an equity interest in the entity may be a 
qualified opportunity property only if the entity conducts a qualified 
opportunity zone business in the U.S. territory in which the entity is 
organized.
    The proposed regulations defined a U.S. possession, now referred to 
as a U.S. territory, to mean any jurisdiction outside of the 50 states 
and the District of Columbia in which a designated QOZ exists under 
section 1400Z-1. This definition includes the following jurisdictions: 
(1) American Samoa, (2) Guam, (3) the Commonwealth of the Northern 
Mariana Islands, (4) the Commonwealth of Puerto Rico, and (5) the U.S. 
Virgin Islands.
    Certain comments discussed the interaction between the section 
1400Z-2 rules and the rules for taxation of controlled foreign 
corporations (as defined in section 957) (CFCs). One commenter 
requested the basis for the proposed rule requiring that a QOF be 
organized in one of the 50 states, District of Columbia, or a U.S. 
territory, but did not request any change. Other than for clarifying 
that an entity qualifying as a QOF or qualified opportunity zone 
business can be organized under the laws of an Indian tribal 
government, this rule is being finalized without change. This rule was 
proposed due to the difficulty of tracking whether a foreign entity 
continuously satisfies the requirements for QOF status. Additionally, a 
foreign entity may not be subject to Federal income tax; thus, imposing 
the penalty under section 1400Z-2(f)(1) if the entity

[[Page 1931]]

fails to maintain the 90-percent investment standard set forth in 
section 1400Z-2(d)(1) could be difficult. Finally, a foreign entity is 
unlikely to be a QOF given the requirement that a QOF must invest 
almost exclusively in QOZs, which must themselves be located only in 
the United States and U.S. territories.
    As noted previously, although a QOF cannot be an entity organized 
in a foreign country, it can be an entity organized in a U.S. 
territory. A corporation organized in a U.S. territory is treated as a 
CFC on a given day if the ownership requirements in section 957 are 
satisfied on that day. A United States shareholder (as defined in 
section 951(b)) of a CFC generally includes in gross income, for its 
taxable year in which or with which the CFC's taxable year ends, its 
pro rata share of the CFC's subpart F income (as defined in section 
952) under section 951(a) (subpart F regime), as well as the United 
States shareholder's global intangible low-taxed income under section 
951A(a) (GILTI regime), which is based on the tested income (as defined 
in section 951A(c)(2)(A)) of the CFC and other items relevant to 
determining the amount of the United States shareholder's inclusion in 
gross income under section 951A(a).
    The proposed rules relating to entities organized in U.S. 
territories are adopted without change.

VI. Comments on and Changes to Proposed Sec.  1.1400Z2(e)-1

    Proposed Sec.  1.1400Z2(e)-1 provided rules regarding mixed-funds 
investments. This part VI of this Summary of Comments and Explanation 
of Revisions addresses comments regarding proposed Sec.  1.1400Z2(e)-1 
as well as comments regarding provisions of section 1400Z-2(e) that 
were not addressed in the proposed regulations, such as the definition 
of ``related persons'' in section 1400Z-2(e)(2). For a discussion of 
whether certain transactions between investors and QOFs or qualified 
opportunity zone businesses are treated as transactions between related 
persons, see part II.A.1.d of this Summary of Comments and Explanation 
of Revisions.

A. Related Persons and the Step Transaction Doctrine

    Section 1400Z-2(e)(2) provides that, for purposes of section 1400Z-
2, parties are ``related'' if their relationship satisfies either 
section 267(b) or 707(b)(1), with the threshold for relatedness lowered 
from 50 percent to 20 percent. This definition applies to two 
categories of transactions. First, eligible gain must arise from a sale 
or exchange with an unrelated party. See section 1400Z-2(a)(1) and 
proposed Sec.  1.1400Z2(a)-1(b)(2)(i)(C). Second, in order for tangible 
property to qualify as qualified opportunity zone business property, a 
QOF or qualified opportunity zone business must acquire the subject 
tangible property from an unrelated party. See section 1400Z-
2(d)(2)(D)(i)(I) and proposed Sec.  1.1400Z2(d)-1(c)(4)(i)(A). The 
proposed regulations did not further elaborate on the statutory 
definition of ``relatedness.''
    One commenter recommended that a sale be considered to take place 
between unrelated parties for purposes of section 1400Z-2 and the 
section 1400Z-2 regulations if, as part of an overall plan, the seller 
and buyer become unrelated in a series of transactions that includes 
the tested sale. The commenter noted that certain other income tax 
regulations determine ``relatedness'' after the last step in a series 
of related transactions and advocated a similar rule in the section 
1400Z-2 regulations.
    The Treasury Department and the IRS have determined that all 
relevant provisions of the Code and general principles of tax law, 
including the step transaction doctrine, govern the determination 
whether a transaction is between unrelated parties for purposes of 
section 1400Z-2 and the section 1400Z-2 regulations. Accordingly, the 
final regulations do not include a specific step transaction rule as 
requested by the commenter.

B. Non-Qualifying Investment in a QOF Corporation for Which No Stock Is 
Received

    Commenters requested clarification regarding the treatment of 
mixed-funds investments in QOF corporations. More specifically, 
commenters asked for clarification regarding situations in which a 
shareholder with a qualifying investment in a QOF corporation makes a 
non-qualifying investment in the QOF but receives no stock in exchange 
(that is, a meaningless-gesture contribution). One commenter requested 
confirmation that the shareholder in such situations has a mixed-funds 
investment, and that the basis in the non-qualifying investment is 
determined without regard to section 1400Z-2(b)(2)(B). Another 
commenter questioned whether the shareholder would have two implicit 
blocks of stock in the QOF, with separate basis determinations and with 
distributions and redemptions being apportioned between the qualifying 
and non-qualifying blocks of stock (analogous to the result under the 
special rules for QOF partnerships discussed in part III.E.1 of this 
Summary of Comments and Explanation of Revisions), or whether each 
share of QOF stock would have an identical basis under general Federal 
income tax principles.
    The final regulations confirm that a meaningless-gesture 
contribution results in a mixed-funds investment. However, the Treasury 
Department and the IRS have determined that addressing the foregoing 
questions regarding basis in a mixed-funds investment in a QOF 
corporation is beyond the scope of the final regulations. The Treasury 
Department and the IRS continue to study such issues. See REG-143686-
07, 84 FR 11686 (March 28, 2019).

VII. Comments on and Changes to Proposed Sec.  1.1400Z2(f)-1

    Proposed Sec.  1.1400Z2(f)-1 prescribed rules for QOFs that fail to 
maintain the 90-percent investment standard of section 1400Z-2(d)(1) 
and proposed Sec.  1.1400Z2(d)-1. In particular, proposed Sec.  
1.1400Z2(f)-1(b) specified the time period in which proceeds must be 
reinvested in qualifying property, and proposed Sec.  1.1400Z2(f)-1(c) 
provided a general anti-abuse rule.

A. Time Period for a QOF To Reinvest Proceeds

1. Reinvestment
    Section 1400Z-2(e)(4)(B) provides that the Secretary shall 
prescribe such regulations as may be necessary or appropriate to ensure 
that a QOF has a reasonable period of time to reinvest the return of 
capital from investments in qualified opportunity zone property and to 
reinvest proceeds received from sale or disposition of qualified 
opportunity zone property. To this end, proposed Sec.  1.1400Z2(f)-1(b) 
provided that if a QOF received proceeds from the return of capital or 
the sale or disposition of some or all of its qualified opportunity 
zone property, and if the QOF reinvested some or all of the proceeds in 
qualified opportunity zone property by the last day of the 12-month 
period beginning on the date of the distribution, sale, or disposition, 
then the proceeds were treated as qualified opportunity zone property 
in evaluating whether the QOF satisfied the 90-percent investment 
standard, but only to the extent the proceeds were continuously held in 
cash, cash equivalents or debt instruments with a term of 18-months or 
less. Several commenters have requested modifications to this 
reinvestment rule for QOFs.
    In the proposed regulations, the Treasury Department and the IRS 
requested comments addressing

[[Page 1932]]

whether an analogous rule for qualified opportunity zone businesses 
would be beneficial. Multiple commenters have requested an extension of 
this QOF reinvestment rule to qualified opportunity zone businesses so 
that certain dispositions of qualified opportunity zone business 
property would not adversely affect satisfaction of the 70-percent 
tangible property standard in section 1400Z-2(d)(3)(A)(i). The primary 
argument for the extension of the QOF reinvestment rule to qualified 
opportunity zone businesses is that like a QOF, a qualified opportunity 
zone business may dispose of assets and reinvest proceeds in other 
qualified opportunity zone business property. These commenters assert 
that a qualified opportunity zone business in the course of its 
business operations is more likely to acquire and dispose of assets 
than the QOF itself.
    Because section 1400Z-2(e)(4)(B) specifically directs the Secretary 
to prescribe regulations relating to the time period for QOFs to 
reinvest proceeds from the sale of qualified opportunity zone property 
and does not explicitly refer to qualified opportunity zone businesses, 
the Treasury Department and the IRS decline to extend this reinvestment 
concept to similar dispositions by a qualified opportunity zone 
business. However, qualified opportunity zone businesses may avail 
themselves of the working capital safe harbor to enable proceeds to 
qualify as qualified opportunity zone business property.
    Proposed Sec.  1.1400Z2(f)-1(b) also provides that the 12-month 
reinvestment period is tolled while waiting on government action if the 
QOF has completed the application for action and is awaiting a 
government response. A commenter requested that the time period for 
waiting on government action be expanded to 24 months if a state of 
emergency is declared by the federal government in the jurisdiction in 
which the qualified opportunity zone property is located. The Treasury 
Department and the IRS agree that the reinvestment period should be 
expanded if additional delays are caused by a Federally declared 
natural disaster, and have modified the rules relating to the 
reinvestment period to allow for such expansion. However, a QOF must 
invest proceeds as originally planned before the disaster. For example, 
if a QOF is unable to invest in a certain qualified opportunity zone 
business property because the property is located in a Federally 
declared disaster area, the QOF must invest the proceeds in similar 
property located in that QOZ.
2. Nonrecognition Provisions and Their Application to Section 1400Z-2
    In the preamble to the proposed regulations, the Treasury 
Department and the IRS requested comments identifying prior examples of 
tax regulations that would exclude from gross income gain from the sale 
or disposition of assets held by a QOF or qualified opportunity zone 
business without an operative statutory nonrecognition provision. Other 
code sections that permit nonrecognition of income or gain have 
operative language permitting nonrecognition. In response, one 
commenter recommended a rule that would exclude from gross income the 
gain from the disposition of assets by a QOF if the gain was reinvested 
in ``qualifying assets'' within a 180-day period after the disposition. 
In support of this recommendation, the commenter explained that such a 
rule would encourage reinvestment in assets located in the areas 
designated as QOZs. A second commenter submitted a similar 
recommendation with an additional suggestion that to qualify for 
nonrecognition treatment on the disposition of assets, a QOF or 
qualified opportunity zone business must satisfy a minimum holding 
period for the qualified opportunity zone property or qualified 
opportunity zone business property. Another commenter suggested that 
nonrecognition treatment for the disposition of QOF or qualified 
opportunity zone business assets should follow the principles of 
sections 1031 and 1033. This commenter cited Sec.  1.1031(k)-1 with its 
qualified intermediary rules as an example of a regulation that expands 
the scope of the underlying Code section. While the Treasury Department 
and the IRS understand that such a rule would provide additional 
benefits for QOFs and qualified opportunity zone businesses, the 
statutory regime permits gain deferral only at the QOF owner level; 
section 1400Z-2 does not contemplate nonrecognition of gain arising 
from transactions at any other level. Consequently, in order for a QOF 
or qualified opportunity zone business to receive nonrecognition 
treatment on the disposition of assets, the disposition must qualify 
for nonrecognition treatment under another provision of subtitle A. 
Accordingly, the Treasury Department and the IRS do not adopt this 
recommendation.

B. Land Banking

    As provided in Rev. Rul. 2018-29, 2019 I.R.B. 45, and the proposed 
regulations, land that is purchased and located within a qualified 
opportunity zone is not subject to either the original use requirement 
under section 1400Z-2(d)(2)(D)(i)(II) or the substantial improvement 
requirement under sections 1400Z-2(d)(2)(D)(i)(II) and 1400Z-
2(d)(2)(D)(ii). See additional discussion at V.H, and V.I, of this 
Summary of Comments and Explanation of Revisions. However, in certain 
circumstances, unimproved land might be held in a manner that is 
inconsistent with the purposes of section 1400Z-2, such as if a parcel 
of unimproved land does not receive new capital investment or is not 
the subject of increased economic activity or output. As a result, the 
Treasury Department and the IRS have requested and received comments 
related to the application of the anti-abuse rule under section 1400Z-
2(e)(4)(C) to so-called ``land banking'' and similar arrangements in 
addition to the general anti-abuse rule in proposed 1.1400Z2(f)-1(c).
    Some commenters objected to the use of the term ``land banking'' to 
describe the practice of holding land primarily for speculative 
investment and without an intention to develop a trade or business on 
that land and similar arrangements. These commenters noted that a 
commonly used second definition of the term land banking involves 
certain arrangements whereby a local government may acquire real 
property and convert the property to productive use, or hold the 
properties for long-term strategic purposes with the objective of 
community development rather than to earn a profit. The Treasury 
Department and the IRS recognize that the use of the term ``land 
banking'' in the final regulations may cause confusion with this second 
definition. In response to this comment, these final regulations do not 
use the term ``land banking'' or another alternate term and instead 
describe the non-qualifying arrangements as holding land for 
speculative investment.
    Several commenters requested that the final regulations explicitly 
identify the policy reasons that holding land for speculative 
investment is inconsistent with the purposes of section 1400Z-2. 
Commenters also requested specific examples of land use that would be 
abusive under the regulations. Some commenters recommended that 
specific types of land use be enumerated as per se abusive including 
long-term holding of vacant land and speculative passive holding of 
vacant land. Another commenter recommended an anti-abuse rule that 
would prohibit arrangements that only marginally improve land while 
providing a significant tax benefit to investors without a clear and 
direct economic benefit to the community.

[[Page 1933]]

    Other commenters requested an explicit definition for the 
arrangements that constitute holding land for speculative investment. 
Several commenters requested and recommended a standard for the use of 
land that would be considered abusive. Multiple commenters indicated 
that such an anti-abuse standard should incorporate the principles of 
proposed Sec.  1.1400Z2(d)-1(f), which provides that a QOF may not rely 
on the proposed rules for qualified opportunity zone property in 
proposed Sec.  1.1400Z2(d)-1(c)(8)(ii)(B) and (d)(4)(ii)(B) if land is 
unimproved or minimally improved and the QOF or qualified opportunity 
zone business purchases the land with an expectation, an intention, or 
a view not to improve the land by more than an insubstantial amount 
within 30 months after the date of purchase. Regarding the minimal 
improvement or insubstantial improvement standard, commenters requested 
that the final regulations include either a bright-line threshold or 
provide examples of insubstantial improvement to land. In addition to a 
bright-line threshold for insubstantial improvement, one commenter 
suggested that the final regulations require that QOFs or qualified 
opportunity zone businesses provide a timeline for the improvements to 
be made on the unimproved land.
    One commenter provided an illustration of a potentially problematic 
fact pattern in which a taxpayer, a QOF or a qualified opportunity zone 
business, constructs a small shed for use by an attendant on a parking 
lot and charges customers to park on the lot which is, except for the 
attendant's shed, vacant land. According to the commenter, this example 
may represent improvements that fall in the range between insubstantial 
and substantial improvement and would not be captured by a rule that 
prohibits the practice of holding unimproved land merely for passive 
investment due to the profit motivated trade or business activities on 
the lot. By contrast, referring to a similar fact pattern, another 
commenter provided an analysis that the proposed regulations were 
sufficient to thwart speculative land investment of this type. The 
commenter suggested that there were two existing proposed rules that 
would apply to such an arrangement (1) the requirement that tangible 
property must be used in the trade or business of a QOF or a qualified 
opportunity zone business to be considered qualified opportunity zone 
business property; and (2) the general anti-abuse rule in proposed 
Sec.  1.1400Z2(f)-1(c). Under the commenter's analysis, the parking lot 
fact pattern would meet the trade or business standard; however, under 
the general anti-abuse rule, a significant purpose of the transaction 
would be a speculative investment purpose, therefore, the arrangement 
could be recast.
    The Treasury Department and the IRS have provided examples to 
illustrate the application of the general anti-abuse rule to two fact 
patterns related to the acquisition of land that multiple commenters 
have indicated require additional guidance. The first example involves 
a taxpayer that establishes a parking lot business on a land parcel in 
a QOZ. The second example involves a taxpayer that acquires farmland, 
repurposes the land for a different principal business activity, and 
makes a significant investment of capital and labor into that new 
business. In the parking lot example, notwithstanding the fact that the 
business has built small structures on an otherwise empty lot, because 
a significant purpose for the acquisition of the land is to hold the 
land for speculative investment, the anti-abuse rule functions to 
recharacterize the transaction so that the taxpayer may not receive the 
benefits of section 1400Z-2. By contrast, in the second example, the 
taxpayer's post-acquisition investment tends to show that land is being 
used to develop an operating business in the QOZ, rather than merely 
being held with a minimum level of activity to reap the benefit of 
appreciation on what is essentially bare land. These examples serve to 
reiterate the guiding principle that land held for speculative purposes 
does not further the purposes of section 1400Z-2 and the section 1400Z-
2 regulations.

C. General Anti-Abuse Rule

    A number of comments addressed the anti-abuse rule of proposed 
Sec.  1.1400Z2(f)-1(c), which provides that section 1400Z-2 and the 
1400Z-2 regulations must be applied in a manner consistent with the 
purposes of section 1400Z-2. To this end, if a significant purpose of a 
transaction is to achieve a tax result that is inconsistent with the 
purposes of section 1400Z-2, then the proposed regulations provided 
that the Commissioner can recast a transaction to achieve consistency 
with the purposes of section 1400Z-2. The determination of whether a 
tax result is inconsistent with the purposes of section 1400Z-2 
requires a facts and circumstances analysis.
    Many commenters requested an articulation of the purposes of 
section 1400Z-2 to assist taxpayers in avoiding a recast of their 
transaction. The Treasury Department and the IRS have determined that 
the purposes of section 1400Z-2 and the section 1400Z-2 regulations are 
to provide specified tax benefits to owners of QOFs to encourage the 
making of longer-term investments, through QOFs and qualified 
opportunity zone businesses, of new capital in one or more QOZs and to 
increase the economic growth of such QOZs. Therefore, these purposes 
have been included in the text of the anti-abuse rule in the final 
regulations.
    Another commenter requested a safe harbor from the anti-abuse rule 
for failure to comply with the rules, where the entity's efforts are in 
good faith. The Treasury Department and the IRS disagree that the 
purposes of section 1400Z-2 are so elusive that a good faith attempt to 
comply with the rules would be subject to the anti-abuse rule. As 
stated previously, the purposes of section 1400Z-2 and the section 
1400Z-2 regulations are to provide specified tax benefits to owners of 
QOFs to encourage the making of longer-term investments, through QOFs 
and qualified opportunity zone businesses, of new capital in one or 
more QOZs and to increase the economic growth of such QOZs. 
Accordingly, the Treasury Department and the IRS decline to provide a 
good faith exception.
    Several commenters requested enumeration of specific instances of 
per se abuse. Items that might be on this list include: Non-qualifying 
investments; a specific rule to ensure that taxpayers do not exploit 
the inventory safe harbor to evade the 90-percent investment standard 
for QOFs or the 70-percent tangible property standard; and a rule, 
similar to an ``anti-stuffing'' rule, that establishes that certain 
transactions undertaken to qualify property as qualified opportunity 
zone property, but with transitory effect, would be deemed abusive.
    Other commenters suggested adding to the list of per se abuses 
activities that would be harmful to the community in which the QOF or 
qualified opportunity zone business operates, such as dramatically 
increased rents, a high number of tenant evictions, lack of direct or 
sustained community benefit, and activities not vetted by community or 
local government and that result in a dislocation of community 
residents. To this end, several commenters suggested that QOFs and 
qualified opportunity zone businesses identify, ex ante, one or more 
beneficial community outcomes that the QOF and qualified opportunity 
zone businesses intend to achieve. These outcomes would include 
creating quality jobs, developing affordable housing, and investing in 
community

[[Page 1934]]

facilities that benefit low-income residents of the community. One 
commenter recommended a safe harbor from the anti-abuse provision for 
QOFs that receive third party certification demonstrating the QOF's 
public benefit. The commenter cited benefit corporation legislation and 
standards under the Small Business Administration as precedent for this 
approach.
    The Treasury Department and the IRS are appreciative of the 
comments received on the anti-abuse provision. Accordingly, several 
examples of the operation of the general anti-abuse rule have been 
included in the final regulations.

VIII. Comments on and Changes to Proposed Sec.  1.1400Z2(g)-1

    Proposed Sec.  1.1400Z2(g)-1 prescribed rules regarding the Federal 
income tax treatment of QOFs owned by members of consolidated groups.

A. Section 1400Z-2 and the Consolidated Return Regulations

    As discussed in part II.A.1 of this Summary of Comments and 
Explanation of Revisions, section 1400Z-2 and the section 1400Z-2 
regulations permit the deferral of eligible gain when a taxpayer makes 
a qualifying investment in a QOF. The deferred gain is tracked by the 
taxpayer's basis in its qualifying investment and is included in gross 
income upon an inclusion event.
    Section 1501 provides that an affiliated group of corporations, as 
defined in section 1504, may elect to file a consolidated income tax 
return. The regulations under section 1502 provide rules applicable to 
consolidated groups. Many of the consolidated return provisions aim to 
treat members of a consolidated group as a single entity. For example, 
the investment adjustment rules under Sec.  1.1502-32 affect the 
determination of members' basis in the stock of subsidiary members. The 
purpose of the investment adjustment rules is to treat the consolidated 
group as a single entity by ensuring that members' items of income, 
gain, deduction, and loss are taken into account by the tax system 
once, and only once.
    As stated in the preamble to the May 2019 proposed regulations, the 
respective frameworks of section 1400Z-2 and the consolidated return 
regulations are incompatible in many respects. The preamble emphasized 
that special rules would be required to harmonize the policy objectives 
of sections 1400Z-2 and 1502; for example, special rules would be 
required under Sec. Sec.  1.1502-13, 1.1502-19, and 1.1502-32. For this 
reason, among others, the Treasury Department and the IRS proposed 
treating stock of a QOF C corporation as not stock for purposes of 
section 1504. Accordingly, under the May 2019 proposed regulations, a 
QOF C corporation could be the common parent of a consolidated group 
but could not be a subsidiary member of the consolidated group. 
However, the Treasury Department and the IRS requested comments on 
whether the burden of potentially applying two different sets of 
consolidated return rules would be outweighed by the benefits of 
permitting QOF C corporations to be subsidiary members of consolidated 
groups.
    The Treasury Department and the IRS received numerous comments 
regarding the consolidated return rules in the May 2019 proposed 
regulations. For example, as a procedural matter, commenters 
recommended moving these rules to the regulations under sections 1502 
and 1504. The Treasury Department and the IRS agree with this 
recommendation and have moved the rules regarding the Federal income 
tax treatment of QOFs owned by members of consolidated groups from 
Sec.  1.1400Z2(g)-1 to Sec. Sec.  1.1502-14Z and 1.1504-3.
    Part VIII.B.1 of this Summary of Comments and Explanation of 
Revisions sets forth summaries of the comments received with respect to 
the consolidated return rules in the May 2019 proposed regulations. The 
remainder of part VIII of this Summary of Comments and Explanation of 
Revisions provides the responses of the Treasury Department and the IRS 
and describes the revisions adopted in the final regulations.

B. QOF C Corporation as a Subsidiary Member of a Consolidated Group

1. Comments on Consolidating Subsidiary QOF C Corporations
    Commenters requested generally that QOF C corporations be permitted 
to join in the filing of consolidated income tax returns as subsidiary 
members. The commenters maintained that, if consolidation of subsidiary 
QOF C corporations were permitted, investors would possess greater 
flexibility to structure and manage qualifying investments, which would 
result in increased investment in QOZs. Consistent with the preamble to 
the May 2019 proposed regulations, commenters acknowledged that, if a 
QOF C corporation could be a subsidiary member of a consolidated group 
(QOF member), special rules might be needed under Sec.  1.1502-13 
(regarding intercompany transactions), Sec.  1.1502-19 (regarding 
excess loss accounts, or ELAs), and Sec.  1.1502-32 (regarding stock 
basis adjustments). In particular, commenters suggested adopting rules 
similar to the rules in proposed Sec.  1.1400Z2(b)-1(e)(4) for pass-
through entities to resolve complications arising from the interaction 
of section 1400Z-2 and Sec.  1.1502-32.
    Commenters also suggested alternatives to a blanket permission for 
QOF corporations to be subsidiary members of a consolidated group. For 
example, some commenters requested that subsidiary QOF C corporations 
formed as members of, or acquired by, a consolidated group prior to the 
publication of the May 2019 proposed regulations (pre-existing QOF 
subs) be permitted to continue as QOF members. Commenters argued that, 
even if the Treasury Department and the IRS decline to generally allow 
the consolidation of subsidiary QOF C corporations, grandfathering 
these pre-existing QOF subs would be appropriate. Those commenters 
stressed that many taxpayers had evaluated, structured, and completed 
transactions prior to the issuance of the May 2019 proposed regulations 
based on the assumption that subsidiary QOF C corporations could join 
in the filing of consolidated returns. One commenter suggested that QOF 
members formed within a reasonable grace period after the issuance of 
the May 2019 proposed regulations also be grandfathered.
    As a second alternative, commenters requested that taxpayers be 
allowed to convert their QOF members into partnerships and treat those 
entities as partnerships retroactive to the date of the qualifying 
investment. These commenters also requested that the final regulations 
provide rules to ensure that such restructuring would not constitute an 
inclusion event. Similarly, commenters requested that taxpayers be 
allowed to retroactively treat a QOF C corporation either as a 
nonmember of a consolidated group or as a member of the consolidated 
group that is not a QOF.
    Commenters also requested rules detailing the consequences of 
deconsolidating pre-existing QOF subs if the Treasury Department and 
the IRS decline to allow pre-existing QOF subs to remain members of the 
consolidated group. The commenters requested that the deconsolidation 
event not be treated as an inclusion event and suggested multiple 
approaches with regard to stock basis adjustments, ELA inclusions, 
application of the unified loss rule, and other issues on 
deconsolidation.

[[Page 1935]]

2. Election To Consolidate a Subsidiary QOF C Corporation
    As discussed in part VIII.B.1 of this Summary of Comments and 
Explanation of Revisions, commenters requested that subsidiary QOF C 
corporations be permitted to join in the filing of consolidated returns 
while acknowledging that additional rules may be required to harmonize 
the operation of section 1400Z-2 and the consolidated return 
regulations. In response to these comments, the final regulations 
permit the consolidation of subsidiary QOF C corporations, subject to 
certain conditions. The final regulations also include special rules to 
coordinate the simultaneous application of section 1400Z-2 and the 
consolidated return regulations to QOF members.
a. Conditions To Consolidate a Subsidiary QOF C Corporation
    These final regulations permit the consolidation of a subsidiary 
QOF C corporation only if certain conditions are satisfied. 
Specifically, except in very limited circumstances, and consistent with 
the general principles of section 1400Z-2, the consolidated group 
member that makes the qualifying investment in the QOF member (QOF 
investor member) must maintain a direct equity interest in the QOF 
member. In addition, the final regulations require all QOF investor 
members to be wholly owned, directly or indirectly, by the common 
parent of the consolidated group. The Treasury Department and the IRS 
have determined that these conditions will help preserve the integrity 
of the consolidated return regulations and ensure that taxpayers apply 
section 1400Z-2 and the section 1400Z-2 regulations in a manner 
consistent with the policies underlying section 1400Z-2 and the 
consolidated return regulations.
    Failure to satisfy either of the foregoing conditions for 
consolidation will result in the deconsolidation of the QOF member. 
Part VIII.B.4 of this Summary of Comments and Explanation of Revisions 
describes the Federal income tax consequences of deconsolidation of a 
QOF member.
i. Direct Ownership Requirement
    Section 1400Z-2 sets forth a general requirement that a QOF owner 
must retain its direct qualifying investment in a QOF in order to 
retain the benefits of that section. See Sec.  1.1400Z2(b)-1(c) and 
part III.A of this Summary of Comments and Explanation of Revisions; 
see also the preamble to the May 2019 proposed regulations. 
Accordingly, to consolidate a subsidiary QOF C corporation, the 
investor member generally must retain direct ownership of the QOF stock 
of the QOF member (QOF member stock). In addition, the QOF investor 
member generally is subject to the same rules regarding inclusion 
events as an investor in a non-member QOF. However, the final 
regulations provide a limited exception for certain transfers of QOF 
member stock that are treated as intercompany transactions and are 
eligible for single-entity treatment. See part VIII.C.3 of this Summary 
of Comments and Explanation of Revisions for a discussion of this 
limited exception.
    The direct ownership requirement is not a section 1502-specific 
rule, for this requirement generally applies outside of consolidation 
as well. The operation of the section 1400Z-2 rules requires close 
monitoring of a QOF owner's basis in the qualifying investment. See 
generally part III.G of this Summary of Comments and Explanation of 
Revisions. Moreover, as noted in the preamble to the May 2019 proposed 
regulations, application of the investment adjustment rules of Sec.  
1.1502-32 results in substantial and ongoing stock basis adjustments to 
QOF member stock that are unrelated to the rules and policies of 
section 1400Z-2 and that complicate the operation of section 1400Z-2 in 
the consolidated group context. In addition, the transfer of QOF member 
stock between consolidated group members, and across ownership chains, 
further increases the complexity of appropriately tracking the QOF 
investor member's basis in its QOF member stock. Therefore, the 
Treasury Department and the IRS have determined that applying the 
general rule in Sec.  1.1400Z2(b)-1(c) (regarding dispositions of 
qualifying investments) inside the consolidated group, by imposing the 
direct ownership requirement on the QOF investor member, would simplify 
the administration of section 1400Z-2 to QOF members. But see part 
VIII.C.3 of this Summary of Comments and Explanation of Revisions for a 
discussion of an exception to the general rule for certain intercompany 
sales of qualifying investments.
ii. Wholly Owned QOF Investor Member
    The requirement that each QOF investor member itself be wholly 
owned, directly or indirectly, by the common parent of the consolidated 
group further serves to prevent uneconomic or other inappropriate 
outcomes that otherwise might be achieved through the interaction of 
sections 1400Z-2 and 1502.
    Under the general affiliation rules, to be a member of a 
consolidated group, an includible corporation need not be wholly owned. 
Instead, only 80 percent of the vote and value of the stock of an 
includible corporation must be owned directly by other consolidated 
group members. Therefore, an includible corporation that is owned 80 
percent by members of a consolidated group and 20 percent by non-
members can be a member of the consolidated group (80/20 member).
    The final regulations impose a stricter requirement for the 
ownership of QOF investor members to ensure the application of the 
inclusion rules of section 1400Z-2(b) conforms to the policy underlying 
section 1400Z-2. As emphasized in part III.G of this Summary of 
Comments and Explanation of Revisions, the application of key 
provisions under section 1400Z-2 depends upon a close monitoring of the 
basis of the qualifying investment in the hands of the QOF owner. If 
QOF investor members were not required to be wholly owned, a 
consolidated group effectively could alienate and monetize a 
substantial portion of its qualifying investment by selling shares in 
QOF investor members or in higher-tier members in a QOF investor 
member's ownership chain, but the consolidated group would continue to 
enjoy section 1400Z-2 benefits because direct ownership of the 
qualifying investment would not change hands. The requirement that each 
QOF investor member be wholly owned, directly or indirectly, by the 
common parent also limits incongruities in the application of Sec.  
1.1502-32 to an ownership chain that includes a QOF member. Both of 
these issues are discussed later in this part VIII.B.2.a of this 
Summary of Comments and Explanation of Revisions.
    Under Sec.  1.1502-76(b), a consolidated group includes in its 
computation of taxable income all income, gain, deduction, and loss 
items of a consolidated group member, regardless of the percentage of 
the member's stock that is directly or indirectly (economically) held 
by the common parent. However, under Sec.  1.1502-32, the investment 
adjustments that are made to the stock of that member (and up the chain 
through tiers of stock ownership to the common parent) reflect only the 
pro rata stock ownership held at each tier. For example, assume that 
the common parent owns 80 percent of another member (R) (an 80/20 
member), which owns 80 percent of the QOF investor member (also an 80/
20 member), which wholly owns the QOF member. In that case, the 
consolidated group's use of a $100 loss of the QOF

[[Page 1936]]

member would result in an $80 reduction of basis in the stock of the 
QOF investor member held by R, but only a $64 reduction of basis in the 
stock of R held by the common parent. Adding a third 80/20 member to 
the QOF member's ownership chain would result in a 51 percent indirect 
interest, and adding a fourth 80/20 member would result in a 41 percent 
indirect interest, thereby further reducing the extent to which the QOF 
member's tax items used by the consolidated group are reflected in 
stock basis up the chain.
    The facial incongruity between the full inclusion of taxable items 
and the pro rata adjustment to stock basis generally does not upset the 
equilibrium of the consolidated return system because the rules apply 
to income and gain as well as deduction and loss items. In other words, 
even though a consolidated group may receive an overstated benefit in 
the case of loss and deduction items (that is, full use of a member's 
loss with only a pro rata decrease in the basis of the member's stock), 
the consolidated group also must take into account all of a member's 
income despite holding less than all of the member's stock (and getting 
only a pro rata increase in the basis of the member's stock). Over the 
course of years, this situation generally will remain in balance.
    However, the interaction of the foregoing rules with the rules 
under section 1400Z-2 upsets this balance in the case of 80/20 members 
with outside investors. In fact, the exclusion of gain under section 
1400Z-2(c) upon the sale or exchange of a qualifying investment not 
only ensures that there will be no balancing over the course of years, 
but also may offer opportunities to magnify the imbalance.
    The Treasury Department and the IRS are aware that, outside of 
consolidation, taxpayers can monetize the value of a qualifying 
investment by selling an indirect interest in the QOF (that is, stock 
in the QOF owner). However, in that case, the QOF owner would retain 
all of its ownership of the qualifying investment. Because the 
consolidated group computes its taxable income and tax liability as a 
single entity (headed by the common parent), the sale of a portion of 
the indirect interest in the QOF member out from under the common 
parent is the functional equivalent of a non-consolidated QOF owner 
disposing of part of its qualifying investment. Therefore, these 
regulations require that the QOF investor member be wholly owned, 
directly or indirectly, by the common parent.
b. Effects of Consolidating a Subsidiary QOF C Corporation
    The preamble to the May 2019 proposed regulations noted, and 
commenters have acknowledged, that allowing a QOF C corporation to 
become a subsidiary member of a consolidated group would necessitate 
the imposition of special rules. In addition to the requirements for 
consolidation of a QOF member discussed in part VIII.B.2.a of this 
Summary of Comments and Explanation of Revisions, these final 
regulations add special rules that coordinate the application of the 
consolidated return provisions and the rules in section 1400Z-2 by 
imposing restrictions on the application of the full range of 
consolidated return rules. The Treasury Department and the IRS have 
determined that this approach is preferable to the alternative--
creating a complex set of parallel consolidated investment adjustment 
rules and intercompany transaction rules applicable to QOF member stock 
and transactions by QOF members.
    First, as stated in the preamble to the May 2019 proposed 
regulations, a special rule is needed to effectuate and harmonize the 
ELA rules under Sec.  1.1502-19 and the rules of section 1400Z-2. 
Section 1.1502-19 allows a consolidated group to use tax attributes of 
a member (M) in excess of the consolidated group's investment in M 
without recognition of gain. Instead, members owning M stock must track 
the negative basis (that is, the ELA) in their M shares and must 
include the ELA in income upon the occurrence of specified events, 
including the disposal of M stock. However, upon a sale or exchange of 
a qualifying investment, section 1400Z-2(c) permits an investor that 
has held its qualifying investment for at least 10 years to elect to 
treat its basis in the qualifying investment as equal to fair market 
value. Thus, an investor may eliminate the appreciation on its 
qualifying investment by making the election under section 1400Z-2(c). 
As further noted in the preamble to the May 2019 proposed regulations, 
the existence of negative stock basis is unique to the consolidated 
return regulations and is not contemplated by section 1400Z-2. 
Accordingly, these final regulations include a rule under which the 
investor member must take its ELA into account pursuant to Sec.  
1.1502-19 before its basis in the QOF member stock is adjusted to fair 
market value under section 1400Z-2(c).
    Second, the final regulations include a special rule to determine 
when a distribution by a QOF member to the QOF investor member 
constitutes an inclusion event. Generally, as provided in Sec.  
1.1400Z2(b)-1(c)(8), a distribution by a QOF C corporation is an 
inclusion event to the extent section 301(c)(3) applies to the 
distribution. In a consolidated group, intercompany distributions are 
governed by the rules in Sec.  1.1502-13(f), and distributions in 
excess of the distributee's basis in the distributor do not result in 
income to the distributee under section 301(c)(3); rather, the excess 
amount creates or increases the distributee's ELA in the distributor 
stock. Thus, to coordinate the application of section 1400Z-2 and the 
consolidated return rules, these final regulations provide that a 
distribution by a QOF member to a QOF investor member is an inclusion 
event to the extent the distribution otherwise would create or increase 
an ELA in the QOF member stock.
    Third, the final regulations include a special rule for computing 
the amount includible by an investor member upon the occurrence of an 
inclusion event. Generally, the amount includible under section 1400Z-
2(b)(2) is determined by reference to the investor's basis in the 
qualifying investment. However, when a subsidiary QOF C corporation is 
a member of a consolidated group, Sec.  1.1502-32 applies to adjust the 
QOF investor member's basis in the stock of the QOF member to reflect 
the QOF member's income, gain, deduction, or loss. The preamble to the 
May 2019 proposed regulations raised the issue of how to properly 
determine the QOF investor member's amount includible when its basis in 
the QOF member includes basis adjustments unrelated to section 1400Z-2.
    Commenters recommended that the final regulations adopt rules 
similar to those for pass-through entities to compute the QOF investor 
member's amount includible under section 1400Z-2. The investment 
adjustment rules under Sec.  1.1502-32 are similar to the partnership 
basis provisions of section 705, and these final regulations adopt 
rules similar to the special rule for pass-through entities in Sec.  
1.1400Z2(b)-1(e)(4). The Treasury Department and the IRS have 
determined that the adoption of this rule to compute the QOF investor 
member's amount includible, in conjunction with the imposition of 
certain conditions for consolidation (as discussed in part VIII.B.2.a 
of this Summary of Comments and Explanation of Revisions), will avoid 
many complexities in the application of the inclusion rules of section 
1400Z-2 within a consolidated group.

[[Page 1937]]

    Fourth, the final regulations include a special rule applicable to 
transactions between the QOF's separate affiliated group (QOF SAG) and 
other members of the consolidated group. A QOF SAG is, with respect to 
a QOF member, the affiliated group that would be determined under 
section 1504(a) if the QOF member were the common parent. The final 
regulations treat a sale or exchange of property between a QOF SAG 
member and a member of the consolidated group that is not a member of 
such QOF SAG as a transaction that is not an intercompany transaction. 
Conversely, transactions between QOF SAG members, and transactions 
between a QOF SAG member and a member of the consolidated group that is 
not a member of such QOF SAG other than a sale or exchange of property, 
are intercompany transactions that are subject to the rules of Sec.  
1.1502-13.
    This rule is necessary to effectuate the application of section 
1400Z-2 in a consolidated group. As noted previously in this part 
VIII.B.2.b of this Summary of Comments and Explanation of Revisions, 
the election under section 1400Z-2(c) potentially allows taxpayers to 
permanently exclude their gain on a qualifying investment held for at 
least 10 years. The availability of this benefit places additional 
import on ensuring that the gain excluded as a result of the election 
under section 1400Z-2(c) is not inflated by bargain sales within the 
consolidated group. Treating property transactions between the QOF SAG 
and other members as currently taxable helps ensure that any such 
transactions are bona fide, arm's-length transactions. This treatment 
also is consistent with treating the QOF as a separate entity for 
purposes integral to the rules of section 1400Z-2 (for example, 
treating a contribution to a QOF member as a qualifying investment).
    Fifth, the final regulations provide that a consolidated group is 
not treated as a single entity for purposes of determining whether a 
QOF member or a qualified opportunity zone business satisfies the 
investment standard rules in section 1400Z-2(d) and (f) and Sec. Sec.  
1.1400Z2(d)-1 and 1.1400Z2(f)-1. Instead, these rules generally apply 
separately to each consolidated group member that is a QOF or qualified 
opportunity zone business. For example, in measuring whether a QOF 
member meets the 90-percent investment standard, only property 
(including qualified opportunity zone stock or qualified opportunity 
zone partnership interests) owned by the QOF member itself is taken 
into account. To preserve the separate-entity treatment of the QOF, the 
QOF member cannot take into account property transferred to a member of 
the consolidated group that is not a member of the QOF member's QOF SAG 
in satisfying the requirements in section 1400Z-2(d). This issue was 
identified in the preamble to the May 2019 proposed regulations. See 
also the discussion of the inapplicability of the intercompany 
transaction regulations to property transactions between QOF members 
and certain other consolidated group members in this part VIII.B.2.b of 
this Summary of Comments and Explanation of Revisions.
c. Anti-Avoidance Rule
    As discussed in parts VIII.A, VIII.B, and VIII.C.2 of this Summary 
of Comments and Explanation of Revisions, the interactions between the 
consolidated return regulations and section 1400Z-2 are novel and 
complex, particularly for QOF members whose consolidation is allowed 
under these final regulations in response to comments received on the 
May 2019 proposed regulations. In response to comments, these final 
regulations also make single-entity treatment available for purposes of 
section 1400Z-2 following certain transfers of qualifying investments, 
including deemed transactions, between members of a consolidated group. 
To prevent inappropriate interactions between the two sets of rules, 
certain consolidated return regulations have been made inapplicable in 
relation to QOF members and qualifying investments transferred between 
consolidated group members, and the application of other consolidated 
return rules has been modified. However, due to the novelty of the 
interactions between the rules, the Treasury Department and the IRS are 
concerned that additional, unanticipated issues may arise from those 
interactions, which might be exploited to produce results that violate 
the purposes underlying section 1400Z-2 or the consolidated return 
regulations.
    To be responsive to comments received but still provide the 
flexibility necessary to obtain an appropriate balancing of the 
purposes underlying section 1400Z-2 and the consolidated return rules, 
these final regulations include an anti-avoidance rule. This rule 
provides that, if a transaction is structured with a view to avoiding 
the application of the rules of section 1400Z-2 and the section 1400Z-2 
regulations or the consolidated return regulations (including section 
1.1502-14Z), appropriate adjustments will be made to carry out the 
purposes of section 1400Z-2 and the section 1400Z-2 regulations. For 
example, if a consolidated group engages in a restructuring (such as a 
distribution described in section 355) with a purpose to make use of 
stock basis adjustments under Sec.  1.1502-32 resulting from increases 
in the basis of stock under section 1400Z-2(b) in a sale or exchange 
transaction but without disposing of any part of the consolidated 
group's direct ownership of the relevant qualifying interest, the 
transaction will be treated as an inclusion event with regard to an 
appropriate amount of deferred gain.
3. Transition Relief
    As discussed in part VIII.B.1 of this Summary of Comments and 
Explanation of Revisions, commenters requested transition relief for 
pre-existing QOF subs. The Treasury Department and the IRS have 
determined that transition relief is appropriate, and these final 
regulations include multiple elective relief options.
    Under the final regulations, a pre-existing QOF sub may elect to be 
reclassified as a QOF partnership, a QOF C corporation that is not a 
member of the consolidated group, or a member of the consolidated group 
that is not a QOF (reclassification election). A reclassification 
election is effective as of the first day the pre-existing QOF sub was 
acquired or formed by members of the consolidated group (day one). If a 
pre-existing QOF sub makes a reclassification election, appropriate 
adjustments (for example, with respect to basis adjustments under Sec.  
1.1502-32 and E&P under Sec.  1.1502-33) must be made to account for 
the change in status of the pre-existing QOF sub. In addition, if a 
pre-existing QOF sub was a QOF C corporation before being acquired by a 
consolidated group, and if the consolidated group elects to treat the 
pre-existing QOF sub as a QOF partnership as of day one (that is, the 
date it was acquired by the consolidated group), the conversion from a 
QOF C corporation to a QOF partnership on day one is an inclusion 
event. See Sec.  1.1400Z2(b)-1(c)(2).
    In the alternative, a pre-existing QOF sub that meets certain 
conditions may elect to maintain its status as a QOF C corporation and 
remain a member of the consolidated group. See part VIII.B.2.a of this 
Summary of Comments and Explanation of Revisions, which describes the 
conditions for such an election. If a pre-existing QOF sub elects to 
remain a member of the consolidated group, the pre-existing QOF sub 
will be subject to unique rules and restrictions not typically 
applicable to a consolidated group member, as discussed in part 
VIII.B.2.b of this Summary of Comments and Explanation

[[Page 1938]]

of Revisions. The pre-existing QOF sub will have 90 days from the date 
of publication of these final regulations to satisfy the conditions for 
consolidating as a subsidiary QOF C corporation.
    Transition relief is available only to pre-existing QOF subs. QOF C 
corporations formed after the publication of the May 2019 proposed 
regulations are not eligible for transition relief, but any such QOF C 
corporation may elect to be treated as a subsidiary member of a 
consolidated group. See part VIII.B.2 of this Summary of Comments and 
Explanation of Revisions for a discussion of the conditions and effects 
of consolidating a subsidiary QOF C corporation.
4. Deconsolidation of Subsidiary QOF C Corporation
    The final regulations also provide rules regarding the 
deconsolidation of QOF members. Deconsolidation can occur when a QOF 
member fails to meet the general section 1504 affiliation requirements 
or fails to satisfy the conditions in these final regulations to 
consolidate a subsidiary QOF C corporation. In addition, 
deconsolidation can occur when a pre-existing QOF sub fails to elect in 
a timely manner one of the transition relief provisions discussed in 
part VIII.B.3 of this Summary of Comments and Explanation of Revisions.
    If a QOF member deconsolidates, the deconsolidation is treated as a 
disposition for purposes of applying the rule in Sec.  1.1502-19 that 
requires any ELA in the QOF member's stock to be included in income, 
and it is treated as a transfer of all of the QOF member stock for 
purposes of applying the unified loss rule in Sec.  1.1502-36. However, 
the deconsolidation constitutes an inclusion event only to the extent 
the deconsolidation event also constitutes an inclusion event as 
defined in Sec.  1.1400Z2(b)-1(c). For example, if a QOF member 
deconsolidates because the investor member sells 25 percent of the QOF 
member stock to a nonmember, the QOF deconsolidates and Sec. Sec.  
1.1502-19 and 1.1502-36 will apply to all QOF shares owned by members, 
but there will be an inclusion event only for 25 percent of the shares. 
In addition, if the investor member has positive basis in QOF member 
stock because of investment adjustments under Sec.  1.1502-32, the 
investor member retains such basis in the QOF member following 
deconsolidation, but such basis is not taken into account in computing 
the investor member's amount includible under section 1400Z-2(b) post-
deconsolidation.
    A special E&P rule applies if the QOF member deconsolidates before 
December 31, 2026. The special E&P rule reverses the general rule for 
deconsolidations in Sec.  1.1502-33(e) to provide that the QOF member 
retains its E&P, and to require elimination from the consolidated group 
of any QOF member's E&P taken into account by other members under Sec.  
1.1502-33. This special rule will permit the QOF C corporation to make 
section 301(c)(1) distributions, to the extent of its E&P, following 
deconsolidation without triggering inclusion of the investor member's 
remaining deferred gain under section 1400Z-2(b).
5. Treatment of QOF Stock Under Section 1504
    The May 2019 proposed regulations treated stock in a QOF C 
corporation as not stock for purposes of section 1504. As discussed in 
part VIII.A of this Summary of Comments and Explanation of Revisions, 
the purpose of this rule was to prevent a subsidiary QOF C corporation 
from being included as a member of an affiliated group filing 
consolidated returns. However, commenters noted that, under this 
proposed rule, the dividends received deduction under section 243 would 
be unavailable to corporate shareholders of QOF C corporations because 
qualification for that deduction depends on the distributing 
corporation and shareholder being part of the same affiliated group. 
Commenters recommended that, even if the final regulations preclude a 
subsidiary QOF C corporation from being a member of an affiliated group 
for purposes of joining in the filing of a consolidated return, the 
final regulations should permit a QOF C corporation to be a member of 
an affiliated group for purposes of the dividends received deduction.
    In response to the foregoing comments, these final regulations 
provide that QOF stock is not treated as stock only for purposes of 
determining eligibility to join in the filing of a consolidated return 
under section 1501. Therefore, this rule will not affect the 
availability of the dividends received deduction or any other provision 
that cross-references affiliation status under section 1504 other than 
consolidated group membership.

C. Qualifying Investments by Members of a Consolidated Group

    In response to the May 2019 proposed regulations, commenters raised 
many questions regarding the interaction of the intercompany 
transaction rules of Sec.  1.1502-13 and section 1400Z-2. For example, 
commenters asked about the application of Sec.  1.1502-13 when a 
qualifying investment is transferred in an intercompany transaction. 
Many of the issues noted by commenters arise regardless of whether the 
QOF is a member of a consolidated group.
    The stated purpose of Sec.  1.1502-13 is to provide rules to 
clearly reflect the taxable income (and tax liability) of the 
consolidated group as a whole by preventing intercompany transactions 
from creating, accelerating, avoiding, or deferring consolidated 
taxable income or consolidated tax liability. In other words, the 
existence of intercompany transactions must not affect consolidated 
taxable income or consolidated tax liability. Therefore, Sec.  1.1502-
13 generally determines the tax treatment of items resulting from 
intercompany transactions by treating members of a consolidated group 
as divisions of a single entity (single-entity treatment).
1. Investment in QOF Member as Qualifying Investment
    As discussed in part VIII.B.1 of this Summary of Comments and 
Explanation of Revisions, commenters requested that subsidiary QOF C 
corporations be permitted to join in the filing of consolidated 
returns. In connection with this request, commenters also sought 
clarification of the application of Sec.  1.1502-13 to the gain 
deferred under section 1400Z-2 when an investor member makes an 
otherwise qualifying investment in a QOF member.
    The Treasury Department and the IRS proposed to exclude a 
subsidiary QOF C corporation from consolidation because, among other 
reasons, the Treasury Department and the IRS determined that section 
1400Z-2 is inconsistent with the intercompany transaction regulations 
under Sec.  1.1502-13. In particular, the Treasury Department and the 
IRS highlighted that the stated purpose of the regulations under Sec.  
1.1502-13 is to ensure that the existence of an intercompany 
transaction (a transaction between two members of a consolidated group) 
does not result in the creation, prevention, acceleration, or deferral 
of consolidated taxable income or tax liability. Based on comments from 
taxpayers and practitioners, the Treasury Department and the IRS have 
considered approaches to provide additional investment structures for 
potential investors in QOZs while ensuring the compatibility of such 
structures with the consolidated return regulations. As a result, the 
final regulations provide that an investment of eligible gain by the 
investor member into a QOF member is not treated as an intercompany 
transaction for purposes

[[Page 1939]]

of Sec.  1.1502-13 and, thus, is a qualifying investment for purposes 
of section 1400Z-2.
2. Treatment of S's Intercompany Gain as Eligible Gain
    These final regulations also include rules that clarify whether and 
when capital gain from an intercompany transaction can constitute 
eligible gain for purposes of section 1400Z-2.
    When a member (S) sells property to another member of the 
consolidated group (B) and recognizes gain, the gain is an intercompany 
gain subject to Sec.  1.1502-13. The matching rule of Sec.  1.1502-
13(c) may apply to redetermine the attributes of S's intercompany gain 
and to control the timing of the reporting of S's intercompany gain. 
Commenters requested clarification as to whether S's intercompany gain 
qualifies as an eligible gain that can be deferred under section 1400Z-
2 and, if so, the time at which S is treated as having an eligible 
gain.
    The final regulations clarify that S's gain and B's gain on the 
property (if any) is treated as eligible gain to the extent the gain 
would be an eligible gain if S and B were divisions of a single entity. 
Moreover, the gain is treated as an eligible gain at the time the gain 
would be taken into account (without regard to the potential 
application of section 1400Z-2) if S and B were divisions of a single 
entity.
3. Application of Sec.  1.1502-13 to Intercompany Transfer of a 
Qualifying Investment
    In discussing the complications arising from the interaction of 
section 1400Z-2 and Sec.  1.1502-13, the preamble to the May 2019 
proposed regulations generally focused on issues that would arise if a 
subsidiary QOF C corporation were a member of a consolidated group. 
Neither the May 2019 proposed regulations nor the preamble thereto 
included any language on the general application of Sec.  1.1502-13 to 
the transfer of qualifying investments. Whether and how Sec.  1.1502-13 
applies to an intercompany transfer of a qualifying investment is an 
issue regardless of whether the QOF is a QOF C corporation or a QOF 
partnership, and regardless of whether the QOF C corporation is a QOF 
member.
    Commenters detailed the technical impediments under the current 
intercompany transaction regulations to achieving single-entity 
treatment when a member of the consolidated group transfers its 
qualifying investment in an intercompany transaction, and they 
requested guidance to grant single-entity treatment to a consolidated 
group after such an intercompany transaction. Commenters also noted 
that section 1400Z-2(c) does not appear to permit an election for the 
basis increase to be made by any party other than the taxpayer who 
makes the qualifying investment.
    As discussed in the preamble to the May 2019 proposed regulations, 
the availability of benefits and the continuation of deferral under 
section 1400Z-2 are determined with respect to the holder's basis in 
the qualifying investment. For example, a shareholder's basis in its 
QOF stock differs from a shareholder's basis in the stock of non-QOF C 
corporations. Because of the difficulties in tracking basis for 
purposes of section 1400Z-2 following the transfer of QOF shares in 
certain nonrecognition transactions (for example, in exchanges to which 
section 351 applies or in reorganizations described in section 
368(a)(1)(B)), the regulations generally applicable to investors in a 
QOF C corporation (whether or not the QOF C corporation is a QOF 
member) provide that the transfer of QOF shares in such nonrecognition 
transactions is an inclusion event under section 1400Z-2(b).
    The same basis tracking issues exist within a consolidated group 
and are magnified by the application of Sec.  1.1502-32, which adjusts 
an upper-tier member's basis in the stock of a lower-tier member to 
reflect items of income, gain, loss, and deduction produced by the 
lower-tier member. As discussed in part VIII.B.2.a.ii of this Summary 
of Comments and Explanation of Revisions, basis adjustments to lower-
tier member stock ``tier up'' within a consolidated group under Sec.  
1.1502-32. In other words, economic items recognized by lower-tier 
members result in basis adjustments to the stock of upper-tier members, 
resulting in blended basis at the upper tiers. Moreover, because an 
upper-tier member may have economic items of its own, the basis of the 
upper-tier members' stock is further blended. This blended basis in the 
consolidated group creates additional tracking issues with regard to 
section 1400Z-2.
    In the interest of administrability and simplicity, the Treasury 
Department and the IRS decline to impose complex new rules for tracing 
the basis in a qualifying investment through tiers of entities and 
across ownership chains within a consolidated group. Instead, to permit 
the movement of qualifying investments within consolidated groups to 
satisfy business needs, these final regulations allow consolidated 
groups to obtain single-entity treatment only on a fully taxable 
intercompany transfer of a qualifying investment. In a fully taxable 
transaction, B takes a cost basis in the qualifying investment; thus, 
S's basis in the qualifying investment is not replicated. As a result, 
in a fully taxable transaction, the gain deferred under section 1400Z-2 
is not replicated in the consolidated group. All other intercompany 
transfers of qualifying investments are treated as not constituting 
intercompany transactions for purposes of Sec.  1.1502-13.
    As noted earlier in this part VIII.C.3 of this Summary of Comments 
and Explanation of Revisions, single-entity treatment for intercompany 
transfers of qualifying investments is not currently available under 
the consolidated return regulations. The limited application of the 
intercompany transaction rules in Sec.  1.1502-13 under these final 
regulations provides consolidated groups with a workable option for 
making necessary transfers of qualifying investments within the 
consolidated group while preventing complications under the section 
1400Z-2 rules.
    To further facilitate single-entity treatment, these final 
regulations enable B to make an election under section 1400Z-2(c) 
following a transfer of a qualifying investment that is treated as an 
intercompany transaction. Specifically, if Sec.  1.1502-13 applies to 
treat S and B as divisions of a single entity for purposes of section 
1400Z-2, then B (and not S) makes the election under section 1400Z-2(c) 
(if eligible), as it is the member that actually owns an interest in 
the qualifying investment at the time of its disposition by the single 
entity. B is eligible to make the election under section 1400Z-2(c) 
only if and when, treating S and B as a single entity, the single 
entity would be eligible to make such an election. For example, under 
single-entity treatment, S and B's holding period in the qualifying 
investment is combined to determine whether the 10-year requirement for 
the election under section 1400Z-2(c) has been met.
4. Treating Investment by One Member as Qualifying Investment by 
Another Member
    Under the May 2019 proposed regulations, the requirements in 
section 1400Z-2 applied separately to each member of a consolidated 
group. Thus, the same member of the consolidated group must both sell 
the capital asset giving rise to eligible gain and timely invest the 
proceeds in a qualifying investment. Commenters argued that this 
requirement is overly restrictive and may limit the ability of 
taxpayers to

[[Page 1940]]

make use of section 1400Z-2 as intended by Congress. Instead, 
commenters recommended that the Treasury Department and the IRS adopt a 
single-entity approach that permits a QOF investment by one member to 
be treated as a qualifying investment by another member with eligible 
gain. One commenter also requested that this treatment be applied to 
investments made prior to June 1, 2019, allowing for a one-month grace 
period following the publication of the May 2019 proposed regulations.
    In response to these comments, and to further the purposes of 
section 1400Z-2, the final regulations include an election to treat the 
investment by one member (M2) as a qualifying investment by another 
member (M1). The election is available when M1 has an eligible gain and 
M2 makes an investment in a QOF that would be a qualifying investment 
if M1 (rather than M2) had made the investment. If the consolidated 
group makes this election, for all Federal income tax purposes M1 is 
treated as making an investment in the QOF and immediately selling the 
qualifying investment to M2 for fair market value. The sale of the 
qualifying investment from M1 to M2 is subject to Sec.  1.1502-13, as 
discussed in part VIII.C.3 of this Summary of Comments and Explanation 
of Revisions.
    The Treasury Department and the IRS decline to adopt the 
recommendation to treat M2's investment as a qualifying investment by 
M1 retroactively because such treatment is available only by election, 
subject to certain conditions. However, taxpayers generally have the 
option to apply these final regulations in their entirety, and in a 
consistent manner, to taxable years beginning after December 21, 2017, 
or to the portion of any taxable year after December 21, 2017. If a 
taxpayer chooses to adopt these final regulations in their entirety for 
taxable years beginning after December 21, 2017, or to the portion of 
any taxable year after December 21, 2017, then taxpayers may elect to 
treat an investment by M2 as a qualifying investment by M1 as of the 
earlier date.

IX. Comments Not Specifically on Regulatory Text

A. Reporting

    The Treasury Department and the IRS have received hundreds of 
comments on whether reporting of the QOF and qualified opportunity zone 
investments was needed, and what type of information should be 
reported. On May 1, 2019, the Treasury Department published a notice 
and request for information to seek public input on the development of 
public information collection and tracking related to investment in 
qualified opportunity funds. See 84 FR 18648. As indicated in the 
proposed regulations, the Treasury Department and the IRS were 
considering certain changes to the Form 8996 requiring QOFs to report 
additional information regarding the location of their investments.
    Several comments suggested that no additional reporting should be 
required and that the amount of reporting already required was 
sufficient. Several other comments requested that additional reporting 
be allowed, but to not be onerous or prohibitive in either cost or 
time. Other comments suggested that the reporting should be coordinated 
with other government agencies, such as the Department of Housing and 
Urban Development (HUD) or the Treasury Department's CDFI Fund, and 
local and state governments.
    Many commenters requested additional reporting, on items such as 
location of investments, job creation in the QOZ, the impact on the 
local economy, number of units of affordable housing built, and any 
reduction in poverty. These comments requested that such information be 
made public, including a database which the public can use to track 
projects nationally and the creation of a standardized set of 
performance metrics. One commenter asked for reporting guidelines for 
entities that lend capital to QOFs.
    The Treasury Department and the IRS are appreciative of the 
comments received focused on requiring reporting of data in addition to 
what is useful for tax administration purposes. Comments received in 
this regard are not adopted in these final regulations. However, On 
October 30, 2019, the IRS released an early release draft of Form 8996 
for public review. The early release draft includes additional 
reporting requirements for QOFs. The information required to be 
reported focuses on data useful for tax administration purposes, data 
that may also be instructive in measuring the impact and effectiveness 
of the statute.

B. REITs

    Several commenters discussed passing the benefits of a REIT's 
qualifying investments to the REIT's shareholders. These comments 
include applying the 1400Z-2(c) basis adjustment rules for E&P purposes 
so that distributions of gain from the disposition of a qualifying 
investment will not result in ordinary income to the REIT's 
shareholders. Additionally, the commenters asked that REITs have the 
ability to distribute tax-exempt capital gain dividends to the extent 
attributable to the REIT's gain with respect to its qualifying 
investments. The Treasury Department and the IRS have concluded that 
such special rules for REITs and their shareholders would create a 
vehicle in which taxpayers that do not make a qualifying investment for 
the required period of time pursuant to section 1400Z-2 would 
nevertheless receive the benefits of that section. Thus, these changes 
were not accepted. REITs may still qualify and elect to be QOF REITs or 
may distribute capital gain dividends to their shareholders who in turn 
may invest those capital gain dividends in a QOF pursuant to section 
1400Z-2.

C. Policy

    In addition to comments concerning the proposed regulations, 
several comments were received concerning the tax benefits of the 
statute. For example, some commenters requested preferred treatment for 
various classes of individuals and entities, including veterans, 
healthcare practitioners, needy individuals, and residents of QOZs. 
Several other commenters requested that the Treasury Department and the 
IRS should disallow the tax benefits provided by section 1400Z-2 if 
entities fail to build a sufficient number of affordable housing units. 
Another commenter suggested that the tax benefits provided by section 
1400Z-2 in general should be disallowed if a QOF or qualified 
opportunity zone business fails to operate solely within a QOZ.
    Many commenters requested a rule requiring managers of QOFs to 
certify that they had not been convicted of financial crimes within the 
past three years, and register with the local government that they are 
managing a QOF. Further, many commenters suggested requiring QOF 
managers to demonstrate that their actions have not encouraged any 
additional displacement of residents in low income areas. Some 
commenters were concerned with the impact that QOFs and qualified 
opportunity zone businesses will have on existing small businesses 
located within QOZs.
    Several commenters requested that the Treasury Department and the 
IRS require that QOFs and qualified opportunity zone businesses 
coordinate their activities with other Federal agencies, like HUD, and 
CDFI Fund, and state and local government and housing agencies. Several 
others suggested allowing local jurisdictions to add criteria that is 
consistent with a locality's needs and goals. Two commenters stated 
that the capital invested in QOFs should be invested in

[[Page 1941]]

small and midsize businesses, rather than large corporations. Another 
commenter suggested additional guidance to permit housing finance 
agencies to layer their programs within QOZs with QOFs or qualified 
opportunity zone businesses. One commenter requested guidance on using 
QOF investments to satisfy requirements pertaining to certain 
depository institutions under the Community Reinvestment Act.
    Several commenters requested coordination and integration with 
local government authorities including measures to coordinate projects 
within QOZs with other government funded projects and a formal process 
for local and regional authorities to review projects in QOZs. Another 
comment suggested that the Treasury Department and the IRS mandate 
cooperation by QOFs with local community banks to determine who needs 
the most assistance.
    The Treasury Department and the IRS received several comments 
concerned that QOFs and qualified opportunity QOZ businesses would not 
benefit the existing residents and businesses in designated QOZs. These 
commenters suggested adding provisions to the final regulations aimed 
at the prevention of displacement of residents, and targeted incentives 
to aid the neediest of QOZs. Several others suggested that the Treasury 
Department and the IRS require that QOF investments target local 
businesses with established ties to the local communities and that 
serve the local community's needs. Another comment requested that 
preference should be shown to local and/or minority owned businesses, 
or sustainably focused companies. Finally, a commenter suggested that 
there should be a requirement that a minimum number of local residents 
be employed by a QOF or qualified opportunity zone business.
    In addition to the comments noted earlier, the Treasury Department 
and the IRS received comments requesting that certain items, such as 
food inventory or business related property owned by the residents of 
QOZs, should qualify as qualified opportunity zone business property.
    The Treasury Department and the IRS will continue to study the 
issues addressed in these comments. However, many of these comments are 
outside the scope of these final regulations. In addition the Treasury 
Department and the IRS are concerned with the potential complexity 
associated with creating rules that would interfere with the ultimate 
intent of the statute, which is to invest new capital in low-income 
communities.

D. QOZ Designations

    The Treasury Department and the IRS received many comments 
regarding section 1400Z-1 and the process for designating QOZs. Several 
comments requested that the determination process be reopened, so new 
QOZs could be designated. One commenter requested that if no investment 
has occurred in a QOZ, that accommodation be provided to replace it 
with another QOZ. Another comment suggested that some designated QOZs 
either do not meet the statutory requirements or were mistakenly 
nominated.
    The Treasury Department and the IRS are appreciative of the 
comments received on the designation of the QOZs. Section 1400Z-1 
provides the statutory authority for one round of nominations and 
designations. Thus, there are no current or proposed plans to reopen 
consideration of additional census tracts to be designated as QOZs.
    Several comments were received questioning how QOFs and qualified 
opportunity zone businesses would be treated after the QOZ designation 
expires. Another commenter asked for clarification for the treatment of 
QOFs and qualified opportunity zone businesses if the census tract 
boundaries change during the designation period. Under the October 2018 
proposed regulations and Sec.  1.1400Z2(c)-1(b) of the final 
regulations, although QOZ designations expire on December 31, 2028, a 
taxpayer who makes an election under section 1400Z-2(a) and whose 
holding period in the qualifying investment is at least 10 years, is 
eligible to make an election described in section 1400Z-2(c) on the 
sale or exchange of the qualifying investment. Accordingly, if a 
portion of the taxpayer's 10-year holding period under section 1400Z-
2(c) accrues after the relevant census tract's QOZ designation expires 
on December 31, 2028, this fact alone should not disqualify a 
taxpayer's properly executed QOF investment from the benefit of section 
1400Z-2(c).

E. Questions and Comments on the Penalty Under Section 1400Z-2(f)(1)

    Under section 1400Z-2(f)(1), if a QOF fails to meet the 90-percent 
investment standard, the QOF shall pay a penalty for each month it 
fails to meet the requirements in an amount equal to the excess of the 
amount equal to 90-percent of its aggregate assets over the aggregate 
amount of qualified opportunity zone property held by the QOF, 
multiplied by the underpayment rate established under section 
6621(a)(2) for such month.
    Several commenters requested clarification on the mechanics of this 
penalty, including whether there is a possibility of the QOF, or its 
investors, of losing the benefits, if the QOF fails to meet the 90-
percent investment standard for an extended period of time.
    Two other commenters requested that, to calculate the penalty, only 
the assets that were the subject of the deferral election, should be 
included. They reason that the statute could be interpreted to assess a 
QOF based upon a shortfall related to its aggregate assets, regardless 
of the source of financing for those assets.
    One commenter requested that the Treasury Department and the IRS 
eliminate the testing dates under section 1400Z-2(d)(2)(A) and instead 
adopt a penalty based on a per month penalty.
    Finally, one commenter suggested that the Treasury Department and 
the IRS should use the anti-abuse provision to create penalties for 
failing to invest in entities that meet the policy objectives mentioned 
in a prior section.
    The Treasury Department and the IRS appreciate the comments 
received on the penalty imposed on QOFs under section 1400Z-2(f)(1). 
All comments will be considered for future guidance.

F. Reasonable Cause

    Under section 1400Z-2(f)(3), no penalty shall be imposed on a QOF 
with respect to any failure to meet the 90-percent investment standard 
if it is shown that the failure is due to reasonable cause.
    Multiple commenters requested clarification on what would 
constitute reasonable cause. Several commenters requested that 
reasonable cause should be defined to include circumstances that are 
outside the QOF's control to deploy capital into qualifying 
investments. The Treasury Department and the IRS are cognizant that 
this is an area for which commenters requested relief. The final rules 
provide a 6 month period in which QOFs may choose to disregard recently 
contributed property from the 90-percent investment standard. That rule 
may be elected in circumstances in which a QOF is unable to deploy its 
capital into qualified opportunity zone property.
    Another commenter requested that the final rule provide a non-
exhaustive list of circumstances that would constitute reasonable 
cause. The final rule does not adopt these comments. The determination 
of whether there is reasonable cause for penalty relief in a particular 
case is inherently factual. The Treasury Department and the IRS have

[[Page 1942]]

determined that the appropriate standards for determining whether the 
reasonable cause exception to the penalty applies in a particular case 
are the general standards set out in the ``Penalty Handbook,'' which is 
included in Internal Revenue Manual (IRM) at section 20.1. The Treasury 
Department and the IRS will consider whether further guidance specific 
to the penalty under section 1400Z-2(f)(1) is necessary in the future.

G. Regulatory Flexibility Act

    The Treasury Department and the IRS received comments on the 
Regulatory Flexibility Act (5 U.S.C. chapter 6) (RFA) urging that an 
RFA analysis on the potential significant economic effect of these 
final regulations on small entities be conducted by the Treasury 
Department and the Small Business Administration. The Treasury 
Department and the IRS do not agree that an analysis is required. There 
is a lack of data as to the extent to which small entities invest in 
QOFs, will certify as QOFs, or receive equity investments from QOFs. 
However, the Treasury Department and the IRS project that most of the 
investment flowing into QOFs will come from large corporations and 
wealthy individuals, though some of these funds would likely flow 
through an intermediary investment partnership. There may be some QOFs 
and qualified opportunity zone businesses that will be classified as 
small entities; however, the number of small entities significantly 
affected is not likely to be substantial.

Effective/Applicability Dates

    Sections 1.1400Z2(a)-1 through 1.1400Z2(f)-1, 1.1502-14Z, and 
1.1504-3 generally apply to taxable years beginning after March 13, 
2020. However, for the portion of a taxpayer's first taxable year 
ending after December 22, 2017, that began on December 22, 2017, and 
for taxable years beginning after December 21, 2017, and on or before 
March 13, 2020, taxpayers may choose either (1) to apply the rules set 
forth in Sec. Sec.  1.1400Z2(a)-1 through 1.1400Z2(f)-1, 1.1502-14Z, 
and 1.1504-3 contained in this document, if applied in their entirety 
and in a consistent manner for all such taxable years, or (2) to rely 
on each section of the proposed regulations under Sec. Sec.  
1.1400Z2(a)-1 through 1.1400Z2(g)-1, except for Sec.  1.1400Z2(c)-1, 
issued on October 29, 2018, and on May 1, 2019, but only if applied in 
their entirety and in a consistent manner for all such taxable years. 
See section 7805(b)(7)

Special Analyses

I. Regulatory Planning and Review--Economic Analysis

    Executive Orders 13711, 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, of reducing costs, of harmonizing rules, and of promoting 
flexibility. For purposes of Executive Order 13771, this rule is 
deregulatory.
    The final regulations have been designated 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 (OMB) regarding review of tax regulations. The 
Office of Information and Regulatory Affairs has designated these 
regulations as economically significant under section 1(c) of the 
Memorandum of Agreement. Accordingly, the OMB has reviewed these 
regulations.

A. Need for the Final Regulations

    As a part of the Tax Cuts and Jobs Act (TCJA), Congress enacted 
section 1400Z, which provided tax incentives related to investment in 
qualified opportunity zones (QOZs). The Treasury Department and the IRS 
issued proposed regulations related to section 1400Z-2 on October 29, 
2018 (October 2018 proposed regulations) and May 1, 2019 (May 2019 
proposed regulations), together referred to as the proposed 
regulations. The numerous comments to the proposed regulations indicate 
substantial interest in the opportunity zone tax incentives provided in 
section 1400Z-2. The comments demonstrate a variety of opinions on how 
to interpret ambiguous parts of section 1400Z-2 and on how section 
1400Z-2 interacts with other sections of the tax code and corresponding 
regulations. The Treasury Department and the IRS are aware of concerns 
raised by commenters that some investors have been reticent to make 
substantial investments in QOZs without first having additional clarity 
on which investments would qualify to receive the preferential tax 
treatment specified by the TCJA.
    Based on these considerations, the final regulations are needed to 
bring clarity to instances where the meaning of the statute was unclear 
and to respond to comments received on the proposed regulations.

B. 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 QOZs (see 
Senate Committee on Finance, Explanation of the Bill, at 313 (November 
22, 2017)). To this effect, taxpayers may elect to defer the 
recognition of capital gain to the extent of amounts invested in a 
qualified opportunity fund (QOF), provided that such 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 investments 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 also may be 
excluded from income. In turn, a QOF is required under the statute to 
hold at least 90 percent of its assets in qualified opportunity zone 
property, as measured by the average percentage of assets held on the 
last day of the first six-month period of the taxable year of the fund 
and on the last day of the taxable year. The statute requires a QOF 
that fails this 90-percent investment standard to pay a penalty for 
each month it fails to satisfy this requirement.

C. Economic Analysis

1. Baseline
    The Treasury Department and the IRS have assessed the economic 
effects of the final regulations relative to a no-action baseline 
reflecting anticipated Federal income tax-related behavior in the 
absence of these final regulations.
2. Summary of Economic Effects
    The final regulations provide certainty and clarity to taxpayers 
regarding utilization of the tax preferences for capital gains provided 
in section 1400Z-2 by defining terms, calculations, and acceptable 
forms of documentation. The Treasury Department and the IRS project 
that this added certainty and clarity generally

[[Page 1943]]

will encourage taxpayers to increase the amount of investment located 
in QOZs relative to the no-action baseline. The certainty and clarity 
added by the final regulations and the specific regulatory decisions 
they entail will further bring the volume and diversity of investment 
in QOZs and in non-QOZs closer to the intent and purpose of the 
statute, relative to the alternative regulatory approaches that were 
considered, including the no-action baseline.
    The Treasury Department and the IRS have not attempted to quantify 
the economic effects of any changes in business activity stemming from 
these final regulations, in part because of the uncertainty regarding 
the patterns of investment that will materialize as a result of QOF 
activity and the distribution of investments across opportunity zones. 
The Treasury Department and the IRS do not have readily available data 
or models that predict with reasonable precision the decisions that 
taxpayers would make under the final regulations versus alternative 
regulatory approaches, including the no-action baseline. Nor do they 
have readily available data or models that would measure with 
reasonable precision the loss or gain in economic surplus resulting 
from these investment and business decisions relative to the decisions 
that would be made under an alternative regulatory approach. Such 
estimates would be necessary to quantify the economic effects of the 
final regulations versus alternative approaches. Subject to these 
limitations, the next two sections of these Special Analyses provide a 
qualitative assessment of the economic effects of the final regulations 
relative to the alternative regulatory approaches that were considered.
    The Treasury Department and the IRS welcome comments on this 
economic analysis as well as analysis regarding how choices made in 
this regulation will materially affect specific types of investments 
that are likely to attract capital that has been invested in QOFs.
3. Number of Affected Taxpayers
    Because section 1400Z-2 is a new provision and many of the entities 
affected by these regulations have not yet been formed, there is 
considerable uncertainty regarding the number of taxpayers that will 
eventually be affected by the final regulations. Based in part on the 
preliminary number of taxpayers filing Form 8996 for tax year 2018 and 
the assumption that a QOF will on average have 10 investors, the 
Treasury Department and the IRS project that between 5,500 and 12,000 
QOFs, 6,000 to 15,000 qualified opportunity zone businesses, and 55,000 
to 120,000 investors in QOFs will eventually be affected by the final 
regulations.
4. Economic Effects of Provisions Substantially Revised From the 
Proposed Regulations
a. Eligible Gains From Section 1231 Property
    The final regulations provide that a gain is eligible for deferral 
under section 1400Z-2(a) if the gain is treated as a capital gain for 
Federal income tax purposes. There is uncertainty, however, regarding 
how to treat gains arising from selling section 1231 property. Section 
1231 property is certain property used in a trade or business, such as 
depreciable property and land, and also includes capital assets subject 
to an involuntary conversion, such as arising from a natural disaster 
or theft. Under the Code, gains from the sale or exchange of section 
1231 property are characterized as capital gains if the sum of all 
section 1231 transactions for the taxable year is positive. If the sum 
of all section 1231 transactions for the year is negative, then the 
losses are ordinary losses.\1\
---------------------------------------------------------------------------

    \1\ One source of ambiguity is determining whether gain from 
selling an item of section 1231 property that is potentially 
eligible for deferral should be included in the summation of 1231 
property in the year the deferral begins or the year the deferral 
ends.
---------------------------------------------------------------------------

    The Treasury Department and the IRS considered two main options for 
the treatment of gains from section 1231 property.\2\ The primary issue 
is whether the amount of the gains eligible for deferral is based on 
the sum of all sales over the taxable year or on an item-by-item basis. 
These approaches are also referred to as the net approach and gross 
approach, respectively.
---------------------------------------------------------------------------

    \2\ The Treasury Department and the IRS also considered the 
option of not issuing specific guidance on this topic but determined 
that this was clearly inferior to the two main options.
---------------------------------------------------------------------------

    The statute also sets a 180-day requirement for investment in a QOF 
beginning on the date of the sale or exchange generating the gain, to 
be eligible for deferral under section 1400Z-2(a). The two options for 
calculating eligible section 1231 gains further determine when the 180-
day requirement begins. When gains are based on the sum of sales over 
the taxable year, the 180-day period starts at the end of the taxable 
year, after it is determined whether the sum is positive or negative, 
and how large the net positive gain is. When gains are counted item-by-
item, it is possible, although not necessary, to start the 180-day 
period from the date of each sale.
    The proposed regulations used the net approach. Under the proposed 
regulations, the only gain arising from section 1231 property eligible 
for deferral under section 1400Z-2(a) was the amount by which the gains 
arising from all of a taxpayer's section 1231 property exceeded all of 
the taxpayer's losses from section 1231 property for a taxable year. In 
addition, the proposed regulations provided that the 180-day period for 
investment with respect to capital gain net income from section 1231 
property for a taxable year began on the last day of the taxable year 
without regard to the date of any particular disposition of section 
1231 property.
    The final regulations adopt the gross approach. Under the final 
regulations, eligible section 1231 gains are determined on an item-by-
item basis and therefore positive gains are not reduced by section 1231 
losses. Furthermore, the amount of the gain is known at the time of 
each sale so it is not necessary for the taxpayer to wait until the end 
of the taxable year to determine whether any positive section 1231 
sales will be offset by losses. As a consequence, the final regulations 
further provide that the 180-day period for investing an amount with 
respect to an eligible section 1231 gain for which a deferral election 
has been made begins on the date of the sale or exchange that gives 
rise to the section 1231 gain. In addition, the final regulations do 
not determine the character of eligible section 1231 gains, other than 
as gains arising from the sale or exchange of section 1231 property, 
until the taxable year such gains are taken into account in computing 
gross income pursuant to section 1231(a)(4). The treatment of section 
1231 property under the gross option is essentially the same treatment 
provided in the final regulations for gain arising from the sale of a 
capital asset as defined by section 1221.
    To illustrate this discussion, suppose that Corporation A sells two 
pieces of section 1231 property during the taxable year, one for a $100 
gain early in its taxable year and the other for a $30 loss later in 
its taxable year. Suppose that Corporation B also sells two pieces of 
section 1231 property during the taxable year, one for a $20 gain, the 
other for a $50 loss. Neither taxpayer realizes any other capital gain 
during the taxable year.
    Under the net approach, Corporation A's net gain is $70, which is 
positive. Thus, it would be able to defer up to $70 in capital gain by 
investing in a QOF. Corporation B has a net loss from selling section 
1231 property. This net loss would be treated as ordinary and no

[[Page 1944]]

gains would be deferrable under section 1400Z-2(a). Furthermore, 
although Corporation A sells the first piece of property for a gain 
early in its taxable year, it would not be able to make a qualifying 
investment in a QOF until the last day of the taxable year, because it 
needs to wait until the end of the tax year to determine whether it is 
eligible to defer any of the gain.
    Under the gross approach, only the gains need to be accounted for. 
Corporation A would be able to defer $100 in gain and Corporation B 
would be able to defer $20. In this case, the amount of gain eligible 
for deferral increases for both taxpayers. The total amount of gain 
eligible for deferral increases from $70 to $120 compared to the net 
approach.
    Although not determinative, we note that the gross approach, as 
adopted under the final regulations, will generally expand the pool of 
gains eligible for deferral under section 1400Z-2(a) relative to the 
net approach specified under the proposed regulations.\3\ Based on 
recent taxpayer records, the Treasury Department and the IRS estimate 
that the gross option may increase the amount of eligible gains by four 
to eight percent compared to the net option. The increase in 
potentially eligible gains overstates the likely increase in investment 
in QOFs resulting from using the gross approach (rather than the net 
approach) for two different reasons. First, for many taxpayers, the 
amount of section 1231 gains is not likely to be a binding constraint 
on the amount of investment made by the taxpayer into a QOF because of 
the ability of the taxpayer to defer other sources of capital gains. 
Second, taxpayers have considerable discretion over when to realize 
gains, and even under the net approach taxpayers could often plan on 
selling section 1231 property with sufficient net gain in a taxable 
year to cover the amount of desired QOF investment. The Treasury 
Department and the IRS have not attempted to estimate the overall 
effect of this provision of the final regulations (relative to the 
proposed regulations) on either QOZ or non-QOZ investment.
---------------------------------------------------------------------------

    \3\ For a given set of section 1231 sales, positive gains for 
each individual taxpayer will never be lower under the gross 
approach than the net approach; this result follows from 
mathematical principles and is not specific to this example. In 
practice, taxpayers might choose to recognize gains differently 
under the two approaches. This difference complicates any projection 
of actual gains that would be eligible for deferral.
---------------------------------------------------------------------------

    An additional effect of the gross option would be to minimize the 
tax considerations of determining the best time to sell section 1231 
property, leading to a more efficient use of resources. Under the gross 
option, taxpayers would be less likely to delay or rush selling section 
1231 property in order to achieve the desired amount of net gain that 
would be eligible for deferral within a particular year. Also, under 
the gross option, taxpayers would have more flexibility in realizing 
gains eligible to be invested in a QOF in calendar year 2019.
    The Treasury Department and the IRS considered several variations 
to these two primary options. For example, one intermediate option 
would have required taxpayers to wait to determine the capital gain 
character of section 1231 property sales until summing at the end of 
the taxable year, but then allow the gross amount of gains to be 
eligible for deferral if the net is positive. Under this intermediate 
option, Corporation A would be eligible to defer $100 in gain, while 
Corporation B would not be able to defer any amount. The pool of 
eligible gains would be greater than under the net option, but less 
than the gross option. This intermediate option would also have the 
costs similar to the net option regarding the need for taxpayers to 
wait to until the end of the taxable year before investing in a QOF.
    The number of taxpayers expected to be affected by this aspect of 
the final regulations ranges between 36,000 and 80,000 investors in 
QOFs.
b. Sales or Exchanges of Property by QOF Partnerships and QOF S 
Corporations
    The Treasury Department and the IRS considered three options for 
how owners of QOF partnerships and QOF S corporations may exclude gains 
from tax on qualifying investments in the QOF held longer than 10 
years. First, the Treasury Department and the IRS considered not 
providing a specialized rule for QOF partnerships and QOF S 
corporations. Under this option, owners of a QOF would need to sell or 
exchange their QOF ownership interest to another party in order to 
receive the exemption from tax on the gain. For certain business 
structures, this would not be the most efficient way to dispose of the 
assets of the QOF. For example, suppose QOF A has 20 partners and QOF A 
owns two commercial buildings that are qualified opportunity zone 
business property. If another investor B would like to purchase one of 
the buildings, it would generally be easier for QOF A to sell the 
building to investor B directly, rather than investor B buying out the 
partnership interests of several or all of the partners of QOF A. Under 
this first option, the owners of QOF A would only receive tax free gain 
from their investment if they are able to find an investor willing to 
buy their partnership interests in QOF A. This option would likely lead 
to relatively high negotiating costs and may reduce the pool of 
potential buyers for QOF assets.
    Second, the May 2019 proposed regulations proposed that investors 
in a QOF partnership or a QOF S corporation could elect to exclude 
capital gains arising from the QOF selling qualified opportunity zone 
property from gross income. This option would provide a simpler way for 
owners of pass-through QOFs to receive tax-free gain, but it would 
apply only in certain cases. It would apply only to capital gains and 
not ordinary gains, such as the recapture of depreciation deductions. 
Also, this option would apply only to QOFs selling qualified 
opportunity zone property, and would not apply to qualified opportunity 
zone business property sold by a qualified opportunity zone business 
that is a subsidiary of the QOF.
    Third, the final regulations allow QOF owners to elect to exclude 
from gross income all gains and losses of a QOF partnership or QOF S 
corporation (except those deriving from sales of inventory in the 
ordinary course of business). This would allow the gains from the sale 
of qualified opportunity zone business property by a qualified 
opportunity zone business to flow through to the owners of the QOF as 
excluded from income. This election can be made on an annual basis, but 
it must apply to all gains and losses of the QOF partnership or QOF S 
corporation for that taxable year. In addition, when the proceeds from 
the asset sales are reinvested, rather than distributed as cash, then 
the QOF owner's share of the qualifying investment is reduced as the 
reinvested amount is deemed to be a non-qualifying investment.
    These rules generally match the tax treatment that would exist for 
an owner of a QOF partnership or QOF S corporation after selling a 
qualifying investment in the QOF after it has been held at least 10 
years, but would avoid the extra costs associated with negotiating the 
selling price of the interest in the QOF, rather than the underlying 
assets owned by the QOF or qualified opportunity zone business. The 
Treasury Department and the IRS project that this approach will lead to 
a reduction in transactions costs for taxpayers relative to alternative 
approaches (the no-action baseline and the proposed regulations), and 
will continue to treat similar taxpayers similarly. The number of 
taxpayers

[[Page 1945]]

expected to be affected by this rule ranges between 5,000 and 11,500 
QOFs, and 50,000 to 115,000 investors in QOFs.
c. Substantial Improvement of Qualified Opportunity Zone Business 
Property
    Section 1400Z-2(d)(2)(D) requires that if tangible property was 
already used in a QOZ (non-original use asset) when purchased by a QOF 
or qualified opportunity zone business, then it needs to be 
substantially improved by the QOF or qualified opportunity zone 
business before it can become qualified opportunity zone business 
property. Substantial improvement, as defined by section 1400Z-
2(d)(2)(D)(ii), requires the QOF or qualified opportunity zone business 
to more than double the adjusted basis of the property within 30 months 
after acquiring the property. The Treasury Department and the IRS 
considered two options for how to measure substantial improvement.
    First, the proposed regulations provided an asset-by-asset 
approach. This option would require each property to be substantially 
improved in order to become qualified opportunity zone business 
property. For example, if a QOF purchases an existing commercial 
building, a separate determination for each piece of tangible property 
associated with the building would be needed, such as the structure 
itself, and every item of furniture and equipment within the building 
that is not part of the building structure.
    This approach would limit the ability of taxpayers to purchase 
property already used within a QOZ, place that property in service in 
the taxpayer's business with little improvement from the previous 
owner, and have the property be qualified opportunity zone business 
property. This option would also likely encourage the purchase and 
substantial improvement of existing property with low existing basis; 
that is, property where it is easier for improvement expenditures to 
double the existing basis. Such properties are more likely to be older 
and more in need of repair and upgrades.
    Second, the final regulations allow taxpayers to use an asset-by-
asset approach (as provided in the proposed regulations) or a more 
aggregative approach. The final regulations allow purchased original 
use property to count towards the determination of whether non-original 
use property has been substantially improved if such purchased original 
use property improves the functionality of the non-original use 
property along with other conditions. Also, certain betterment 
expenses, such as environmental remediation or utility upgrades, which 
are properly chargeable to the basis of the land, may be added to the 
basis of a building on the land that was non-original use property for 
the purpose of calculating substantial improvement of that building. 
These rules in effect expand the definition of what expenses could be 
considered improvements for a particular asset. In some cases, this 
option could reduce compliance costs for taxpayers, as it is not always 
clear under the Code and regulations when expenditures should be 
considered an improvement of an existing property, for example a 
building, or be considered separate depreciable property.
    These rules will make it easier for purchased non-original use 
property to be substantially improved compared to the proposed 
regulations. This will help to smooth the cliff effect that occurs with 
the statutory requirement that improvements need to more than double 
the cost basis. For example, suppose a QOF purchases a non-original use 
building in a QOZ for $1 million, makes $950,000 in improvements to the 
building that bring that building into good condition for that local 
market, and purchases $50,001 of furniture or equipment for use within 
the building. This building would not meet the substantial improvement 
test under the proposed regulations but it would meet it under the 
final regulations.
    In addition, the final regulations allow a QOF or qualified 
opportunity zone business to aggregate multiple buildings into a single 
property for purposes of the substantial improvement test. The 
buildings must either be entirely located within a parcel of land 
described in a single deed, or the buildings may be on contiguous 
parcels of land with separate deeds if certain conditions are met that 
indicate the buildings are related in management or use.
    This rule would expand the number of existing buildings in a QOZ 
that could be purchased by a QOF or a qualified opportunity zone 
business and be deemed to have met the substantial improvement test 
relative to the first option. For example, one expensive renovation 
project would provide excess ``improvement expenses'' that could be 
applied to other buildings. This increases the likelihood that certain 
substantial renovation projects would be undertaken. However, the 
ability to aggregate improvement of non-original use property could 
effectively allow a QOF or qualified opportunity zone business to 
purchase property already fully in use in a QOZ and count it as 
qualified opportunity zone business property, though use by the new 
owner would be qualitatively similar to the previous owner.
    In summary, the Treasury Department and the IRS considered two 
primary options for how much aggregation to allow when determining 
whether purchased non-original use property satisfied the substantial 
improvement test. The different options would likely have different 
effects on the amount and distribution of non-original use property 
purchased by QOFs and qualified opportunity zone businesses. The 
proposed regulations would not allow any aggregation, and instead 
require each of the assets purchased under this option to receive 
substantial improvement. This would focus improvement expenditures on 
properties most in need of considerable rehabilitation to remain 
productive.
    The final regulations allow aggregation, and will likely encourage 
the purchase and improvement of more non-original use property compared 
to the proposed regulations. The final regulations will also likely 
lead to a broader mix of properties purchased and improved relative to 
the first option. However, the final regulations also increase the 
likelihood that some buildings will meet the substantial improvement 
test when the individual building receives little to moderate 
improvements. Overall, the rules provided in the final regulations make 
it easier for a non-original use property to be substantially improved 
relative to the proposed regulations, which will encourage more 
investment through QOFs.
    The Treasury Department and the IRS project that the number of 
taxpayers expected to be affected by this rule ranges between 5,500 and 
12,000 QOFs plus 6,000 to 15,000 qualified opportunity zone businesses.
d. Vacancy
    Property that is eligible for opportunity zone treatment must be 
``original use'' or substantially improved. This statutory language 
leaves open the question of the conditions under which vacant property 
that is developed and used by an opportunity zone business might count 
as original use.\4\ The Treasury Department and the IRS considered 
options of one, three, or five years for how long existing property 
located in a QOZ must be vacant before the purchase

[[Page 1946]]

of such property would allow it to be considered original use property. 
The May 2019 proposed regulations proposed that property would need to 
be vacant for at least five years prior to the purchase by a QOF or 
qualified opportunity zone business in order to satisfy the original 
use requirement under section 1400Z-2(d)(2)(D)(i)(II).
---------------------------------------------------------------------------

    \4\ The Treasury Department and the IRS also considered taking 
no action but determined that providing a definition of vacancy and 
setting a time period for when vacant property could be purchased 
and considered original use property would be beneficial relative to 
providing no specific guidance.
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    In selecting among these options, the Treasury Department and the 
IRS recognize that vacant property is an underused resource to the 
owner and potential users of the property, and can lower the value and 
use of neighboring property. The Treasury Department and the IRS 
further recognize that property could become vacant due to economic 
reasons unrelated to section 1400Z-2, but also because the owner 
strategically let the property become or stay vacant in expectation 
that the property would have a higher resale value if it were eligible 
to be original use property under section 1400Z-2(d)(2)(D)(i)(II).
    A shorter period of required vacancy provides a greater incentive 
for owners of vacant property to keep it vacant for purposes of later 
selling it for use as original use property. This incentive may also 
result in owners vacating property that is currently occupied. On the 
other hand, a longer period of required vacancy means that on average 
properties would remain vacant for a longer period before being sold 
and put into productive use, which would increase the likelihood that 
such property (and possibly surrounding property) would be 
inefficiently used.
    The final regulations provide that the required time of vacancy is 
three years except for property that was vacant as of the date of 
publication of the QOZ designation notice in which the designation of 
the QOZ is listed, in which case the vacancy period is one year. This 
one-year period for vacant property at the time of designation provides 
an incentive for property that was vacant for economic reasons at the 
time of publication of the QOZ designation notice to be quickly placed 
back into service through sale to a new owner, thus reducing the social 
costs that would occur if those properties remained unused, relative to 
the longer three-year period. The three-year period for property that 
was not initially vacant makes it costly for owners to strategically 
limit the use of the property in order to gain a more favorable 
condition for selling the property in the future, relative to a shorter 
period. The Treasury Department and the IRS recognize, however, that 
even under this three-year specification, there may be situations where 
a property becomes vacant for a period of time due to economic reasons 
and the owner of that property decides to let the property remain 
vacant in order to receive an expected higher price upon selling after 
the three-year vacancy period is met.
    The number of taxpayers expected to be affected by this rule ranges 
between 5,500 and 12,000 QOFs plus 6,000 to 15,000 qualified 
opportunity zone businesses.
e. Subsidiary of a Consolidated Group
    The statute is silent regarding the treatment of corporate 
taxpayers that file consolidated returns and seek to invest in a QOF. 
The Treasury Department and the IRS considered two options to address 
this issue. Under the proposed regulations a consolidated group could 
invest in a corporate QOF only if the QOF would not be treated as part 
of the consolidated group for tax filing purposes. That is, a QOF could 
not be a subsidiary of a consolidated group, because of concerns of 
potential conflicts between the section 1400Z-2 rules and the 
consolidated group rules in Sec.  1.1502. Under this approach, the 
gains and losses of a corporate QOF would not be shared with the 
consolidated group owning the QOF when determining aggregate tax 
liability of the consolidated group, but rather the QOF would file its 
own tax return, leading to a small increase in compliance burden.
    This treatment could affect the choice of QOF entity for a 
consolidated corporate group that wanted to own a QOF, making a 
partnership QOF a more likely choice as tax attributes of the 
partnership QOF (income, deductions, credits, etc.) would flow to the 
member of the consolidated corporate group that owns the QOF. Sharing 
those tax attributes of a partnership QOF with other members of the 
group is subject to certain limitations. However, if the QOF is a 
corporate subsidiary member of the consolidated group, there is more 
flexibility with how tax attributes of the QOF are shared with the rest 
of the consolidated group. In addition, some corporate consolidated 
groups are likely to favor a using a corporate form due to familiarity 
with the corporate rules that would lead to lower organizational costs. 
These additional organizational or tax compliance costs are not likely 
to be large, but nevertheless may discourage investment in QOFs for 
some consolidated groups.
    Therefore, the final regulations permit corporate taxpayers filing 
consolidated returns to own a QOF that is a subsidiary member of the 
consolidated group; and, as provided in the proposed regulations, a 
corporate QOF may be the parent member of a consolidated group. This 
option will reduce the limitations on the organizational structure of 
QOF investments that would have occurred under the proposed 
regulations. The final regulations permit the consolidation of a 
subsidiary QOF corporation only if certain conditions are satisfied. 
Specifically, except in very limited circumstances, the group member 
making the qualifying investment in the QOF member (investor member) 
must maintain direct equity interest of the QOF member stock. More 
importantly, all investor members must be wholly owned, directly or 
indirectly, by the common parent of the group. The final regulations 
also provide special rules to govern the treatment of an investment of 
eligible gain in the subsidiary QOF in order not to conflict with the 
consolidated return rules found in Sec.  1.1502. However, these rules 
are not expected to be overly burdensome, because the choice of 
establishing the QOF as a subsidiary member of the consolidate group 
are elective; taxpayers would not choose to consolidate a corporate QOF 
subsidiary unless the benefits to the taxpayer were greater than the 
costs.
    One drawback to allowing QOFs to be part of subsidiary member of a 
consolidated group is that there would be less information available 
regarding taxable income and loss of the QOF and its subsidiary 
qualified opportunity zone businesses, as that information will be 
reported as part of the aggregated income and deductions of the parent 
on the consolidated tax return.
    The number of taxpayers expected to be affected by these rules 
ranges between 25 and 500.
5. Economic Effects of Provisions Not Substantially Revised From the 
Proposed Regulations
a. Definition of Substantially All
    There are five uses of the term ``substantially all'' in section 
1400Z-2 but the statute is ambiguous regarding the precise meaning of 
this term. The final regulations establish thresholds for all five uses 
of this term. The final regulations provide that ``substantially all'' 
means at least 90 percent with regard to the three holding period 
requirements in section 1400Z-2(d)(2) and at least 70 percent with 
regard to section 1400Z-2(d)(3)(A)(i) and in the context of ``use'' in 
section 1400Z-2(d)(2)(D)(i)(III). The Treasury Department and the IRS 
have not attempted to assess how taxpayers would have interpreted these 
terms in the absence of specific guidance and

[[Page 1947]]

therefore have not projected whether these regulations will increase or 
decrease investment in QOZs or non-QOZ's relative to regulatory 
alternatives.
    In choosing what values to assign to the substantially all terms, 
the Treasury Department and the IRS considered the economic 
consequences of setting the thresholds higher or lower. Setting the 
threshold higher would reduce investment in QOFs but would increase the 
percentage of that investment that would be located within a QOZ. One 
reason why a higher threshold would reduce overall investment in QOFs 
is that it will be more difficult for businesses with diverse 
operations and/or multiple locations to satisfy the threshold. Setting 
the threshold lower would increase investment in QOFs but reduce the 
percentage of that investment that is located within a QOZ.
    A lower threshold would further increase the likelihood that a 
taxpayer may receive the benefit of the preferential treatment on 
capital gains without placing in service more tangible property within 
a QOZ than would have occurred in the absence of section 1400Z-2. This 
effect would be magnified by the way the different requirements in 
section 1400Z-2 interact. For example, these final regulations imply 
that, in certain limited fact patterns, a QOF could satisfy the 
substantially all standards with as little as 40 percent of the 
tangible property effectively owned by the fund being used within a 
QOZ. This could occur if 90 percent of QOF assets are invested in a 
qualified opportunity zone business, in which 70 percent of the 
tangible assets of that business are qualified opportunity zone 
business property; and if, in addition, the qualified opportunity zone 
business property is only 70 percent in use within a QOZ, and for 90 
percent of the holding period for such property. Multiplying these 
shares together (0.9 x 0.7 x 0.7 x 0.9 = 0.4) generates the result that 
a QOF could satisfy the requirements of section 1400Z-2 under the final 
regulations with just 40 percent of its assets effectively in use 
within a QOZ.
    The Treasury Department and the IRS have not undertaken 
quantitative estimates of the volume of investment that would be placed 
in QOZs under the different thresholds for ``substantially all'' 
because we do not have data or models that can predict spatial patterns 
of investment with reasonable precision. The Treasury Department and 
the IRS further recognize that the specified thresholds may indirectly 
affect investment outside of QOZs; we have likewise not undertaken 
quantitative estimates of this investment effect.
    The Treasury Department and the IRS have determined that the 
substantially all thresholds provided in the final regulations 
represent an appropriate balance between the ability of investors in 
QOFs to receive preferential capital gains treatment only for placing a 
consequential amount of tangible property (used in the underlying 
business) within a QOZ, and the flexibility provided to business 
operations so as not to significantly distort the types of businesses 
that can qualify for opportunity zone funds.
b. Treatment of Leased Property
    The Treasury Department and the IRS have determined that leased 
property that is located in a QOZ may be treated as qualified 
opportunity zone business property under certain conditions. This 
determination means, effectively, that the value of leased property 
should be included in both in the numerator and the denominator of the 
90-percent investment standard and the substantially all tests.\5\ We 
project that the inclusion of leased property will enhance the 
efficiency of business decisions compared to other available regulatory 
options because leasing is a common business practice and because 
business decisions would be distorted if otherwise similar property 
(owned versus leased) were treated differently.
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    \5\ Under the statute, the value of leased property is included 
in the denominator of the substantially all test. The statute is 
ambiguous, however, as to whether leased property should be included 
in the numerator.
---------------------------------------------------------------------------

    This treatment of leased property is efficiency-enhancing (compared 
to alternative treatments) because of other features of the statute. 
For example, a start-up business that leased office space within a QOZ 
and owned tangible property in the form of computers and other office 
equipment would likely fail the substantially all test (if the office 
space is sufficiently valuable relative to the other tangible property) 
because the leased property is included in the denominator of the 
substantially all test; this failure to satisfy the substantially all 
test would occur despite all of this business's operations being 
located within a QOZ. This possibility may lead the business to 
purchase rather than lease its office property, a decision that 
significantly changes the nature of the business's risk and expenses.
    The Treasury Department and the IRS recognize that the treatment of 
leased property as qualified opportunity zone business property may 
weaken the incentive for taxpayers to construct new real property or 
renovate existing real property within a QOZ, as taxpayers would be 
able to lease existing real property in a zone without improving it and 
thereby become a qualified opportunity zone business (assuming the 
other conditions of the statute were met). However, allowing the 
leasing of existing real property within a zone may encourage fuller 
utilization and improvement of such property and limit the abandonment 
or destruction of existing productive property within a QOZ when new 
tax-favored real property becomes available.
    In summary, the Treasury Department and the IRS project that the 
inclusion of leased property in both the numerator and the denominator 
of the 90-percent investment standard and the substantially all test 
will increase economic activity within QOZs relative to alternative 
decisions including the no-action baseline. This provision will reduce 
potential distortions between owned and leased property that may occur 
under other options.
c. Valuation of Property
    The final regulations provide taxpayers with a choice between two 
methods for determining the asset values for purposes of the 90-percent 
investment standard in section 1400Z-2(d)(1) for QOFs or the value of 
tangible property for the substantially all test in section 1400Z-
2(d)(3)(A)(i) for qualified opportunity zone businesses. Under the 
first method (applicable financial statement valuation method), the 
taxpayer values owned or leased property as reported on its applicable 
financial statement for the reporting period. Under the alternative 
valuation method, the taxpayer sets the value of owned property equal 
to the unadjusted cost basis of the property under section 1012. The 
final regulations specify that the value of leased property under the 
alternative method equals the present value of total lease payments at 
the beginning of the lease. The value of the property under the 
alternative method for the 90-percent investment standard and 
substantially all test does not change over time as long as the 
taxpayer continues to own or lease the property.
    The Treasury Department and the IRS project that the two methods 
will, in the majority of cases, provide similar values for leased 
property at the time that the lease begins because, as beginning in 
2019, generally accepted accounting principles (GAAP) require public 
companies to calculate the present value of lease payments in order to 
recognize the value of leased assets on the balance sheet. However, 
there are situations in which the two methods may differ in the value 
they assign to leased property.

[[Page 1948]]

On financial statements, the value of the leased property declines over 
the term of the lease. Under the alternative method, the value of the 
leased asset is calculated once at the beginning of the lease term and 
remains constant while the term of the lease is still in effect. This 
difference in valuation of property over time between using financial 
statements and the alternative method also exists for owned property. 
In addition, the two approaches would generally apply different 
discount rates, thus leading to some difference in the calculated 
present value under the two methods.
    The Treasury Department and the IRS provide the alternative method 
to allow for taxpayers that either do not have applicable financial 
statements or do not have them available in time for the asset tests. 
In addition, the alternative method is simpler, thus reducing 
compliance costs, and provides greater certainty in projecting future 
compliance with the 90-percent investment standard and the 
substantially all test. Thus, even some taxpayers with applicable 
financial statements may choose to use the alternative method. One 
drawback to the alternative method is that it is less likely to provide 
accurate asset valuation over time because it does not account for 
depreciation or other items that may affect the value of assets after 
the time of purchase, and, over time, the values used for the sake of 
the 90-percent investment standard and the substantially all test may 
diverge from the actual value of the property.
    Because this provision provides an election to taxpayers, the 
Treasury Department and the IRS project that this provision will 
slightly increase investment in QOFs, relative to not providing an 
election. The Treasury Department and the IRS have not estimated the 
proportion of taxpayers likely to use the alternative method nor the 
volume of increased investment in QOFs relative to not providing an 
election.
d. Gross Income Requirement of Section 1397C(b)(2)
    Section 1400Z-2(d)(3)(A)(ii) incorporates the requirement of 
section 1397C(b)(2) that a qualified business entity must derive at 
least 50 percent of its total gross income during a taxable year from 
the active conduct of a qualified business in a zone. The final 
regulations provide multiple safe harbors for determining whether this 
standard has been satisfied.
    Two of these safe harbors provide that the 50 percent of gross 
income standard would be satisfied if the majority of the labor input 
of the trade or business is located within a QOZ and provide two 
different methods for measuring the labor input of the trade or 
business. The labor input can be measured in terms of hours (hours 
performed test) or compensation paid (amounts paid test) of employees, 
independent contractors, and employees of independent contractors for 
the trade or business. The final regulations clarify that guaranteed 
payments to partners in a partnership for services provided to the 
trade or business are also included in the amounts paid test. The final 
regulations provide that if at least 50 percent of the labor input of 
the trade or business is located within a QOZ (as measured by one of 
the two provided approaches), then the section 1397C(b)(2) requirement 
is satisfied.
    In addition, a third safe harbor (business functions test) provides 
that the 50-percent gross income requirement is met if the tangible 
property of the trade or business located in a QOZ and the management 
or operational functions performed in the QOZ are each necessary for 
the generation of at least 50 percent of the gross income of the trade 
or business.
    The determination of the location of income for businesses that 
operate in multiple jurisdictions can be complex, and the rules 
promulgated by taxing authorities to determine the location of income 
are often burdensome and may distort economic activity. The provision 
of alternative safe harbors in the final regulations should reduce the 
compliance and administrative burdens associated with determining 
whether this statutory requirement has been met. In the absence of such 
safe harbors, some taxpayers may interpret the 50 percent of gross 
income standard to require that a majority of the sales of the entity 
must be located within a zone. The Treasury Department and the IRS have 
determined that a standard based strictly on sales would discriminate 
against some types of businesses (for example, manufacturing) in which 
the location of sales is often different from the location of the 
production, and thus would preclude such businesses from benefitting 
from the incentives provided in section 1400Z-2. Furthermore, the 
potential distortions introduced by the provided safe harbors would 
increase incentives to locate labor inputs within a QOZ. To the extent 
that such distortions exist, they further the statutory goal of 
encouraging economic activity within QOZs. Given the flexibility 
provided to taxpayers in choosing a safe harbor, other distortions, 
such as to business organizational structuring, are likely to be 
minimal.
e. Working Capital Safe Harbor
    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 QOZ. The final regulations clarify the rules related to nonqualified 
financial property and what amounts can be held in cash and cash 
equivalents as working capital. A qualified 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 final 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 final regulations also provide that qualified 
opportunity zone businesses may utilize multiple working capital safe 
harbors, provided that each one satisfies all of the conditions of the 
safe harbor provided in the final regulations. In the case where 
multiple working capital safe harbors applies to the same unit of 
tangible property, then total length of time the working capital safe 
harbor may last is 62 months.
    The Treasury Department and the IRS expect that the establishment 
of the working capital 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 rule 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.
    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 QOZ, 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 QOZ.

[[Page 1949]]

f. QOF Reinvestment Rule
    The final regulations provide that a QOF has 12 months from the 
time of the sale or disposition of qualified opportunity zone property 
or the return of capital from investments in qualified opportunity zone 
stock or qualified opportunity zone partnership interests to reinvest 
the proceeds in other qualified opportunity zone property before the 
proceeds would not be considered qualified opportunity zone property 
with regards to the 90-percent investment standard. This rule provides 
clarity and gives substantial flexibility to taxpayers in satisfying 
the 90-percent investment standard. The Treasury Department and the IRS 
have not projected the effect of this rule on the volume of investment 
held by QOFs compared to a no action baseline.
g. Clarity Regarding Electing Post-10-Year Gain Exclusion if Zone 
Designation Expires
    The final regulations specify in Sec.  1.1400Z2(c)-1 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 effects of the four 
options follows.
(i) Remaining Silent on Electing Post-10-Year Gain Exclusion
    The first alternative would be for the final 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 QOZs on December 31, 2028, makes it 
unclear to what extent investments in a QOF made after 2018 would 
qualify for this exclusion.
    In absence of the guidance provided in the final regulations, some 
taxpayers may have believed 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 have rushed 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 have planned 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 
would likely 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 QOZs.
(ii) Providing a Clear Deadline for Electing Post-10-Year Gain 
Exclusion
    The alternative adopted by the final 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), then the 10-year 
gain exclusion election is allowed as long as the disposition of the 
investment occurs before January 1, 2048. This 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 rule would likely lead to 
an increase in investment within QOFs compared the final regulations 
remaining silent on this issue.
    However, setting a fixed date for the disposition of eligible QOFs 
investments could introduce economic inefficiencies. Some taxpayers 
might 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, even if that selling date is not 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 
QOZs 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 QOZs or affect other 
investors in such zones that did not 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 QOZs. While the final 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 final regulations will lead any such inefficiencies to be 
minor.
(iii) Providing No Deadline for Electing Gain Exclusion
    As an alternative, the final 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 QOZs 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. (Or, the final 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 unsold 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 of the 
October 2018 proposed regulations, the Treasury Department and the IRS 
have determined the ability to exclude gains

[[Page 1950]]

for investment held at least 10 years in a QOF is integral to the 
TCJA's purpose of creating QOZs. The final 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 
the final regulations. The relative costs and benefits of the various 
alternatives are difficult to measure and compare. The final 
regulations would likely produce the lowest compliance and 
administrative costs among the alternatives and any associated economic 
inefficiencies are likely to be small.

II. Paperwork Reduction Act

    The collections of information in these final regulations are in 
Sec. Sec.  1.1400Z2(b)-1(h), 1.1502-14Z(c)(2), (f)(2)(ii), (iii), and 
(iv), (f)(3), and (h), and 1.1504-3(b)(2) and (c). The information in 
all of the collections of information provided will be used by the IRS 
for tax compliance purposes.

A. Partnership and S Corporation Collections of Information

    The final regulations establish a new collection of information in 
Sec.  1.1400Z2(b)-1(h). In Sec.  1.1400Z2(b)-1(h)(1), the collection of 
information requires a partnership that takes a deferral election to 
notify all of its partners of the deferral election and their shares of 
the deferred gain. Similar requirements are set forth in Sec.  
1.1400Z2(b)-1(h)(4) regarding S corporations and S corporation 
shareholders.
    The collection of information in Sec.  1.1400Z2(b)-1(h)(2) requires 
indirect owners of a QOF partnership that sell or otherwise dispose of 
all or a portion of their indirect interest in the QOF partnership in a 
transaction that is an inclusion event to notify the QOF owner so it 
can recognize an appropriate amount of deferred gain. Lastly, the 
collection of information in Sec.  1.1400Z2(b)-1(h)(3) requires a QOF 
partner to notify the QOF partnership of an election under section 
1400Z-2(c) to adjust the basis of the qualifying QOF partnership 
interest that is disposed of in a taxable transaction. Similar 
requirements again are set forth in Sec.  1.1400Z2(b)-1(h)(4) regarding 
QOF S corporations and QOF S corporation shareholders.
    The collection of information contained in this final regulation 
will not be conducted using a new or existing IRS form. The 
notifications required by Sec.  1.1400Z2(b)-1(h)(1) will be provided by 
the respective partnership to its partners n order to properly track 
the amount of eligible gain invested in a QOF. The notification 
requires a statement to be sent by the partnership electing deferral to 
the relevant partners.
    The notifications required by Sec.  1.1400Z2(b)-1(h)(2) will be 
provided by indirect owners of a QOF partnership to the QOF owner and 
must include information needed in order to enable the QOF owner, in a 
timely manner, to recognize an appropriate amount of deferred gain. The 
notification requires a statement to be sent from an indirect owner of 
a QOF partnership to the QOF owner.
    The notifications required by Sec.  1.1400Z2(b)-1(h)(3) will be 
provided by a QOF partner to a QOF partnership to inform the 
partnership that the partner made an election under section 1400Z-2(c) 
to adjust the basis of the qualifying QOF partnership interest disposed 
of in a taxable transaction. The notification requires a statement be 
sent by the partner electing deferral under section 1400Z-2(c) to the 
QOF partnership.
    Similar notifications between shareholders and S Corporations are 
also required by Sec.  1.1400Z2(b)-1(h)(4).
    The likely respondents are partnerships and partners, and S 
corporations and S corporation shareholders.
    Estimated total annual reporting burden: 8,500 hours.
    Estimated average annual burden per respondent: 1 hour.
    Estimated number of respondents: 8,500.
    Estimated frequency of responses: One time notification.

B. Collections of Information Under Existing Tax Forms

    The collections of information imposed on consolidated groups in 
these regulations are contained in Sec. Sec.  1.1502-14Z(c)(2), 
(f)(2)(ii), (iii), (iv), and (f)(3), 1.1502-14Z(h), and 1.1504-3(b)(2) 
and (c). The collection of information provided by these regulations 
has been approved by the Office of Management and Budget (OMB) under 
control number 1545-0123. The information is required to inform the IRS 
on whether, and to what extent, a taxpayer makes any of the 
consolidated group elections as described in these regulations. For 
purposes of the Paperwork Reduction Act, 44 U.S.C. 3501 et seq. (PRA), 
the reporting burden associated with the collection of information in 
Form 1065, ``U.S. Return of Partnership Income,'' Form 1120, ``U.S. 
Corporation Income Tax Return,'' Form 851, ``Affiliations Schedule,'' 
and/or Form 8996 will be reflected in the Paperwork Reduction Act 
Submission associated with OMB control number 1545-0123.
    The consolidated return rules in Sec. Sec.  1.1502-14Z and 1.1504-3 
provide for certain elections that are available to consolidated 
groups. These elections may require the consolidated group and/or the 
QOF to file original, amended or superseding returns and attach an 
election statement to such return with the required information to make 
the applicable election. Section 1.1504-3(b)(2) generally allows the 
consolidated group (subject to certain requirements and limitations) to 
elect to consolidate a subsidiary QOF C corporation that was formed or 
acquired by the consolidated group after May 1, 2019. In order to make 
the Sec.  1.1504-3(b)(2) election, the consolidated group must attach 
an election statement as described in Sec.  1.1504-3(c) to its Form 
1120 and include the QOF C corporation as a subsidiary member on its 
Form 851. Section 1.1502-14Z(c)(2) allows a consolidated group to elect 
to treat an investment of one member as a qualifying investment by 
another member. This election is available to consolidated groups after 
March 13, 2020. The consolidated group must attach an election 
statement as described in Sec.  1.1502-14Z(h)(2) with its Form 1120.
    The elections provided in Sec.  1.1502-14Z(f) are available only to 
consolidated groups that formed or acquired a subsidiary QOF C 
corporation and included the subsidiary QOF C corporation in its 
consolidated group prior to May 1, 2019. These elections allow the 
consolidated group to treat the subsidiary QOF C corporation as (i) a 
QOF partnership, (ii) a non-member QOF C corporation, (iii) a non-QOF C 
corporation, or (iv) to continue treating the pre-existing QOF 
subsidiary corporation as a member of the consolidated group. In 
general, if the consolidated group makes an election under Sec.  
1.1502-14Z(f), the consolidated group is required to amend its Form 
1120 to account for the changes resulting from the election and to 
attach the applicable election statement as provided in Sec.  1.1502-
14Z(h)(3). If the consolidated group makes an election to treat the QOF 
C corporation as a QOF partnership as described in Sec.  1.1502-
14Z(f)(2)(ii), the QOF partnership is required to file its own Form 
1065 as well as a new Form 8996 for the taxable year the election is 
effective. If the consolidated group elects to treat the subsidiary QOF 
C corporation as not a member of the group (as described in Sec.  
1.1502-14Z(f)(2)(iii)), the subsidiary

[[Page 1951]]

QOF C corporation is required to file its own Form 1120 and include its 
Form 8996 with the return for the taxable year the election is 
effective.
    The following table displays the number of respondents estimated to 
be required to report on Form 1120, Form 851, Form 8996 and/or Form 
1065, with respect to the collections of information required by the 
these consolidated group regulations. Due to the absence of available 
tax data, estimates of respondents required to attach a statement to 
other types of tax returns, as applicable, are not available.

------------------------------------------------------------------------
                                               Number of respondents
                                                    (estimated)
------------------------------------------------------------------------
Transition Relief Elections--Sec.
 1.1502-14Z(f):
  Form 1120.............................  10 to 100.
Expected Number of Consolidated C
 Corporations formed after May 1, 2019:
  Form 1120.............................  0 to 50.
------------------------------------------------------------------------
Source: RAAS:CDW.

    The numbers of respondents in the table were estimated by the 
Research, Applied Analytics and Statistics Division (RAAS) of the IRS 
from the Compliance Data Warehouse (CDW).
    Data for Form 1120 represents estimates of the total number of 
taxpayers that may attach an election statement to their Form 1120 to 
make the elections in Sec. Sec.  1.1.1502-14Z(c)(2), (f)(2)(ii), (iii), 
and (iv), and (f)(3), and 1.1504-3(b)(2). The lower bound estimate is 
based on the number of consolidated group taxpayers filing Form 1120 
and Form 8996 through July 2019. The upper bound estimate is based on 
consolidated group taxpayer filing trends, the observed filings to 
date, and uncertainty about the number of future filers. Accordingly, 
the difference between the lower bound and upper bound estimates 
reflect an estimate of the possible number of respondents as a result 
of the changes made by TCJA and the regulations.
    An agency may not conduct or sponsor and a person is not required 
to respond to a collection of information unless it displays a valid 
OMB control number.

III. Regulatory Flexibility Act

    Pursuant to the Regulatory Flexibility Act (5 U.S.C. chapter 6), it 
is hereby certified that the final regulations will not have a 
significant economic impact on a substantial number of small entities 
under section 601(6) of the Regulatory Flexibility Act (small 
entities).
    As discussed elsewhere in this preamble, the final regulations 
provide certainty and clarity to taxpayers regarding the utilization of 
the tax preference for capital gains provided in section 1400Z-2 by 
defining terms, calculations, and acceptable forms of documentation. 
The Treasury Department and the IRS anticipate that this clarity 
generally will encourage taxpayers to invest in QOFs and will increase 
the amount of investment located in QOZs. Investment in QOFs is 
entirely voluntary, and the certainty that would be provided by these 
final regulations, will minimize any compliance or administrative 
costs, such as the estimated average annual burden (1 hour) under the 
Paperwork Reduction Act. For example, the final regulations provide 
multiple safe harbors for the purpose of determining whether the 50-
percent gross income test has been met as required by section 1400Z-
2(d)(3)(A)(ii) for a qualified opportunity zone business. Taxpayers 
affected by these final regulations include QOFs, investors in QOFs, 
and qualified opportunity zone businesses in which a QOF holds an 
ownership interest. The final regulations will not directly affect the 
taxable incomes and liabilities of qualified opportunity zone 
businesses; they will affect only the taxable incomes and tax 
liabilities of QOFs (and owners of QOFs) that invest in such 
businesses. Although there is a lack of available data regarding the 
extent to which small entities invest in QOFs, will certify as QOFs, or 
receive equity investments from QOFs, the Treasury Department and the 
IRS project that most of the investment flowing into QOFs will come 
from large corporations and wealthy individuals, though some of these 
funds would likely flow through an intermediary investment partnership. 
It is expected that some QOFs and qualified opportunity zone businesses 
would be classified as small entities; however, the number of small 
entities significantly affected is not likely to be substantial.
    For the reasons explained previously, the Treasury Department and 
the IRS certify that the final regulations will not have a significant 
economic impact on a substantial number of small entities. Pursuant to 
section 7805(f), the notice of proposed rulemaking preceding these 
final regulations was submitted to the Chief Counsel for Advocacy of 
the Small Business Administration for comment on its impact on small 
business.

IV. 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 2019, that threshold is approximately $154 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.

V. 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 rule does not have federalism 
implications and does not impose substantial direct compliance costs on 
state and local governments or preempt state law.

VI. Executive Order 13175: Consultation and Coordination With Indian 
Tribal Governments

    Executive Order 13175 requires that Federal departments and 
agencies engage in consultation procedures in certain circumstances 
where regulations are issued which have substantial direct effects with 
respect to the Federal Government and Indian tribes. As noted in the 
Background, on October 21, 2019, the Treasury Department and the IRS 
held a government-to-government tribal consultation on Opportunity 
Zones (Consultation). Seven organizations representing tribal interests 
participated, with one tribal designee providing comments expressing 
support for the May 2019 proposed regulations. In addition, many tribes 
submitted written comments in response to the proposed regulations, and 
the presiding officer of one Indian tribe provided oral testimony at 
the February 14, 2019 public hearing.
    Several commenters requested that Indian tribal governments and 
corporations organized under Indian tribal laws should be included in 
the definition of entities eligible to be a QOF. The final regulations 
provide that an entity ``organized in'' one of the 50 states includes 
an entity organized under the law of a federally recognized Indian 
tribe if the entity's domicile is located in one of the 50 states or 
the District of Columbia. Such entity satisfies the requirement in 
section 1400Z-2(d)(2)(B)(i) and (C) that

[[Page 1952]]

qualified opportunity zone stock is stock in a domestic corporation, 
and a qualified opportunity zone partnership interest is an interest in 
a domestic partnership.
    The Treasury Department and the IRS, while acknowledging the 
sovereignty of Indian tribal governments, also note that an entity 
eligible to be a QOF must be subject to Federal income tax, including 
the penalty imposed by section 1400Z-2(f)(1) where a QOF fails to meet 
the 90-percent investment standard, regardless of the laws under which 
it is established or organized. Tribal commenters at the Consultation 
did not disagree with the position that if an entity organized under 
the law of an Indian tribal government is eligible to be a QOF, and the 
entity's domicile is located in one of the 50 states or the District of 
Columbia, that such entity would be subject to Federal income tax 
because the QOF would include investors from outside of the tribe. 
Accordingly, the Treasury Department and IRS affirm these positions and 
incorporate a reference to entities organized under the law of an 
Indian tribal government in the definition of the term ``eligible 
entity.''
    Several tribal commenters, commenting on the October 2018 proposed 
regulations (83 FR 54279), requested that leased tangible property 
qualify as qualified opportunity zone business property for purposes of 
the section 1400Z-2 although the statute only addresses the 
qualification of tangible property acquired by purchase, as defined in 
section 179(d)(2), as qualified opportunity zone business property. The 
commenters stated that typically long-term ground leases of land held 
in trust by the Federal government are used for economic development 
purposes because such real property is generally not transferred 
through a sale. As provided for in the May 2019 proposed regulations 
(84 FR 18652), leased tangible property may qualify as qualified 
opportunity zone business property held by a QOF of qualified 
opportunity zone business, provided the regulatory requirements are 
met. At the Consultation, no participant requested additional guidance 
on this provision, or disagreed with the position taken by the Treasury 
Department and the IRS.
    Prior to the publication of the May 2019 proposed regulations (84 
FR 18652), the Treasury Department and the IRS received a comment 
requesting that the final regulations provide flexibility regarding the 
valuation of leases. The commenter requested that the final regulations 
permit QOFs to use a basis for valuing property other than the basis 
used for GAAP purposes (for example, cost basis under section 1012). 
Because Indian tribal governments typically rely upon leases of land 
held in trust by the Federal Government for economic development and 
recent changes to GAAP methods require the recognition of leasehold 
interests valued at the present value of prospective lease payments 
over the lifetime of the lease, the commenter was concerned that 
applying GAAP methods to value long-term leasehold interests would 
result in eligible entities not qualifying as QOFs or qualified 
opportunity zone businesses. In responding to this comment, as well as 
other comments expressing similar concerns, the Treasury Department and 
the IRS determined that the alternative valuation method for leased 
tangible property, as set forth in the final regulations, addresses the 
concerns raised by these commenters. In addition, the Treasury 
Department and the IRS note that no participant of the Consultation 
requested additional guidance regarding these issues. Therefore, 
proposed Sec.  1.1400Z2(d)-1(b)(3) has not been modified as a result of 
those comments.
    Following the Consultation, one tribe submitted additional comments 
regarding the issue of whether leased property is qualified opportunity 
zone business property. First, the commenter asked for clarification on 
whether leasehold interests of the real property subject to a sublease 
can be qualified opportunity zone business property for a qualified 
opportunity zone business where the sublease is entered into after 
December 31, 2017. The Treasury Department and the IRS, while declining 
to clarify the rule, generally do not view tangible property acquired 
under a sublease entered into after December 31, 2017, as necessarily 
different from tangible property acquired under a lease entered into 
after December 31, 2017, to the extent that the tangible property 
otherwise would qualify as qualified opportunity zone business 
property.
    Second, the commenter inquired whether a leasehold interest that 
was assigned by a tribe to a qualified opportunity zone business would 
not qualify as qualified opportunity zone business property because the 
leasehold interest is not tangible property solely being leased or 
subleased to the qualified opportunity zone business. The Treasury 
Department and the IRS agree that assigning an existing lease, the 
parties to which are not related persons within the meaning of section 
1400Z-2(e)(2), to another entity would not prevent the tangible 
property subject to the lease from qualifying as qualified opportunity 
zone business property. However, it should be noted that assigning an 
existing lease that was entered into by unrelated persons to an 
assignee that is related person with respect to the lessee may make the 
leased tangible property subject to the special rules for leases 
between related persons within the meaning of section 1400Z-2(e)(2).
    In addition to these comments, one tribe requested a more robust 
reporting regime to measure the benefits of section 1400Z-2. As 
discussed in part IX.A. of this Summary of Comments and Explanation of 
Revision, the Treasury Department and the IRS have modified the Form 
8996 to request additional reporting information from QOFs for tax 
administration purposes, which may also be helpful in measuring the 
impact and effectiveness of section 1400Z-2 on designated qualified 
opportunity zones.

VII. Congressional Review Act

    The Administrator of the Office of Information and Regulatory 
Affairs of the Office of Management and Budget has determined that this 
is a major rule for purposes of the Congressional Review Act (CRA) (5 
U.S.C. 801 et seq.).

Drafting Information

    The principal authors of these final regulations are Alfred Bae and 
Kyle Griffin, Office of the Associate Chief Counsel (Income Tax & 
Accounting); Jeremy Aron-Dine and Sarah Hoyt, Office of the Associate 
Chief Counsel (Corporate); and Marla Borkson, Sonia Kothari, and Vishal 
Amin, Office of the Associate Chief Counsel (Passthroughs and Special 
Industries). Other personnel from the Treasury Department and the IRS 
participated in their development.

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.

List of Subjects in 26 CFR Part 1

    Income Taxes, Reporting and recordkeeping requirements.

Adoption of Amendments to the Regulations

    Accordingly, 26 CFR part 1 is amended as follows:

[[Page 1953]]

PART 1--INCOME TAXES

0
Paragraph 1. The authority citation for part 1 is amended by adding 
sectional authorities for Sec. Sec.  1.1400Z2(a)-1 through 1.1400Z2(f)-
1, 1.1502-14Z, and 1.1504-3 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(b)-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(d)-2 also issued under 26 U.S.C. 1400Z-2(e)(4).
    Section 1.1400Z2(f)-1 also issued under 26 U.S.C. 1400Z-2(e)(4).
* * * * *
    Section 1.1502-14Z also issued under 26 U.S.C. 1400Z-2(e)(4) and 
1502.
* * * * *
    Section 1.1504-3 also issued under 26 U.S.C. 1400Z-2(e)(4) and 
1504(a)(5).
* * * * *

0
Par. 2. Section 1.1400Z2-0 is added to read as follows:


Sec.  1.1400Z2-0.  Table of Contents.

    This section lists the table of contents for Sec. Sec.  
1.1400Z2(a)-1 through 1.1400Z2(f)-1.


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

    (a) Deferring tax on capital gains.
    (1) Overview.
    (2) Procedure for deferring gain.
    (b) Definitions.
    (1) 30-month substantial improvement period.
    (2) 70-percent tangible property standard.
    (3) 70-percent use test.
    (4) 90-percent investment standard.
    (5) 90-percent qualified opportunity zone property holding 
period.
    (6) 90-percent qualified opportunity zone business property 
holding period.
    (7) 180-day period.
    (8) Boot.
    (9) Consolidated group.
    (10) Deferral election.
    (11) Eligible gain.
    (12) Eligible interest.
    (13) Eligible taxpayer.
    (14) Inclusion event.
    (15) Mixed-funds investment.
    (16) Non-qualifying investment.
    (17) Property.
    (18) QOF.
    (19) QOF C corporation.
    (20) QOF corporation.
    (21) QOF RIC.
    (22) QOF REIT.
    (23) QOF owner.
    (24) QOF partner.
    (25) QOF partnership.
    (26) QOF S corporation.
    (27) QOF shareholder.
    (28) QOZ designation notice.
    (29) Qualified opportunity zone business.
    (30) Qualified opportunity zone business property.
    (31) Qualified opportunity zone partnership interest.
    (32) Qualified opportunity zone property.
    (33) Qualified opportunity zone stock.
    (34) Qualifying investment.
    (35) Qualifying QOF partnership interest.
    (36) Qualifying QOF stock.
    (37) Qualifying section 355 transaction.
    (38) Qualifying section 381 transaction.
    (39) Related persons.
    (40) Remaining deferred gain.
    (41) Section 1400Z-2 regulations.
    (c) Operational and special rules.
    (1) Attributes of gains included in income under section 1400Z-
2(a)(1)(B).
    (2) Identification of which interest in a QOF corporation has 
been disposed of.
    (3) Pro-rata method.
    (4) Examples.
    (5) Making an investment for purposes of an election under 
section 1400Z-2(a).
    (6) Amount invested for purposes of section 1400Z-2(a)(1)(A).
    (7) Eligible gains that a partnership elects to defer.
    (8) Eligible gains that the partnership does not defer.
    (9) Passthrough entities other than partnerships.
    (d) Elections.
    (1) Taxable year of deferral election.
    (2) Taxable years after deferral election.
    (e) Interaction of section 1400Z-2 and Sec.  1.897-6T.
    (f) Treatment of mixed-funds investments.
    (1) Investments to which no election under section 1400Z-2(a) 
applies.
    (2) Treatment of deemed contributions of money under section 
752(a).
    (3) Treatment of contributions to QOF corporation in which no 
stock is received.
    (4) Example.
    (g) Applicability dates.
    (1) In general.
    (2) Prior periods.


Sec.  1.1400Z2 (b)-1  Inclusion of gains that have been deferred under 
section 1400Z-2(a).

    (a) Scope.
    (b) General inclusion rule.
    (c) Inclusion events.
    (1) In general.
    (2) Termination or liquidation of QOF or QOF owner.
    (3) Transfer of an investment in a QOF by gift or incident to 
divorce.
    (4) Transfer of an investment in a QOF by reason of the 
taxpayer's death.
    (5) Grantor trusts.
    (6) Special rules for partners and partnerships.
    (7) Special rules for S corporations.
    (8) Distributions by a QOF corporation.
    (9) Dividend-equivalent redemptions and redemptions of section 
306 stock.
    (10) Qualifying section 381 transactions.
    (11) Section 355 transactions.
    (12) Recapitalizations and section 1036 transactions.
    (13) Section 304 transactions.
    (14) Deduction for worthlessness.
    (15) Decertification of a QOF.
    (16) Other inclusion and non-inclusion events.
    (d) Holding periods.
    (1) Holding period for qualifying investment.
    (2) Status of QOF assets as qualified opportunity zone property.
    (e) Amount includible.
    (1) In general.
    (2) Property received from a QOF in certain transactions.
    (3) Gain recognized on December 31, 2026.
    (4) Special amount includible rule for partnerships and S 
corporations.
    (5) Limitation on amount of gain included after statutory five-
year and seven-year basis increases.
    (f) Examples.
    (g) Basis adjustments.
    (1) Basis adjustments under section 1400Z-2(b)(2)(B)(ii) 
resulting from the inclusion of deferred gain.
    (2) Amount of basis adjustment under section 1400Z-
2(b)(2)(B)(iii) and (iv).
    (3) Examples.
    (4) Special partnership rules.
    (5) Basis adjustments in S corporation stock.
    (6) Basis in the hands of a taxpayer who received a qualifying 
investment in a QOF by reason of the prior owner's death.
    (h) Notifications by partners and partnerships, and shareholders 
and S corporations.
    (1) Notification of deferral election.
    (2) Notification of deferred gain recognition by indirect QOF 
owner.
    (3) Notification of section 1400Z-2(c) election by QOF partner 
or QOF partnership.
    (4) S corporations.
    (i) Reserved.
    (j) Applicability dates.
    (1) In general.
    (2) Prior periods.


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

    (a) Scope.
    (b) Investment for which an election can be made.
    (1) In general.
    (2) Special election rules for QOF partnerships and QOF S 
corporations.
    (3) Basis adjustments upon sale or exchange of qualifying QOF 
stock.
    (c) Extension of availability of the election described in 
section 1400Z-2(c).
    (d) Examples.
    (e) Capital gain dividends paid by a QOF RIC or QOF REIT that 
some shareholders may be able to elect to receive tax free under 
section 1400Z-2(c).
    (1) Eligibility.
    (2) Definition of capital gain dividend identified with a date.
    (3) General limitations on the amounts of capital gain with 
which a date may be identified.
    (4) Determination of the amount of capital gain with which a 
date may be identified.
    (f) Applicability dates.


Sec.  1.1400Z2 (d)-1  Qualified opportunity funds and qualified 
opportunity zone businesses.

    (a) Overview.
    (1) Eligible entity.
    (2) Self-certification as a QOF.

[[Page 1954]]

    (3) Self-decertification of a QOF.
    (4) Involuntary decertification.
    (b) Valuation of property for purposes of the 90-percent 
investment standard and the 70-percent tangible property standard.
    (1) In general.
    (2) Special rules.
    (3) Applicable financial statement valuation method.
    (4) Alternative valuation method.
    (c) Qualified opportunity zone property.
    (1) In general.
    (2) Qualified opportunity zone stock.
    (3) Qualified opportunity zone partnership interest.
    (d) Qualified opportunity zone business.
    (1) In general.
    (2) Satisfaction of 70-percent tangible property standard.
    (3) Operation of section 1397C requirements adopted by 
reference.
    (4) Trade or businesses described in section 144(c)(6)(B) not 
eligible.
    (5) Tangible property of a qualified opportunity zone business 
that ceases to be qualified opportunity zone business property
    (6) Cure period for qualified opportunity zone businesses.
    (e) Applicability dates.
    (1) In general.
    (2) Prior periods.


Sec.  1.1400Z2 (d)-2  Qualified opportunity zone business property

    (a) Qualified opportunity zone business property.
    (1) In general.
    (2) Qualified opportunity zone business property requirements.
    (b) Tangible property owned by an eligible entity.
    (1) Purchase requirement.
    (2) Original use or substantial improvement requirement.
    (3) Original use of tangible property acquired by purchase.
    (4) Substantial improvement of tangible property acquired by 
purchase.
    (c) Tangible property leased by an eligible entity.
    (1) Qualifying acquisition of possession.
    (2) Arms-length terms.
    (3) Additional requirements for tangible property leased from a 
related person.
    (4) Plan, intent, or expectation for purchases not for fair 
market value.
    (d) Holding period and use within a qualified opportunity zone 
of owned or leased tangible property.
    (1) In general.
    (2) Valuation of owned and leased property.
    (3) Substantially all of an eligible entity's holding period for 
owned or leased tangible property.
    (4) Substantially all of the use of owned or leased tangible 
property in a qualified opportunity zone.
    (e) Applicability dates.
    (1) In general.
    (2) Prior periods.


Sec.  1.1400Z2 (e)-1  [Reserved]


Sec.  1.1400Z2 (f)-1  Administrative rules- penalties, anti-abuse, etc.

    (a) In general.
    (b) Time period for a QOF to reinvest certain proceeds.
    (1) In general.
    (2) Federally declared disasters.
    (c) Anti-abuse rules.
    (1) General anti-abuse rule.
    (2) Special anti-abuse rule for partnerships.
    (3) Examples.
    (d) Applicability dates.
    (1) In general.
    (2) Prior periods.

0
Par. 3. 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) Deferring tax on capital gains--(1) Overview. Under section 
1400Z-2(a) of the Internal Revenue Code (Code) and the section 1400Z-2 
regulations (as defined in paragraph (b)(41) of this section), an 
eligible taxpayer may elect to defer recognition of some or all of one 
or more eligible gains that otherwise would be recognized by the 
eligible taxpayer in the taxable year to the extent that the eligible 
taxpayer timely acquires a qualifying investment in a qualified 
opportunity fund (QOF) within the meaning of section 1400Z-2(d)(1) and 
Sec.  1.1400Z2(d)-1. Paragraph (a)(2) of this section describes how a 
taxpayer elects to defer gain. Paragraph (b) of this section defines 
terms used in the section 1400Z-2 regulations. Paragraph (c) of this 
section provides operational rules for applying section 1400Z-2 and the 
section 1400Z-2 regulations, including special rules regarding the 
election to defer gain under section 1400Z-2(a) and this section when 
an eligible taxpayer that is a partnership, S corporation, trust, or 
decedent's estate recognizes an eligible gain in a taxable year. 
Paragraph (d) of this section provides the manner in which a deferral 
election under section 1400Z-2(a) must be made. Paragraph (e) of this 
section provides the treatment of section 1400Z-2 for purposes of Sec.  
1.897-6T. Paragraph (f) of this section provides rules for mixed-funds 
investments. Paragraph (g) of this section provides dates of 
applicability. See Sec. Sec.  1.1502-14Z and 1.1504-3 for special rules 
applicable to consolidated groups that invest in QOFs.
    (2) Procedure for deferring gain. A taxpayer defers gain, in whole 
or in part, by making an election on its Federal income tax return for 
the taxable year in which the gain would be included if not deferred. 
The election must be made in the manner prescribed by the Internal 
Revenue Service 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).
    (b) Definitions. The following definitions apply for purposes of 
section 1400Z-2 and the section 1400Z-2 regulations:
    (1) 30-month substantial improvement period. The term 30-month 
substantial improvement period means any 30-month period, beginning 
after the date of acquisition of tangible property, in which additions 
to the basis of the tangible property in the hands of the QOF or 
qualified opportunity zone business (see Sec.  1.1400Z2(d)-2(b)(4)) 
exceed an amount equal to the adjusted basis of such property at the 
beginning of the 30-month period in the hands of the QOF or qualified 
opportunity zone business.
    (2) 70-percent tangible property standard. The term 70-percent 
tangible property standard means the requirement in section 1400Z-
2(d)(3)(A)(i) that a qualified opportunity zone business must satisfy 
with respect to qualified opportunity zone business property (see Sec.  
1.1400Z2(d)-2) that the qualified opportunity zone business holds, 
whether the qualified opportunity zone business property is owned by 
the qualified opportunity zone business or leased by the qualified 
opportunity zone business from another person.
    (3) 70-percent use test. The term 70-percent use test means the 
test used to determine if a QOF or qualified opportunity zone business 
satisfies the requirement in sections 1400Z-2(d)(2)(D)(i)(III) and 
1400Z-2(d)(3)(A)(i) that substantially all of the use of tangible 
property was in a qualified opportunity zone.
    (4) 90-percent investment standard. The term 90-percent investment 
standard means the requirement provided in section 1400Z-2(d)(1) that a 
QOF must hold at least 90 percent of its assets in qualified 
opportunity zone property, as defined in section 1400Z-2(d)(2) and 
Sec.  1.1400Z2(d)-1(c)(1), determined by the average of the percentage 
of qualified opportunity zone property held by the QOF as measured on 
the last day of the first six-month period and on the last day of the 
taxable year of the QOF.
    (5) 90-percent qualified opportunity zone property holding period. 
The term 90-percent qualified opportunity zone property holding period 
means the minimum portion of a QOF's holding period in stock of a 
corporation or interests in a partnership, during which the corporation 
or partnership qualifies as a qualified opportunity zone business in 
order for the stock or the partnership interests to meet the 
substantially all requirement under section 1400Z-2(d)(2)(B)(i)(III) to 
be treated as qualified

[[Page 1955]]

opportunity zone stock or the substantially all requirement under 
section 1400Z-2(d)(2)(C)(iii) to be treated as qualified opportunity 
zone partnership interests, as applicable, held by the QOF.
    (6) 90-percent qualified opportunity zone business property holding 
period. The term 90-percent qualified opportunity zone business 
property holding period means the minimum portion of a QOF's or 
qualified opportunity zone business's holding period in tangible 
property during which the 70-percent use test with respect to the 
tangible property must be satisfied, in order for the tangible property 
to meet the requirement under section 1400Z-2(d)(2)(D)(i)(III) to be 
treated as qualified opportunity zone business property held by the QOF 
or qualified opportunity zone business.
    (7) 180-day period--(i) In general. Except as otherwise provided 
elsewhere in this section, the term 180-day period means the 180-day 
period referred to in section 1400Z-2(a)(1)(A) with respect to any 
eligible gain meeting the requirements of paragraph (b)(11) of this 
section that begins on the day on which the gain would be recognized 
for Federal income tax purposes if the eligible taxpayer did not elect 
under section 1400Z-2 and the section 1400Z-2 regulations to defer 
recognition of that gain.
    (ii) 180-day period for RIC and REIT capital gain dividends--(A) 
General rule. Unless the shareholder of a regulated investment company 
(RIC) or real estate investment trust (REIT) chooses to apply paragraph 
(b)(7)(ii)(B) of this section, the 180-day period for a RIC or REIT 
capital gain dividend begins on the last day of the shareholder's 
taxable year in which the capital gain dividend would otherwise be 
recognized by the shareholder.
    (B) Elective rule. Notwithstanding the general rule in paragraph 
(b)(7)(ii)(A) of this section, a shareholder of a RIC or REIT may 
choose to treat the 180-day period with respect to a capital gain 
dividend that the shareholder receives from the RIC or REIT as 
beginning on the date of the dividend distribution; provided, however, 
that the aggregate amount of the shareholder's eligible gain with 
respect to capital gain dividends from the RIC or REIT is limited to 
the aggregate amount of capital gain dividends reported for that 
shareholder by the RIC for that shareholder's taxable year or 
designated for that shareholder by the REIT for that shareholder's 
taxable year.
    (C) Undistributed capital gains. If section 852(b)(3)(D) or 
857(b)(3)(C) (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 rule in paragraph 
(b)(7)(ii)(B) of this section does not apply to that amount. The 180-
day period with respect to the included undistributed capital gain 
begins, at the shareholder's election, on either the last day of the 
RIC or REIT's taxable year or the last day of the shareholder's taxable 
year in which the amount would otherwise be recognized as long-term 
capital gains by the shareholder.
    (iii) 180-day period for partners, S corporation shareholders, and 
owners of other passthrough entities. See paragraph (c)(8) and (9) of 
this section for rules relating to the determination of the 180-day 
period for partners, S corporation shareholders, or beneficiaries of a 
trust or decedent's estate in cases in which a partnership, S 
corporation, trust, or decedent's estate is not an eligible taxpayer 
with respect to an eligible gain, or does not make a deferral election 
with respect to an eligible gain.
    (iv) Examples. The following examples illustrate the principles of 
paragraph (b)(7)(i) through (iii) of this section.

    (A) Example 1. Regular-way trades of stock. Individual A sells 
stock at a gain in a regular-way trade on an exchange (that is, in a 
transaction in which a trade order is placed on the trade date, and 
settlement of the transaction, including payment and delivery of the 
stock, occurs a standardized number of days after the trade date). 
The 180-day period with respect to A's gain on the stock begins on 
the trade date.
    (B) Example 2. Capital gain dividends received by a REIT 
shareholder. REIT and Shareholder are calendar year taxpayers. REIT 
distributes a dividend to Shareholder on March 1, Year 1. REIT 
designates the March 1 dividend as a capital gain dividend before 30 
days after the close of Year 1. Shareholder's 180-day period with 
respect to that capital gain dividend begins on December 31, Year 1. 
However, Shareholder may choose to begin the 180-day period on March 
1, Year 1. If so, an equity interest in a QOF received by 
Shareholder in exchange for an investment of an amount corresponding 
to that capital gain dividend may be a qualifying investment to the 
extent that Shareholder's aggregate elected deferrals of dividends 
from REIT for Year 1 do not exceed Shareholder's aggregate capital 
gain dividends from REIT for the taxable year.
    (C) Example 3. Multiple capital gain dividends received by a RIC 
shareholder. RIC is a calendar year taxpayer. RIC distributes a 
dividend of $100 to Shareholder, a calendar year taxpayer, on March 
1, Year 1 and distributes another dividend of $50 to Shareholder on 
June 1, Year 1. RIC reports both the March 1 and June 1 dividends as 
capital gain dividends on Shareholder's Form 1099-DIV for Year 1. 
Shareholder's 180-day period with respect to both capital gain 
dividends begins on December 31, Year 1. However, Shareholder may 
choose to begin the 180-day period for the $100 RIC capital gain 
dividend on March 1, Year 1, and may choose to begin the 180-day 
period for the $50 RIC capital gain dividend on June 1, Year 1. 
Thus, if Shareholder makes a single investment of $200 in a QOF in 
exchange for an eligible interest (as defined in paragraph (b)(12) 
of this section) on July 1, Year 1, absent any other eligible gain, 
Shareholder may treat $150 of the eligible interest as a qualifying 
investment in the QOF (that is, the amount that corresponds to the 
aggregate amount of the RIC capital gain dividends in Year 1) and 
$50 of the eligible interest as a non-qualifying investment therein.
    (D) Example 4. Additional deferral of previously deferred 
gains--(1) Facts. Taxpayer A invested in a QOF and properly elected 
to defer realized gain. On March 15, 2025, A disposes of its entire 
investment in the QOF in a transaction that, under sections 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 March 15, 2025, the date 
on which A disposed of its entire interest in the QOF. A wants to 
make a deferral election with respect to A's gain from the disposal 
of the QOF investment.
    (2) Analysis. Under paragraph (b)(7)(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 March 
15, 2025, 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 March 15, 2025, the date 
when A disposed of its entire investment in the QOF.

    (8) Boot. The term boot means money or other property that section 
354 or 355 does not permit to be received without the recognition of 
gain.
    (9) Consolidated group. The term consolidated group has the meaning 
provided in Sec.  1.1502-1(h).
    (10) Deferral election. The term deferral election means an 
election under section 1400Z-2(a) and the section 1400Z-2 regulations 
made before January 1, 2027, with respect to an eligible gain.
    (11) Eligible gain--(i) In general. An amount of gain is an 
eligible gain, and thus is eligible for deferral under section 1400Z-
2(a) and the section 1400Z-2 regulations, if the gain--
    (A) Is treated as a capital gain for Federal income tax purposes or 
is a qualified 1231 gain within the meaning of paragraph 
(b)(11)(iii)(A) of this section, determined by--
    (1) Not taking into account any losses unless otherwise specified 
in the section 1400Z-2 regulations; and

[[Page 1956]]

    (2) Taking into account any other provision of the Code that 
requires the character of potential capital gain to be recharacterized 
or redetermined as ordinary income, as defined in section 64, for 
purposes of the Code;
    (B) Would be recognized for Federal income tax purposes and subject 
to tax under subtitle A of the Code before January 1, 2027 (subject to 
Federal income tax), 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 of property with a 
person that, within the meaning of section 1400Z-2(e)(2), is related 
to--
    (1) The eligible taxpayer that would recognize the gain in the 
taxable year in which the sale or exchange occurs if section 1400Z-
2(a)(1) and the section 1400Z-2 regulations did not apply to defer 
recognition of the gain; or
    (2) Any passthrough entity or other person recognizing and 
allocating the gain to the eligible taxpayer described in paragraph 
(b)(11)(i)(C)(1) of this section.
    (ii) Portion of eligible gain not already subject to a deferral 
election. In the case of an eligible taxpayer who has made an election 
under section 1400Z-2(a) and the section 1400Z-2 regulations regarding 
some but not all of an eligible gain, the portion of that eligible gain 
with respect to which no election under section 1400Z-2(a) and the 
section 1400Z-2 regulations has been made remains an eligible gain for 
which a deferral election may be made.
    (iii) Qualified 1231 gains--(A) Definition. A section 1231 gain (as 
defined in section 1231(a)(3)(A)) recognized on the sale or exchange of 
property defined in section 1231(b) (1231(b) property) is a qualified 
1231 gain to the extent that it exceeds any amount with respect to the 
1231(b) property that is treated as ordinary income under section 1245 
or section 1250.
    (B) 180-day period. For the applicable 180-day period with respect 
to a qualified 1231 gain, see paragraph (b)(7) of this section.
    (C) Attributes of included income when deferral ends. For the 
Federal income tax treatment of the later inclusion of a qualified 1231 
gain deferred under section 1400Z-2(a)(1) and the section 1400Z-2 
regulations, see paragraph (c)(1) of this section.
    (iv) Gain arising from an inclusion event--(A) In general. Gain 
that is otherwise required to be included in gross income under Sec.  
1.1400Z2(b)-1(e)(1), whether from the disposition of an entire interest 
in a QOF or a disposition of a partial interest, may be eligible for 
deferral under section 1400Z-2(a)(1), provided that all of the 
requirements to elect to defer gain under section 1400Z-2(a)(1)(A) are 
met. For purposes of determining whether such gain is eligible gain 
under section 1400Z-2(a)(1)(A) and this paragraph (b)(11)(iv)(A), the 
eligible taxpayer should treat such inclusion gain as if it was 
originally realized upon the occurrence of the inclusion event rather 
than on the sale or exchange that gave rise to the eligible gain to 
which the inclusion event relates.
    (B) 180-day period. The 180-day period for investing gain from an 
inclusion event begins on the date of the inclusion event.
    (C) Holding period. The holding period for a qualifying investment 
attributable to eligible gain arising from an inclusion event begins on 
the date that the gain is reinvested in a QOF.
    (v) No deferral for gain realized upon the acquisition of an 
eligible interest. Gain is not eligible for deferral under section 
1400Z-2(a)(1) and the section 1400Z-2 regulations if such gain is 
realized upon the contribution, exchange, or other transfer of property 
to a QOF in exchange for an eligible interest (see paragraph 
(c)(6)(ii)(C) of this section) or the transfer of property to an 
eligible taxpayer in exchange for an eligible interest (see paragraph 
(c)(6)(iv) of this section).
    (vi) Gain from section 1256 contracts and from positions in a 
straddle--(A) General rule. Except as otherwise explicitly provided in 
paragraph (b)(11)(vi)(B), (C), or (D) of this section, eligible gain 
for a taxable year does not include--
    (1) Gain from a section 1256 contract as defined in section 
1256(b);
    (2) Gain from a position that was part of a straddle as defined in 
section 1092 (straddle) during the taxable year; or
    (3) Gain from a position that was part of a straddle in a previous 
taxable year if, under section 1092(a)(1)(B), a loss from any position 
in that straddle is treated as sustained, subject to the limitations of 
section 1092(a)(1)(A), during the taxable year.
    (B) Exception for net gain from certain section 1256 contracts. 
Paragraph (b)(11)(vi)(A)(1) of this section does not apply to the net 
gain during the taxable year from section 1256 contracts that were not 
part of a straddle at any time during the taxable year (qualified 
section 1256 contracts). For purposes of this paragraph (b)(11)(vi)(B), 
the net gain during the taxable year from qualified section 1256 
contracts is determined by taking into account all capital gains and 
losses from such contracts for the taxable year that are recognized for 
Federal income tax purposes, determined without regard to section 
1400Z-2(a)(1). The 180-day period with respect to any eligible gain 
described in this paragraph (b)(11)(vi)(B) begins on the last day of 
the taxable year, and the character of that gain when it is later 
included under sections 1400Z-2(a)(1)(B) and 1400Z-2(b) is determined 
under the general rule in paragraph (c)(1) of this section. If, under 
section 1256(a)(4), section 1092 does not apply to a straddle, such 
straddle is not treated as a straddle for purposes of this paragraph 
(b)(11)(vi)(B).
    (C) Exception for net gain from certain identified straddles--(1) 
Paragraph (b)(11)(vi)(A) of this section does not apply to the net gain 
during the taxable year from positions in a straddle if--
    (i) During the taxable year, the positions were part of an 
identified straddle under section 1092(a)(2), part of an identified 
mixed straddle under Sec.  1.1092(b)-3T (and, as applicable, Sec.  
1.1092(b)-6), part of an identified straddle under section 1256(d), or 
included in a mixed straddle account under Sec.  1.1092(b)-4T;
    (ii) All gains and losses with respect to the positions that were 
part of such straddle or included in such mixed straddle account are 
recognized by the end of the taxable year (other than gain that would 
be recognized but for deferral under section 1400Z-2(a)(1));
    (iii) None of the positions in such straddle or mixed straddle 
account were part of a straddle during the taxable year, other than a 
straddle described in paragraph (b)(11)(vi)(C)(1)(i) and (ii) of this 
section; and
    (iv) None of the positions in such straddle or mixed straddle 
account were part of a straddle in a previous taxable year if, under 
section 1092(a)(1)(B), a loss from any position in such straddle is 
treated as sustained, subject to the limitations of section 
1092(a)(1)(A), during the taxable year.
    (2) For purposes of paragraph (b)(11)(vi)(C)(1) of this section, 
net gain during the taxable year from an identified straddle or mixed 
straddle account described in paragraph (b)(11)(vi)(C)(1)(i) through 
(iv) of this section is equal to the excess of the capital gains 
recognized in the taxable year for Federal income tax purposes, 
determined without regard to section 1400Z-2(a)(1), from all of the 
positions that were part of that straddle over the sum of the capital 
losses and net ordinary loss (if any) from all of the positions that 
were part of that straddle. For purposes of this paragraph 
(b)(11)(vi)(C)(2), capital gains and losses from an identified straddle 
or mixed straddle account include capital gains and losses from section 
1256 contracts

[[Page 1957]]

and other positions marked to market either upon termination or on the 
last business day of the taxable year, as well as annual account net 
gain from positions in a mixed straddle account covered by Sec.  
1.1092(b)-4T. In addition, for purposes of this paragraph 
(b)(11)(vi)(C)(2), net ordinary loss means the excess of ordinary 
losses over ordinary gains.
    (3) If a straddle is an identified straddle described in section 
1092(a)(2), the basis adjustment provisions described in sections 
1092(a)(2)(A)(ii) and (iii) must be applied in determining the net gain 
during the taxable year from positions that were part of that straddle.
    (4) The 180-day period with respect to any eligible gain described 
in paragraph (b)(11)(vi)(C)(2) of this section begins on the earlier of 
the date when all of the positions that are, or have been, part of the 
straddle are disposed of (or otherwise terminated) or the last day of 
the taxable year.
    (5) If net gain described in paragraph (b)(11)(vi)(C)(2) of this 
section is deferred under section 1400Z-2(a)(1), that gain is not 
treated as unrecognized gain for purposes of section 1092(a)(3)(A)(ii).
    (D) Additional exceptions to the general rule. Additional 
exceptions to the general rule in paragraph (b)(11)(vi)(A) of this 
section may be prescribed in guidance published in the Internal Revenue 
Bulletin (see Sec.  601.601(d)(2) of this chapter).
    (E) Examples. The following examples illustrate the rules described 
in paragraph (b)(11)(vi) of this section. All of the examples assume 
that Taxpayer holds the positions described as capital assets and that 
Taxpayer holds no offsetting positions other than those described in 
the examples.

    (1) Example 1. Taxpayer owns 100 shares of publicly traded 
Company X common stock and acquires put options on 100 shares of 
Company X common stock during the taxable year. Taxpayer does not 
make any straddle identifications under section 1092. During the 
taxable year, Taxpayer sells all 100 shares of its Company X common 
stock and has a $40 capital gain. During the taxable year, Taxpayer 
also closes out all of its put options on Company X common stock and 
has a $30 capital loss. That $40 of capital gain is from a position 
that was part of a straddle during the taxable year because the 
position in Company X common stock and the position in put options 
on Company X stock are offsetting positions as defined in section 
1092(c). Under paragraph (b)(11)(vi)(A) of this section, none of 
Taxpayer's $40 of capital gain is eligible gain.
    (2) Example 2. Taxpayer's taxable year is the calendar year. 
Taxpayer owns 100 shares of publicly traded Company Y common stock 
and has a basis in each share of $10.00. Taxpayer also owns put 
options on 100 shares of Company Y common stock. Taxpayer makes a 
valid and timely identification under section 1092(a)(2) of the 100 
shares of Company Y common stock and the put options on the 100 
shares of Company Y common stock. On January 10, Year 1, Taxpayer 
closes out all of the put options and has a $30.00 capital loss. On 
March 10, Year 1, Taxpayer sells 40 shares of the Company Y common 
stock for $11.00 per share. At the end of Year 1, the fair market 
value of each of the 60 remaining shares of Company Y common stock 
held by Taxpayer is $10.50. Under section 1092(a)(2)(A)(ii), when 
the put options are closed out at a loss of $30.00, the basis of 
each of Taxpayer's shares of Company Y common stock is increased by 
$0.30 ($30.00/100). Thus, Taxpayer has a gain of $28.00 ((40 * 
$11.00)-(40 * $10.30)) on the sale of the 40 shares of Company Y 
common stock. Paragraph (b)(11)(vi)(A) of this section applies to 
all of Taxpayer's gain during the taxable year from the straddle. 
Because Taxpayer has unrecognized gain from the straddle at the end 
of the taxable year, paragraph (b)(11)(vi)(C) of this section does 
not shield any of Taxpayer's gain from that result. The $28 of gain 
is thus not eligible gain. Taxpayer must recognize and include in 
taxable income for the taxable year the $28.00 capital gain. Under 
section 1092(a)(2)(A)(iv), Taxpayer may not deduct the $30.00 loss 
from the put options.
    (3) Example 3. The facts are the same as in paragraph 
(b)(11)(vi)(E)(2) of this section (Example 2), except Taxpayer sells 
the 100 shares of Company Y common stock on March 10, Year 1, for 
$11.50 per share. Under section 1092(a)(2)(A)(ii), as in paragraph 
(b)(11)(vi)(E)(2) of this section (Example 2), when the put options 
are closed out at a loss of $30.00, the basis of each of Taxpayer's 
shares of Company Y common stock is increased by $0.30 ($30.00/100). 
Taxpayer has a gain of $120.00 ((100 * $11.50)-(100 * $10.30)) on 
the sale of the 100 shares of Company Y common stock. Taxpayer has 
net gain during the taxable year from the identified straddle of 
$120.00. Under paragraph (b)(11)(vi)(C) of this section, paragraph 
(b)(11)(vi)(A) of this section does not apply to prevent the $120.00 
net gain from being eligible gain. As in paragraph (b)(11)(vi)(E)(2) 
of this section (Example 2), under section 1092(a)(2)(A)(iv), 
Taxpayer may not deduct the $30.00 loss from the put options.
    (4) Example 4. Taxpayer's taxable year is the calendar year. 
Taxpayer owns 100 shares of publicly traded Company Z common stock 
and has a basis in each share of $10. Taxpayer also owns put options 
on 100 shares of Company Z common stock. In Year 1, Taxpayer closes 
out the put options at a $100 loss. At the end of Year 1, the fair 
market value of each of the shares of Company Z common stock held by 
Taxpayer is $15 and, under section 1092(a)(3), Taxpayer has $500 of 
unrecognized gain. Because Taxpayer's unrecognized gain on the 
Company Z common stock at the end of Year 1 exceeds Taxpayer's loss 
on the put options, Taxpayer's loss is deferred under section 
1092(a)(1). During Year 2, Taxpayer sells 40 shares of Company Z 
common stock for $14 per share. Taxpayer has a gain of $160 ((40 * 
$14)-(40 * $10)) on the sale of the 40 shares of Company Z common 
stock. Under paragraph (b)(11)(vi)(A) of this section, because 
Taxpayer's Company Z common stock was part of a straddle in a 
previous taxable year and a loss from a position in that straddle 
was deferred under section 1092(a) at the end of Year 1, the 
preceding taxable year, Taxpayer's $160 Year 2 gain on the sale of 
the Company Z common stock is not eligible gain. At the end of Year 
2, the fair market value of each of the 60 remaining shares of 
Company Z common stock held by Taxpayer is $10 and Taxpayer has no 
unrecognized gain on its Company Z common stock. Under section 
1092(a)(1)(B), Taxpayer's $100 loss from Year 1 is treated as 
sustained in Year 2. Because Taxpayer has no unrecognized gain on 
its Company Z common stock at the end of Year 2, Taxpayer may deduct 
the $100 loss in Year 2. In Year 3, Taxpayer sells the remaining 60 
shares of Company Z common stock for $50 per share. Taxpayer has a 
gain of $2,400 ((60 * $50)-(60 * $10)) on the sale of the 60 shares 
of Company Z common stock. Because there was no loss from the 
straddle deferred under section 1092(a) at the end of Year 2, 
paragraph (b)(11)(vi)(A) of this section does not apply to prevent 
the $2,400 of Year 3 net gain from being eligible gain.
    (5) Example 5. Taxpayer's taxable year is the calendar year. On 
October 5, Year 1, Taxpayer buys 100 shares of publicly traded 
Exchange Traded Fund A (ETF A) and acquires offsetting section 1256 
contracts on the index that underlies the ETF A shares. Taxpayer 
makes a valid and timely identification of all 100 ETF A shares and 
the offsetting section 1256 contracts under Sec.  1.1092(b)-3T. On 
December 31, Year 1, the fair market value of the ETF A shares has 
increased by $500, and the fair market value of the section 1256 
contracts has decreased by $450. On December 31, Year 1, Taxpayer 
sells the ETF shares for a $500 gain. In addition, under section 
1256(a)(1), the section 1256 contracts are treated as sold for fair 
market value on December 31, Year 1, for a $450 loss. Pursuant to 
Sec.  1.1092(b)-3T(b)(4), Taxpayer has a net short term capital gain 
from the identified mixed straddle of $50 ($500-$450). Under 
paragraph (b)(11)(vi)(C) of this section, paragraph (b)(11)(vi)(A) 
of this section does not apply to prevent the $50 of net short term 
capital gain from being eligible gain.

    (vii) [Reserved]
    (viii) Eligible installment sale gains--(A) In general. The term 
eligible gain includes gains described in this paragraph (b)(11) that 
would be recognized by an eligible taxpayer under the installment 
method pursuant to section 453 and with Sec. Sec.  1.453-1 through 
1.453-12 for a taxable year, provided such gain otherwise meets the 
requirements of this paragraph (b)(11). This includes gains recognized 
under the installment method under section 453 from an installment sale 
that occurred before December 22, 2017.
    (B) 180-day period for gain from installment sales. For gains 
reported on

[[Page 1958]]

the installment method, an eligible taxpayer may treat the date the 
payment on the installment sale is received or the last day of the 
taxable year in which the eligible taxpayer would have recognized the 
gain under the installment method as the beginning of the 180-day 
period described in paragraph (b)(7) of this section. Thus, if an 
eligible taxpayer receives one or more payments on an installment sale 
and treats the date the payment on the installment sale is received as 
the beginning of the 180-day period, each payment will begin a new 180-
day period.
    (ix) Additional rules for determining if gain is subject to Federal 
income tax--(A) Application of a treaty--(1) In general. For purposes 
of paragraph (b)(11)(i)(B) of this section, whether gain would be 
subject to Federal income tax is determined after application of any 
treaty exemption provision that an eligible taxpayer elects to apply 
under any applicable U.S. income tax convention.
    (2) Treaty waiver. An eligible taxpayer who is not a United States 
person within the meaning of section 7701(a)(30) (or an eligible 
taxpayer who is a United States person within the meaning of section 
7701(a)(30) but who is treated as a resident of another country under 
an applicable U.S. income tax convention) may not make an election to 
defer gain pursuant to section 1400Z-2(a) after the applicability date 
of this section (see paragraph (g) of this section) unless such 
eligible taxpayer irrevocably waives, in accordance with forms and 
instructions (see Sec.  601.602 of this chapter), any treaty benefits 
that would exempt such gain from being subject to Federal income tax at 
the time of inclusion pursuant to an applicable U.S. income tax 
convention. In the event that such forms and instructions that include 
such waiver have not yet been published when an election pursuant to 
paragraph (d)(1) of this section is required to be made, such an 
eligible taxpayer must attach a written statement, signed under 
penalties of perjury, to any forms on which an election is made 
pursuant to paragraph (d)(1) of this section, which states ``With 
respect to gain deferred pursuant to an election under section 1400Z-
2(a), the below signed taxpayer irrevocably waives any treaty benefits 
that would exempt such gain from being subject to Federal income tax at 
the time of inclusion pursuant to an applicable U.S. income tax 
convention.'' If such an eligible taxpayer chooses to apply the section 
1400Z-2 regulations in a consistent manner for all taxable years (see 
paragraph (g)(2)(i) of this section), the taxpayer must include the 
signed statement required under this paragraph (b)(11)(ix)(A)(2) with 
the first annual report described in paragraph (d)(2) of this section 
that is required to be filed on a date that is after March 13, 2020. An 
eligible taxpayer not described in the first sentence of this paragraph 
(b)(11)(ix)(A)(2) will only be required to make the waiver described in 
this paragraph (b)(11)(ix)(A)(2) if and to the extent required in forms 
and publications (see Sec.  601.602 of this chapter).
    (3) Non-application to certain entities. This paragraph 
(b)(11)(ix)(A) does not apply to an entity described in paragraph 
(b)(11)(ix)(B) of this section.
    (B) Gain of a partnership. Subject to Sec.  1.1400Z2(f)-1(c), with 
respect to a partnership, the requirement in paragraph (b)(11)(i)(B) of 
this section that a gain be subject to Federal income tax does not 
apply to an otherwise eligible gain of the partnership, provided the 
partnership acquires the eligible interest with respect to such gain. 
See Sec.  1.1400Z2(f)-1(c)(3)(i) and (ii), Examples 1 and 2, for 
illustrations of the application of Sec.  1.1400Z2(f)-1(c) (providing 
an anti-abuse rule) to a partnership.
    (12) 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 including those within the meaning of section 1275(a)(1) and 
Sec.  1.1275-1(d). An eligible interest includes a pre-existing 
interest in an entity that becomes a QOF pursuant to Sec.  1.1400Z2(d)-
1(a)(1)(iii).
    (ii) Use as collateral permitted. Provided that the eligible 
taxpayer is the owner of the equity interest in the QOF 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 creating mixed-funds investment. See 
paragraph (f)(2) of this section for rules regarding deemed 
contributions of money to a partnership pursuant to section 752(a).
    (13) Eligible taxpayer. An eligible taxpayer is a person that is 
required to report the recognition of gains during the taxable year 
under Federal income tax accounting principles. Thus, for example, 
eligible taxpayers include individuals; C corporations, including RICs 
and REITs; organizations subject to tax under section 511; and 
partnerships, S corporations, trusts, and decedents' estates to the 
extent permitted by paragraphs (c)(7) through (9) of this section.
    (14) Inclusion event. The term inclusion event has the meaning 
provided in Sec.  1.1400Z2(b)-1(c).
    (15) Mixed-funds investment. The term mixed-funds investment means 
an investment a portion of which is a qualifying investment and a 
portion of which is a non-qualifying investment.
    (16) Non-qualifying investment. The term non-qualifying investment 
means an investment in a QOF described in section 1400Z-2(e)(1)(A)(ii).
    (17) Property--(i) In general. The term property means money, 
securities, or any other property.
    (ii) Inclusion events regarding QOF corporation distributions. For 
purposes of Sec.  1.1400Z2(b)-1(c), in the context in which a QOF 
corporation makes a distribution, the term property does not include 
stock (or rights to acquire stock) in the QOF corporation that makes 
the distribution.
    (18) QOF. The term QOF means a qualified opportunity fund, as 
defined in section 1400Z-2(d)(1) and Sec.  1.1400Z2(d)-1.
    (19) QOF C corporation. The term QOF C corporation means a QOF 
corporation other than a QOF S corporation.
    (20) QOF corporation. The term QOF corporation means a QOF that is 
classified as a corporation for Federal income tax purposes.
    (21) QOF RIC. The term QOF RIC means a QOF that elects to be taxed 
as a RIC for Federal income tax purposes. For purposes of section 
1400Z-2 and the section 1400Z-2 regulations, a RIC is a regulated 
investment company within the meaning of section 851.
    (22) QOF REIT. The term QOF REIT means a QOF that elects to be 
taxed as a REIT for Federal income tax purposes. For purposes of 
section 1400Z-2 and the section 1400Z-2 regulations, a REIT is a real 
estate investment trust within the meaning of section 856.
    (23) QOF owner. The term QOF owner means a QOF shareholder or a QOF 
partner.
    (24) QOF partner. The term QOF partner means a person that directly 
owns a qualifying investment in a QOF partnership or a person that owns 
such a qualifying investment through equity interests solely in one or 
more partnerships.
    (25) QOF partnership. The term QOF partnership means a QOF that is 
classified as a partnership for Federal income tax purposes.
    (26) QOF S corporation. The term QOF S corporation means a QOF

[[Page 1959]]

corporation that has elected under section 1362 to be an S corporation.
    (27) QOF shareholder. The term QOF shareholder means a person that 
directly owns a qualifying investment in a QOF corporation.
    (28) QOZ designation notice. The term QOZ designation notice means 
a notice designating population census tracts as qualified opportunity 
zones (QOZs) in guidance published in the Internal Revenue Bulletin 
(see Sec.  601.601(d)(2) of this chapter).
    (29) Qualified opportunity zone business. The term qualified 
opportunity zone business has the meaning provided in section 1400Z-
2(d)(3) and Sec.  1.1400Z2(d)-1(d).
    (30) Qualified opportunity zone business property. The term 
qualified opportunity zone business property has the meaning provided 
in section 1400Z-2(d)(2)(D) and Sec.  1.1400Z2(d)-2.
    (31) Qualified opportunity zone partnership interest. The term 
qualified opportunity zone partnership interest has the meaning 
provided in section 1400Z-2(d)(2)(C) and Sec.  1.1400Z2(d)-1(c)(3).
    (32) Qualified opportunity zone property. The term qualified 
opportunity zone business property has the meaning provided in section 
1400Z-2(d)(2)(A) and Sec.  1.1400Z2(d)-1(c)(1).
    (33) Qualified opportunity zone stock. The term qualified 
opportunity zone stock has the meaning provided in section 1400Z-
2(d)(2)(B) and Sec.  1.1400Z2(d)-1(c)(2).
    (34) Qualifying investment. The term qualifying investment means an 
eligible interest, or portion thereof, in a QOF to the extent that a 
deferral election is made and applies with respect to such eligible 
interest or portion thereof and the IRS has been timely notified of the 
deferral election. An eligible interest in a QOF ceases to be a 
qualifying investment of the owner upon, and to the extent of, the 
occurrence of an inclusion event with regard to that eligible interest, 
or portion thereof, except as is expressly provided otherwise in Sec.  
1.1400Z2(b)-1(c) or other provisions of the section 1400Z-2 
regulations.
    (35) Qualifying QOF partnership interest. The term qualifying QOF 
partnership interest means a direct or indirect interest in a QOF 
partnership that is a qualifying investment.
    (36) Qualifying QOF stock. The term qualifying QOF stock means 
stock in a QOF corporation that is a qualifying investment.
    (37) Qualifying section 355 transaction. The term qualifying 
section 355 transaction means a distribution described in Sec.  
1.1400Z2(b)-1(c)(11)(i)(B).
    (38) Qualifying section 381 transaction. The term qualifying 
section 381 transaction means a transaction described in section 
381(a)(2), except the following transactions:
    (i) An acquisition of assets of a QOF by a QOF shareholder that 
holds a qualifying investment in the QOF;
    (ii) An acquisition of assets of a QOF by a tax-exempt entity as 
defined in Sec.  1.337(d)-4(c)(2);
    (iii) An acquisition of assets of a QOF by an entity operating on a 
cooperative basis within the meaning of section 1381;
    (iv) An acquisition by a QOF of assets of a QOF shareholder that 
holds a qualifying investment in the QOF;
    (v) A reorganization of a QOF in a transaction that qualifies under 
section 368(a)(1)(G);
    (vi) A transaction, immediately after which one QOF owns an 
investment in another QOF; and
    (vii) A triangular reorganization of a QOF within the meaning of 
Sec.  1.358-6(b)(2)(i), (ii), or (iii).
    (39) Related persons. The term related when used with regard to 
persons and the term related persons means that there is a relationship 
described in section 267(b) or 707(b)(1), determined by substituting 
``20 percent'' for ``50 percent'' each place it occurs in such 
sections. The term unrelated when used with regard to persons means 
that there is no relationship described in preceding sentence.
    (40) Remaining deferred gain. With respect to a qualifying 
investment, the term remaining deferred gain means the full amount of 
gain that was deferred under section 1400Z-2(a)(1)(A), reduced by the 
amount of gain previously included under Sec.  1.1400Z2(b)-1(b). After 
December 31, 2026, an eligible taxpayer's remaining deferred gain is 
$0.
    (41) Section 1400Z-2 regulations. The term section 1400Z-2 
regulations means the regulations in this chapter, which are prescribed 
in whole or in part under section 1400Z-2.
    (c) Operational and special rules--(1) Attributes of gains included 
in income under section 1400Z-2(a)(1)(B). If section 1400Z-2(a)(1)(B), 
section 1400Z-2(b), and the section 1400Z-2 regulations require a 
taxpayer to include in income some or all of a previously deferred 
gain, the rules of paragraphs (c)(1)(i) and (ii) of this section apply 
with respect to such gain.
    (i) Deferral year attributes. The gain so included per paragraph 
(c)(1) of this section has the same attributes in the taxable year of 
inclusion that the gain would have had if recognition of the gain had 
not been deferred under section 1400Z-2(a)(1)(A). These attributes 
include those taken into account by sections 1(h), 1222, 1231(b), 1256, 
and any other applicable provisions of the Code.
    (ii) Inclusion year treatment. The gain so included per paragraph 
(c)(1) of this section is subject to the same Federal income tax 
provisions and rates that would apply to any other gains that are 
realized and recognized at the same time as the included gain and that 
have the same attributes as the deferred gain. For example, when a 
deferred qualified 1231 gain, as defined in paragraph (b)(11)(iii) of 
this section, is required to be included in income, the included 
section 1231 gain is treated as if it were a section 1231 gain (within 
the meaning of section 1231(a)(3)(A)) that was recognized on the date 
of inclusion.
    (iii) Rules for associating included gain with deferred gains--(A) 
In general. For purposes of paragraphs (c)(1)(i) and (ii) of this 
section, a taxpayer determines which previously deferred gain is 
associated with a qualifying investment in accordance with 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). The rules 
of paragraphs (c)(1)(iii)(B) and (C) of this section only apply only to 
the extent a deferred gain is not clearly associated with a particular 
qualifying investment under this paragraph (c)(1)(iii)(A).
    (B) Only one eligible gain associated with a deferral election. If 
only one eligible gain could have been deferred with respect to a 
qualifying investment, that deferred gain is associated with that 
qualifying investment. For example, if an eligible taxpayer makes a 
deferral election with respect to an investment in a QOF and only one 
eligible gain of the taxpayer satisfies the 180-day period with respect 
to the investment in the QOF, that eligible gain is the gain deferred 
with respect to the qualifying investment for purposes of paragraphs 
(c)(1)(i) and (ii) of this section.
    (C) Multiple eligible gains associated with a deferral election--
(1) In general. If more than one eligible gain may have been deferred 
with respect to an investment in a QOF for which a deferral election 
has been made, then for purposes of paragraphs (c)(1)(i) and (ii) of 
this section, the eligible taxpayer is treated as making the investment 
in the QOF first with respect to the earliest realized eligible gain, 
followed by the next earliest eligible gain and any other eligible 
gains in order of the date of their realization.
    (2) Rule for gains realized on the same day. If in the application 
of paragraph

[[Page 1960]]

(c)(1)(iii)(C)(1) of this section, two eligible gains are realized on 
the same day, such gains are allocated to the investment in the QOF 
proportionately.
    (2) Identification of which interest in a QOF corporation has been 
disposed of--(i) Need for identification. If a taxpayer holds shares of 
QOF stock with identical rights (fungible interests), and if the 
taxpayer disposes of less than all of the fungible interests, it is 
necessary to identify which interest or interests were disposed of. A 
taxpayer may effect this identification in accordance with the rules 
and principles of Sec.  1.1012-1(c). Consistent with Sec.  1.1012-1(c), 
if a taxpayer does not adequately identify which of the fungible 
interests are disposed of, the first-in, first-out identification 
method (FIFO method) applies.
    (ii) Consequences of identification. The identification 
determines--
    (A) Whether an investment disposed of is a qualifying investment or 
a non-qualifying investment; and
    (B) In the case of qualifying investments--
    (1) The attributes of the gain addressed in paragraph (c)(1) of 
this section; and
    (2) 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.
    (3) 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 (c)(2)(ii) of this section, then a proportionate 
allocation must be made to determine which interests were disposed of 
(pro-rata method).
    (4) Examples. The following examples illustrate the rules of 
paragraph (c)(1) through (3) 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 eligible 
gain that, if not deferred, would have been recognized as short-term 
capital gain, as defined in section 1222(1). In 2022, sections 
1400Z-2(a)(1)(B) and (b) require taxpayer B to include the gain in 
gross income. Under paragraph (c)(1) of this section, the gain 
included in 2022 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 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 capital gain from section 1256 contracts. 
For 2019, taxpayer D had $100 of net capital gain realized from 
section 1256 contracts that is eligible gain under paragraph 
(b)(11)(vi)(B) of this section. 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 D to 
include that deferred gain in gross income. Under paragraph (c)(1) 
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 corporation Q the amount of the 
gain to be deferred, resulting in a total investment in Q of $500. 
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 Q or sell any of its interest in 
Q until 2024, when E sold for a gain 60 percent of its interest in 
Q. E did not adequately identify which investment in QOF Q E sold. 
Under paragraph (c)(2)(i) of this section, E must apply the FIFO 
method to identify which investments in Q that E disposed of. 60 
percent of E's total investment in Q is $300 (60% x $500), thus 
under the FIFO method, E sold its entire 2018 initial investment of 
$300 in 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 to R in exchange for 100 R common 
shares. Later in 2018, after R was a QOF, F invested $500 to R in 
exchange for 400 R common shares and properly elected under section 
1400Z-2 to defer $500 of realized short-term capital gain from a 
separate investment. 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 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. F did not 
adequately identify which investment in R F sold. Under paragraph 
(c)(2)(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 in 
paragraph (c)(4)(v) of this section (Example 5), except that, in 
addition, during 2021 F sold an additional 400 R common shares, and, 
as with the other sale, F did not adequately identify which 
investment in QOF R F sold. Under paragraph (c)(2)(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 (c)(2)(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 (c)(2)(ii) of this 
section). Under paragraph (c)(3) 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).

    (5) Making an investment for purposes of an election under section 
1400Z-2(a)--(i) Transfer of cash or other property to a QOF. A taxpayer 
makes an investment in a QOF by transferring cash or other property to 
a QOF in exchange for eligible interests in the QOF, regardless of 
whether the transfer is one in which the transferor would recognize 
gain or loss on the property transferred.
    (ii) Furnishing services. Rendering services to a QOF is not a 
transfer of cash or other property to a QOF. Thus, if a taxpayer 
receives an eligible interest in a QOF for services rendered to the QOF 
or to a person in which the QOF holds any direct or indirect equity 
interest, then the interest in the QOF that the taxpayer receives is a 
non-qualifying investment.
    (iii) Acquisition of eligible interest from person other than QOF. 
An eligible taxpayer may make an investment in a QOF by acquiring an 
eligible interest in a QOF from a person other than the QOF, provided 
that all of the requirements of section 1400Z-2(a)(1) and the section 
1400Z-2 regulations for making a valid deferral election with respect 
to that investment are otherwise satisfied with respect to such 
acquisition. For example, an eligible taxpayer who acquires an eligible 
interest in a QOF other than from the QOF also must have an eligible 
gain within the 180-day period prior to the

[[Page 1961]]

eligible taxpayer's acquisition of the eligible interest in the QOF.
    (6) Amount invested for purposes of section 1400Z-2(a)(1)(A)--(i) 
In general. In the case of any investments described in this paragraph 
(c)(6), the amount of a taxpayer's qualifying investment cannot exceed 
the amount of eligible gain to be deferred under the deferral election. 
If the amount of an otherwise qualifying investment exceeds the amount 
of eligible gain to be deferred under the deferral election, the amount 
of the excess is treated as a non-qualifying investment. See paragraph 
(c)(6)(iii) of this section for special rules applicable to transfers 
to QOF partnerships.
    (ii) Transfers to a QOF--(A) Cash. If a taxpayer makes an 
investment in a QOF by transferring cash to a QOF, the amount of the 
taxpayer's investment is that amount of cash.
    (B) Property other than cash--Nonrecognition transactions. This 
paragraph (c)(6)(ii)(B) applies if a taxpayer makes an investment in a 
QOF by transferring property other than cash to a QOF and if, but for 
the application of section 1400Z-2(b)(2)(B) and the section 1400Z-2 
regulations, the taxpayer's basis in the resulting investment in the 
QOF would be determined, in whole or in part, by reference to the 
taxpayer's basis in the transferred property. This paragraph 
(c)(6)(ii)(B) applies separately to each item of property transferred 
to a QOF.
    (1) Amount of qualifying investment. If paragraph (c)(6)(ii)(B) of 
this section applies, the amount of the taxpayer's qualifying 
investment is the lesser of the taxpayer's adjusted basis in the 
eligible interest received in the transaction, without regard to 
section 1400Z-2(b)(2)(B) and the section 1400Z-2 regulations, or the 
fair market value of the eligible interest received in the transaction, 
both determined immediately after the transfer.
    (2) Fair market value of the eligible interest received exceeds its 
adjusted basis. If paragraph (c)(6)(ii)(B) of this section applies, and 
if the fair market value of the eligible interest received is in excess 
of the eligible taxpayer's adjusted basis in the eligible interest 
received, without regard to section 1400Z-2(b)(2)(B) and the section 
1400Z-2 regulations, then the eligible taxpayer's investment in a QOF 
is a mixed-funds investment to which section 1400Z-2(e)(1) applies. In 
such a case, an amount equal to the adjusted basis of the eligible 
interest in the hands of the eligible taxpayer is the eligible 
taxpayer's qualifying investment, and the excess is the eligible 
taxpayer's non-qualifying investment.
    (3) Transfer of built-in loss property and section 362(e)(2). If 
paragraph (c)(6)(ii)(B) of this section and section 362(e)(2) both 
apply to a transaction, the eligible taxpayer and the QOF are deemed to 
have made an election under section 362(e)(2)(C).
    (C) Property other than cash--Taxable transactions. This paragraph 
(c)(6)(ii)(C) applies if an eligible taxpayer makes an investment in a 
QOF by transferring property other than cash to a QOF and if, without 
regard to section 1400Z-2(b)(2)(B) and the section 1400Z-2 regulations, 
the eligible taxpayer's basis in the eligible interest received would 
not be determined, in whole or in part, by reference to the eligible 
taxpayer's basis in the transferred property. If this paragraph 
(c)(6)(ii)(C) applies, the amount of the eligible taxpayer's investment 
in a QOF is the fair market value of the transferred property, as 
determined immediately before the transfer. This paragraph 
(c)(6)(ii)(C) applies separately to each item of property transferred 
to a QOF.
    (D) Basis in a mixed-funds investment. If a taxpayer's investment 
in a QOF is a mixed-funds investment to which section 1400Z-2(e)(1) 
applies, the taxpayer's basis in the non-qualifying investment is equal 
to the taxpayer's basis in all of the eligible interests received, 
determined without regard to section 1400Z-2(b)(2)(B) and the section 
1400Z-2 regulations, and reduced by the basis of the taxpayer's 
qualifying investment, determined without regard to section 1400Z-
2(b)(2)(B) and the section 1400Z-2 regulations.
    (iii) Special rules for transfers to QOF partnerships. In the case 
of an investment in a QOF partnership, the following rules apply:
    (A) Amounts not treated as a qualifying investment--(1) Non-
contributions in general. To the extent the transfer of property to a 
QOF partnership is characterized other than as a contribution, such as 
characterization as a sale under section 707 and the regulations in 
this part under section 707 of the Code, the transfer is not treated as 
being made in exchange for a qualifying investment.
    (2) Reductions in investments otherwise treated as contributions. 
If any transfer of cash or other property to a partnership is not 
treated as a contribution, in whole or in part, under paragraph 
(c)(6)(iii)(A)(1) of this section, the part of the transfer to the 
partnership that is not disregarded is not a qualifying investment to 
the extent the partnership makes a distribution to the partner and the 
transfer to the partnership and the distribution would be 
recharacterized as a disguised sale under section 707 and the 
regulations in this part under section 707 of the Code if:
    (i) Any cash contributed were non-cash property; and
    (ii) In the case of a distribution by the partnership to which 
Sec.  1.707-5(b) (relating to debt-financed distributions) applies, the 
partner's share of liabilities is zero.
    (B) Amount invested in a QOF partnership--(1) Calculation of amount 
of qualifying and non-qualifying investments. To the extent paragraph 
(c)(6)(iii)(A) of this section does not apply, the amount of equity 
received by an eligible taxpayer in a QOF partnership in exchange for 
the lesser of the net basis or net value of the property contributed to 
the QOF partnership by the eligible taxpayer is a qualifying 
investment. The amount of equity received by an eligible taxpayer in a 
QOF partnership that is a non-qualifying investment is the excess, if 
any, of the total equity received by the eligible taxpayer over the 
amount treated as a qualifying investment.
    (2) Net basis. For purposes of paragraph (c)(6)(iii)(B) of this 
section, net basis is the excess, if any, of--
    (i) The adjusted basis of the property contributed to the 
partnership; over
    (ii) The amount of any debt to which the property is subject or 
that is assumed by the partnership in the transaction.
    (3) Net value. For purposes of paragraph (c)(6)(iii)(B) of this 
section, net value is the excess of--
    (i) The gross fair market value of the property contributed to the 
partnership; over
    (ii) The amount of the debt described in paragraph 
(c)(6)(iii)(B)(2)(ii) of this section.
    (4) Basis of qualifying and non-qualifying investments. The initial 
basis of a qualifying investment, before application of section 1400Z-
2(b)(2)(B) and the section 1400Z-2 regulations or any section 752 debt 
allocation, is the net basis of the property contributed. The basis of 
a non-qualifying investment, before any section 752 debt allocation, is 
the remaining net basis. The basis of the qualifying investment is 
adjusted as provided in section 1400Z-2(b)(2)(B) and the section 1400Z-
2 regulations. The bases of qualifying and non-qualifying investments 
are increased by any debt allocated to those investments under the 
rules of Sec.  1.1400Z2(b)-1(c)(6)(iv)(B).
    (5) Rules applicable to mixed-funds investments. If one portion of 
an investment in a QOF partnership is a qualifying investment and 
another

[[Page 1962]]

portion is a non-qualifying investment, see Sec.  1.1400Z2(b)-
1(c)(6)(iv) for the rules that apply.
    (iv) Acquisitions from another person. An eligible taxpayer may 
make an investment in a QOF by acquiring in a sale or exchange to which 
Sec.  1.1001-1(a) applies an eligible interest in a QOF from a person 
other than the QOF. The amount of the eligible taxpayer's investment in 
the QOF with respect to which the eligible taxpayer may make a deferral 
election is the amount of the cash, or the net fair market value of the 
other property, as determined immediately before the exchange, that the 
eligible taxpayer exchanged for the eligible interest in the QOF.
    (v) Examples. The following examples illustrate the rules of this 
paragraph (c)(6).

    (A) Example 1. Transfer of built-in gain property with basis 
less than gain to be deferred--(1) Facts. Individual B realizes $100 
of eligible gain within the meaning of paragraph (b)(11) of this 
section. B transfers unencumbered property with a fair market value 
of $100 and an adjusted basis of $60 to QOF Q, a C corporation, in a 
transaction that is described in section 351(a).
    (2) Analysis. Paragraph (c)(6)(ii)(B) of this section applies 
because B transferred property other than cash to Q and, but for the 
application of section 1400Z-2(b)(2)(B), B's basis in the eligible 
interests in Q would be determined, in whole or in part, by 
reference to B's basis in the transferred property. The fair market 
value of the eligible interest B received is $100, and, without 
regard to section 1400Z-2(b)(2)(B), B's basis in the eligible 
interest received would be $60. Thus, pursuant to paragraph 
(c)(6)(ii)(B)(2) of this section, B's investment is a mixed-funds 
investment to which section 1400Z-2(e)(1) applies. Pursuant to 
paragraphs (c)(6)(ii)(B)(1) and (2) of this section, B's qualifying 
investment is $60 (the lesser of the taxpayer's adjusted basis in 
the eligible interest, without regard to section 1400Z-2(b)(2)(B), 
of $60 and the $100 fair market value of the eligible interest 
received). Pursuant to section 1400Z-2(b)(2)(B)(i), B's basis in the 
qualifying investment is $0. Additionally, B's non-qualifying 
investment is $40 (the excess of the fair market value of the 
eligible interest received ($100) over the taxpayer's adjusted basis 
in the eligible interest, without regard to section 1400Z-2(b)(2)(B) 
($60)). B's basis in the non-qualifying investment is $0 (B's $60 
basis in its investment determined without regard to section 1400Z-
2(b)(2)(B), reduced by the $60 of adjusted basis allocated to the 
investment to which section 1400Z-2(e)(1)(A)(i) applies, determined 
without regard to section 1400Z-2(b)(2)(B)). See paragraph 
(c)(6)(ii)(D) of this section. Pursuant to section 362, Q's basis in 
the transferred property is $60.
    (B) Example 2. Transfer of built-in gain property with basis in 
excess of eligible gain to be deferred. The facts are the same as in 
paragraph (c)(6)(v)(A)(1) of this section (Example 1), except that B 
realizes $50 of eligible gain within the meaning of paragraph 
(b)(11) of this section. Pursuant to paragraph (c)(6)(i) of this 
section, B's qualifying investment cannot exceed the amount of 
eligible gain to be deferred (that is, the $50 of eligible gain) 
under the section 1400Z-2(a) election. Therefore, pursuant to 
paragraph (c)(6)(ii)(B)(1) of this section, B's qualifying 
investment is $50 (the lesser of the taxpayer's adjusted basis in 
the eligible interest received, without regard to section 1400Z-
2(b)(2)(B), of $60 and the $100 fair market value of the eligible 
interest, limited by the amount of eligible gain to be deferred 
under the section 1400Z-2(a) election). B's qualifying investment 
has an adjusted basis of $0, as provided in section 1400Z-
2(b)(2)(B)(i). Additionally, B's non-qualifying investment is $50 
(the excess of the fair market value of the eligible interest 
received ($100) over the amount ($50) of B's section 1400Z-
2(a)(1)(A) investment). B's basis in the non-qualifying investment 
is $10 (B's $60 basis in its investment determined without regard to 
section 1400Z-2(b)(2)(B)), reduced by the $50 of adjusted basis 
allocated to B's qualifying investment, determined without regard to 
section 1400Z-2(b)(2)(B).
    (C) Example 3. Transfers to QOF partnerships--(1) Facts. A and B 
each realized $100 of eligible gain and each transfers $100 to a QOF 
partnership. In a subsequent year, the partnership borrows $120 from 
an unrelated lender and distributes $120 equally to A and B.
    (2) Analysis. If the contributions had been of property other 
than cash, the contributions and distributions would have been 
tested under the disguised sale rules of section 707 and the 
regulations in this part under section 707 of the Code, determining 
the timing of the distribution and amount of the debt allocated to 
each partner. Under paragraph (c)(6)(iii)(A)(2) of this section, the 
cash of $200 ($100 from A and $100 from B) is treated as property 
that could be sold in a disguised sale transaction and each 
partner's share of the debt is zero for purposes of determining the 
amount of the qualifying investment. To the extent there would have 
been a disguised sale applying the rule of paragraph 
(c)(6)(iii)(A)(2) of this section, the amount of the qualifying 
investment would be reduced by the amount of the contribution so 
recharacterized.
    (D) Example 4. Return of capital by QOF partnership--(1) Facts. 
A realized $100 of eligible gain and transfers $100 of cash to a QOF 
partnership. Later in the partner's tax year, the partnership 
distributes $20 to A in a distribution that is not recharacterized 
under paragraph (c)(6)(iii)(A)(2) of this section. At the time of 
the distribution, no allocations of income, gain, loss, or deduction 
had been made to A, and A's share of the partnership's debt was zero 
under section 752.
    (2) Analysis. Because the contribution and distribution are not 
recharacterized under paragraph (c)(6)(iii)(A)(2) of this section, 
the amount of A's qualifying investment is $100 despite the $20 
distribution. At the time the $20 distribution is made to A, A's 
basis in its qualifying investment is zero, and thus the 
distribution is an inclusion event under Sec.  1.1400Z2(b)-
1(c)(6)(iii).
    (E) Example 5. Property contributed has built-in gain. The facts 
are the same as in paragraph (c)(6)(v)(C)(1) of this section 
(Example 3), except that the property contributed by A had a value 
of $100 and basis of $20 and the partnership did not borrow money or 
make a distribution. Under paragraph (c)(6)(iii)(B)(1) of this 
section, the amount of A's qualifying investment is $20 (the lesser 
of the net value or the net basis of the property that A 
contributed), and the excess of the $100 contribution over the $20 
qualifying investment is a non-qualifying investment. Under 
paragraph (c)(6)(iii)(B)(4) of this section, A's basis in the 
qualifying investment (determined without regard to section 1400Z-
2(b)(2)(B) or section 752(a)) is $20. After the application of 
section 1400Z-2(b)(2)(B) but before the application of section 
752(a), A's basis in the qualifying investment is zero. A's basis in 
the non-qualifying investment is zero without regard to the 
application of section 752(a).
    (F) Example 6. Property contributed has built-in gain and is 
subject to debt. The facts are the same as in paragraph (c)(6)(v)(E) 
of this section (Example 5), except that the property contributed by 
A has a gross value of $130 and is subject to debt of $30. Under 
paragraph (c)(6)(iii)(B)(1) of this section, the amount of A's 
qualifying investment is zero, the lesser of the property's $100 net 
value ($130 minus $30) or $0 net basis ($20 minus $30, but limited 
to zero). The entire contribution constitutes a non-qualifying 
investment.
    (G) Example 7. Property contributed has built-in loss and is 
subject to debt. The facts are the same as in paragraph (c)(6)(v)(F) 
of this section (Example 6), except that the property contributed by 
A has a basis of $150. Under paragraph (c)(6)(iii)(B)(1) of this 
section, the amount of A's qualifying investment is $100, the lesser 
of the property's $100 net value ($130 minus $30) or $120 net basis 
($150 minus $30). The non-qualifying investment is $0, the excess of 
the net value ($100) over the qualifying investment ($100). A's 
basis in the qualifying investment (determined without regard to 
section 1400Z-2(b)(2)(B) and section 752(a)) is $120, the net basis. 
After the application of section 1400Z-2(b)(2)(B), A's basis in the 
qualifying investment is zero, plus its share of partnership debt 
under section 752(a).

    (7) Eligible gains that a partnership elects to defer. A 
partnership generally is an eligible taxpayer under paragraph (b)(13) 
of this section and may elect to defer recognition of some or all of 
its eligible gains under section 1400Z-2(a)(2) and the section 1400Z-2 
regulations.
    (i) Partnership deferral election. If a partnership properly makes 
a deferral election, then--
    (A) The partnership defers recognition of the eligible gain under 
the rules of section 1400Z-2 and the section 1400Z-2 regulations, that 
is, the partnership does not recognize gain at the time it otherwise 
would have in the absence of the deferral election; and

[[Page 1963]]

    (B) The deferred eligible gain is not included in the distributive 
shares of the partners under section 702 and is not treated as an item 
described in section 705(a)(1).
    (ii) Subsequent recognition. Absent any additional deferral under 
section 1400Z-2(a)(1)(A) and the section 1400Z-2 regulations, any 
amount of deferred gain that an electing partnership subsequently must 
include in income under sections 1400Z-2(a)(1)(B) and (b) and the 
section 1400Z-2 regulations is recognized by the electing partnership 
at the time of inclusion, is subject to section 702 and is treated as 
an item described in section 705(a)(1) in a manner consistent with 
recognition at that time.
    (8) Eligible gains that the partnership does not defer--(i) Federal 
income tax treatment of the partnership. If a partnership does not 
elect to defer some, or all, of its eligible gains, the partnership's 
treatment of any such amounts is unaffected by the fact that the 
eligible gains could have been deferred under section 1400Z-2 and the 
section 1400Z-2 regulations.
    (ii) Federal income tax treatment by the partners. If a partnership 
does not elect to defer some, or all, of the eligible gains--
    (A) The gains for which a deferral election are not made are 
included in the partners' distributive shares under section 702 and are 
treated as items described in 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) and the section 1400Z-2 
regulations to defer some or all of such 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) and the 
section 1400Z-2 regulations, 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)(8)(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 distributive 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)(8)(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--
    (1) The same as the partnership's 180-day period; or
    (2) The 180-day period beginning on the due date for the 
partnership's tax return, without extensions, for the taxable year in 
which the partnership realized the gain that is described in paragraph 
(c)(8)(ii)(C) of this section.
    (C) Example. The following example illustrates the principles of 
this paragraph (c)(8)(iii).

    (1) Facts. Four individuals, A, B, C, and D, have equal 
interests in a partnership, P. P has no other partners, and P's 
taxable year is the calendar year. On January 17, 2019, P realizes a 
capital gain of $1000x that P decides not to elect to defer.
    (2) Analysis of A's election. A is aware of the capital gain 
realized by P, and decides to defer its distributive shares of P's 
eligible gain. A invests $250x in a QOF during February 2020. Under 
the general rule in paragraph (c)(8)(iii)(A) of this section, this 
investment is within the 180-day period for A, which began on 
December 31, 2019, the last day of P's taxable year in which A's 
share of P's eligible gain is taken into account under section 
706(a).
    (3) Analysis of B's election. B is also aware of the capital 
gain realized by P, and decides to defer its distributive shares of 
P's eligible gain. B decides to make the election provided in 
paragraph (c)(8)(iii)(B)(1) of this section, and invests $250x in a 
QOF during February 2019. Under the elective rule in paragraph 
(c)(8)(iii)(B)(1) of this section, this investment is within the 
180-day period for B, which began on January 17, 2019, the same day 
as P's 180-day period.
    (4) Analysis of C's election. On March 15, 2020, P provides all 
of its partners with their Schedules K-1. Upon learning that its 
distributive share of income from P included eligible gain, C 
decides to make a deferral election, and also makes the election 
provided in paragraph (c)(8)(iii)(B)(2) of this section. It then 
invests $250x in a QOF during June 2020. Under the elective rule in 
paragraph (c)(8)(iii)(B)(2) of this section, this investment is 
within the 180-day period for C, which began on March 15, 2020, the 
180-day period beginning on the due date for P's tax return without 
extensions, for the taxable year in which P realized eligible gain.

    (9) Passthrough entities other than partnerships--(i) S 
corporations, nongrantor trusts, and estates. If an S corporation, a 
nongrantor trust, or a decedent's estate realizes an eligible gain, 
then rules analogous to the rules of paragraphs (c)(7) and (8) of this 
section apply to that entity and to its shareholders or its 
beneficiaries, as the case may be, to the extent they receive or are 
deemed to receive an allocable share of the eligible gain.
    (ii) Grantor trusts. If a grantor trust realizes an eligible gain, 
either the trust or the deemed owner of the trust may make the election 
to defer recognition of the gain and make the qualifying investment 
under rules analogous to the rules of paragraphs (c)(7) and (8) of this 
section (other than the rule in paragraph (c)(8)(iii) of this section 
regarding the 180-day period), whether or not the gain is distributed 
to the deemed owner of the trust.
    (d) Elections--(1) Taxable year of deferral election. For a 
deferral election with respect to any eligible gain to be valid, an 
eligible taxpayer must make such election in accordance with 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), as to the 
required time, form, and manner in which an eligible taxpayer 
(including a partner, S corporation shareholder, or beneficiary 
applying the elective 180-day period provided in paragraphs 
(c)(8)(iii)(B) and (c)(9) of this section) may make a deferral 
election.
    (2) Annual reporting of qualifying investments. An eligible 
taxpayer must report whether the gains that have been deferred remain 
deferred at the end of each taxable year, including the year of 
deferral, in accordance with 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). A failure to make this report for any given 
taxable year will result in a rebuttable presumption that the taxpayer 
has had an inclusion event described in Sec.  1.1400Z2(b)-1(c) during 
that year. The presumption described in the previous sentence may be 
rebutted by the taxpayer making the report described in the first 
sentence of this paragraph (d)(2) or by the taxpayer establishing to 
the satisfaction of the Commissioner that an inclusion event described 
in Sec.  1.1400Z2(b)-1(c) did not occur during that taxable year.
    (e) Interaction of section 1400Z-2 and Sec.  1.897-6T. Section 
1400Z-2 is not a nonrecognition provision, as defined in Sec.  1.897-
6T(a)(2), for purposes of Sec.  1.897-6T.
    (f) Treatment of mixed-funds investments--(1) Investments to which 
no election under section 1400Z-2(a) applies. If a taxpayer invests in 
a QOF and makes a deferral election with respect to less than all of 
that investment, the portion of the investment to which the election 
does not apply is a non-qualifying investment. Similarly, an investment 
in a QOF with respect to which no deferral

[[Page 1964]]

election is made is a non-qualifying investment.
    (2) Treatment of deemed contributions of money under section 
752(a). In the case of a QOF partnership, the deemed contribution of 
money described in section 752(a) does not create or increase an 
investment in the QOF 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). See Sec.  
1.1400Z2(b)-1(c)(6)(iv)(B) for rules relating to the application of 
section 752 to a mixed-funds investment.
    (3) Treatment of contributions to QOF corporation in which no stock 
is received. If a taxpayer with a qualifying investment or a non-
qualifying investment in a QOF corporation subsequently makes a non-
qualifying investment or a qualifying investment, respectively, and if 
the taxpayer receives no additional QOF stock in exchange for the 
subsequent investment, the taxpayer has a mixed-funds investment.
    (4) Example. The following example illustrates the rules of this 
paragraph (f):

    (i) Facts. Taxpayer A realizes $1 million of eligible gain and 
on the next day contributes $1 million to a QOF, Partnership P, in 
exchange for a 50 percent interest in Partnership P. Taxpayer A 
makes an election under section 1400Z-2(a) with respect to $900,000 
of that eligible gain. 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.
    (ii) Analysis. Under section 752(a), A is treated as 
contributing $4 million to Partnership P. Under paragraph (f) 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 the deferral election under 
section 1400Z-2(a). As a result, after A's section 752(a) deemed 
contribution, $900,000, or 90 percent, of A's investment in 
Partnership P is described in section 1400Z-2(e)(1)(A)(i) and 
$100,000, or 10 percent, is described in section 1400Z-
2(e)(1)(A)(ii).

    (g) Applicability dates-(1) In general. The provisions of this 
section are applicable for taxable years beginning after March 13, 
2020.
    (2) Prior periods. With respect to eligible gains that would be 
recognized (absent the making of a deferral election) during the 
portion of a taxpayer's first taxable year ending after December 21, 
2017 that began on December 22, 2017, and during taxable years 
beginning after December 21, 2017, and on or before March 13, 2020, an 
eligible taxpayer may choose either--
    (i) To apply the section 1400Z-2 regulations, if applied in a 
consistent manner for all such taxable years; or
    (ii) To rely on the rules in proposed Sec.  1.1400Z2(a)-1 contained 
in the notice of proposed rulemaking (REG-115420-18) published on 
October 29, 2018, as amplified by the notice of proposed rulemaking 
(REG-120186-18) published on May 1, 2019, but only if applied in a 
consistent manner for all such taxable years.

0
Par. 4. Section 1.1400Z2(b)-1 is added to read as follows:


Sec.  1.1400Z2 (b)-1  Inclusion of gains that have been deferred under 
section 1400Z-2(a).

    (a) Scope. This section provides rules under section 1400Z-2(b) of 
the Internal Revenue Code and the section 1400Z-2 regulations (as 
defined in Sec.  1.1400Z2(a)-1(b)(41)) regarding the inclusion in 
income of gain deferred by a QOF owner under section 1400Z-2(a)(1)(A) 
and the section 1400Z-2 regulations. This section applies to a QOF 
owner only until all of such owner's gain deferred pursuant to a 
deferral election has been included in income, subject to the 
limitations described in paragraph (e)(5) of this section, and except 
as otherwise provided in paragraph (c) or (d) of this section. 
Paragraph (b) of this section provides general rules under section 
1400Z-2(b)(1) regarding the timing of the inclusion in income of the 
deferred gain. Paragraph (c)(1) of this section provides the general 
rule regarding the determination of the extent to which an event 
triggers the inclusion in gross income of all, or a portion, of an 
eligible taxpayer's deferred gain, and paragraphs (c)(2) through (16) 
of this section provide specific rules for certain events that are or 
are not treated as inclusion events. Paragraph (d) of this section 
provides rules regarding holding periods for qualifying investments. 
Paragraph (e) of this section provides rules regarding the amount of 
deferred gain included in gross income under section 1400Z-2(a)(1)(B) 
and (b), including special rules for QOF partnerships and QOF S 
corporations. Paragraph (f) of this section provides examples 
illustrating the rules of paragraphs (c), (d), and (e) of this section. 
Paragraph (g) of this section provides rules regarding basis 
adjustments under section 1400Z-2(b)(2)(B). Paragraph (h) of this 
section provides special reporting rules applicable to partners, 
partnerships, and direct or indirect owners of QOF partnerships. 
Paragraph (i) is reserved. Paragraph (j) of this section provides dates 
of applicability.
    (b) General inclusion rule. The gain to which a deferral election 
applies is included in gross income, to the extent provided in 
paragraph (e) of this section and in accordance with the rules of Sec.  
1.1400Z2(a)-1(c)(1), in the taxable year that includes the earlier of:
    (1) The date of an inclusion event; or
    (2) December 31, 2026.
    (c) Inclusion events--(1) In general. Except as otherwise provided 
in this paragraph (c), an event is an inclusion event, if, and to the 
extent that--
    (i) The event reduces an eligible taxpayer's direct equity interest 
for Federal income tax purposes in the qualifying investment;
    (ii) An eligible taxpayer receives property in the event with 
respect to its qualifying investment and the event is treated as a 
distribution for Federal income tax purposes, whether or not the 
receipt reduces the eligible taxpayer's ownership of the QOF;
    (iii) An eligible taxpayer claims a loss for worthless stock under 
section 165(g) or otherwise claims a worthlessness deduction with 
respect to its qualifying investment; or
    (iv) A QOF in which an eligible taxpayer holds a qualifying 
investment loses its status as a QOF.
    (2) Termination or liquidation of QOF or QOF owner--(i) Termination 
or liquidation of QOF. Except as otherwise provided in this paragraph 
(c), an eligible taxpayer has an inclusion event with respect to all of 
its qualifying investment if the QOF ceases to exist for Federal income 
tax purposes. For example, if a QOF partnership converts to a QOF C 
corporation, or if a QOF C corporation converts to a QOF partnership or 
to an entity disregarded as separate from its owner for Federal income 
tax purposes, all investors in the QOF have an inclusion event with 
respect to all of their qualifying investments in the QOF.
    (ii) Liquidation of QOF owner--(A) Portion of distribution treated 
as sale. A distribution of a qualifying investment in a complete 
liquidation of a QOF owner is an inclusion event to the extent that 
section 336(a) treats the distribution as if the qualifying investment 
were sold to the distributee at its fair market value, without regard 
to section 336(d).
    (B) Distribution to 80-percent distributee. A distribution of a 
qualifying investment in a complete

[[Page 1965]]

liquidation of a QOF owner is not an inclusion event to the extent 
section 337(a) applies to the distribution.
    (3) Transfer of an investment in a QOF by gift or incident to 
divorce--(i) Transfer of an investment in a QOF by gift. Except to the 
extent provided in paragraph (c)(5) of this section, a taxpayer's 
transfer of a qualifying investment by gift, as defined for purposes of 
chapter 12 of subtitle B of the Code, whether outright or in trust, is 
an inclusion event, regardless of whether that transfer is a completed 
gift for Federal gift tax purposes, and regardless of the taxable or 
tax-exempt status of the donee of the gift.
    (ii) Transfers between spouses incident to divorce. A transfer 
between spouses or incident to divorce or otherwise as provided in 
section 1041 of the Code is an inclusion event.
    (4) Transfer of an investment in a QOF by reason of the taxpayer's 
death--(i) In general. Except as provided in paragraph (c)(4)(ii) of 
this section, a transfer of a qualifying investment by reason of the 
taxpayer's death is not an inclusion event. Transfers by reason of 
death include, for example:
    (A) A transfer by reason of death to the deceased owner's estate;
    (B) A distribution of a qualifying investment by the deceased 
owner's estate;
    (C) A distribution of a qualifying investment by the deceased 
owner's trust that is made by reason of the deceased owner's death;
    (D) The passing of a jointly owned qualifying investment to the 
surviving co-owner by operation of law; and
    (E) Any other transfer of a qualifying investment at death by 
operation of law.
    (ii) Exceptions. The following transfers are not included as a 
transfer by reason of the taxpayer's death, and thus are inclusion 
events:
    (A) A sale, exchange, or other disposition by the deceased 
taxpayer's estate or trust, other than a distribution described in 
paragraph (c)(4)(i) of this section;
    (B) Any disposition by the legatee, heir, or beneficiary who 
received the qualifying investment by reason of the taxpayer's death; 
and
    (C) Any disposition by the surviving joint owner or other recipient 
who received the qualifying investment by operation of law on the 
taxpayer's death.
    (iii) Liability for deferred Federal income tax. If the owner of a 
qualifying investment in a QOF dies before an inclusion event and the 
deferred gain is not includable in the decedent's gross income, the 
gain that the decedent elected to defer under section 1400Z-2(a) and 
the section 1400Z-2 regulations will be includable in the gross income, 
for the taxable year in which occurs an inclusion event, of the person 
described in section 691(a)(1).
    (iv) Qualifying investment in the hands of the person described in 
section 691(a)(1). A qualifying investment received in a transfer by 
reason of death listed in paragraph (c)(4)(i) of this section continues 
to be a qualifying investment under Sec.  1.1400Z2(a)-1(b)(34).
    (5) Grantor trusts--(i) Contributions to grantor trusts. If the 
owner of a qualifying investment contributes it to a trust and, under 
subpart E of part I of subchapter J of chapter 1 of subtitle A of the 
Code (grantor trust rules), the contributing owner of the investment is 
the deemed owner of the trust (grantor trust), the contribution to the 
grantor trust is not an inclusion event. Similarly, a transfer of the 
investment by the grantor trust to the trust's deemed owner is not an 
inclusion event. For all purposes of the section 1400Z-2 regulations, 
references to the term grantor trust mean the portion of the trust that 
holds the qualifying investment in the QOF, and such a grantor trust, 
or portion of the trust, is a wholly grantor trust as to the deemed 
owner. Such contributions may include transfers by gift or any other 
type of transfer between the grantor and the grantor trust that is a 
nonrecognition event as a result of the application of the grantor 
trust rules (that is, subpart E of part I of subchapter J of chapter 1 
of subtitle A of the Code).
    (ii) Changes in grantor trust status. In general, a change in the 
income tax status of an existing trust owning a qualifying investment 
in a QOF, whether the termination of grantor trust status or the 
creation of grantor trust status, is an inclusion event. 
Notwithstanding the previous sentence, the termination of grantor trust 
status as the result of the death of the owner of a qualifying 
investment is not an inclusion event, but the provisions of paragraph 
(c)(4) of this section apply to distributions or dispositions by the 
trust. If a qualifying investment is held in the grantor portion of an 
electing small business trust (ESBT), as defined in section 1361(e)(1), 
and the ESBT converts into a qualified subchapter S trust (QSST), as 
defined in section 1361(d)(3), the beneficiary of which is the deemed 
owner of the grantor portion of the ESBT, there has been no change in 
the grantor trust status because the deemed owner continues to be 
taxable under subtitle A of the Code on the income and gain from the 
qualifying investment.
    (iii) Conversions of QSSTs and ESBTs. With regard to conversions of 
QSSTs and ESBTs, see paragraphs (c)(7)(i)(B) and (C) of this section. 
For purposes of paragraph (c)(5)(ii) of this section, if a qualifying 
investment is held by a QSST that converts to an ESBT, the beneficiary 
of the QSST is the deemed owner of the grantor portion of the ESBT that 
then holds the qualifying investment, and the deemed owner is not a 
nonresident alien for purposes of this section (and thus 
notwithstanding Sec.  1.1361-1(j)(8)), there has been no change in the 
grantor trust status because the deemed owner continues to be taxable 
under subtitle A of the Code on the income and gain from the qualifying 
investment.
    (6) Special rules for partners and partnerships--(i) Scope. Except 
as otherwise provided in this paragraph (c)(6), in the case of a 
partnership that is a QOF or a QOF partner, the inclusion rules of this 
paragraph (c) apply to transactions involving any direct or indirect 
partner of the QOF to the extent of that partner's share of any 
eligible gain of the QOF.
    (ii) Transactions that are not inclusion events--(A) In general. 
Notwithstanding paragraphs (c)(1) and (2) of this section, and except 
as otherwise provided in paragraph (c)(6) of this section, no 
transaction described in paragraph (c)(6)(ii) of this section is an 
inclusion event.
    (B) Section 721 contributions. Subject to paragraph (c)(6)(v) of 
this section, a contribution by a QOF owner (contributing partner), of 
its qualifying QOF stock, qualifying QOF partnership interest, or 
direct or indirect partnership interest in a qualifying investment to a 
partnership (transferee partnership) to the extent the transaction is 
governed by section 721(a) is not an inclusion event, provided the 
interest transfer does not cause a partnership termination of a QOF 
partnership, or the direct or indirect owner of a QOF, under section 
708(b)(1). See paragraph (c)(6)(ii)(C) of this section for transactions 
governed by section 708(b)(2)(A). The inclusion rules in paragraph (c) 
of this section apply to any part of the transaction to which section 
721(a) does not apply. The transferee partnership becomes subject to 
section 1400Z-2 and the section 1400Z-2 regulations with respect to the 
eligible gain associated with the contributed qualifying investment. 
The transferee partnership must allocate and report the remaining 
deferred gain that is associated with the contributed qualifying 
investment to the contributing partner to the same extent that the 
remaining deferred gain would have been allocated and reported to the

[[Page 1966]]

contributing partner in the absence of the contribution. Additionally, 
the transferee partnership must allocate the basis increases described 
in section 1400Z-2(b)(2)(B)(iii) and (iv) to the contributing partner. 
If a transferee partnership is a direct QOF owner, only the transferee 
partnership may make the elections under section 1400Z-2(c) and the 
regulations in this part under section 1400Z-2(c) of the Code with 
respect to the contributed qualifying investment. See Sec.  1400Z2(c)-
1(b)(1)(ii) (election by transferee partnership).
    (C) Section 708(b)(2)(A) mergers or consolidations--(1) Merger of a 
partnership that is a QOF partner. Subject to paragraphs (c)(6)(iii) 
and (v) of this section, a merger or consolidation of a partnership 
that is a QOF partner (original partnership) with another partnership 
in a transaction to which section 708(b)(2)(A) applies is not an 
inclusion event to the extent section 721(a) applies to the merger. To 
the extent the original partnership terminates in the merger, as 
determined under Sec.  1.708-1(c)(1), the partnership that is a 
continuation of the original partnership becomes subject to section 
1400Z-2 and the section 1400Z-2 regulations to the same extent that the 
original partnership was so subject prior to the transaction, and must 
allocate and report any gain under section 1400Z-2(b) to the same 
extent and to the same partners that the original partnership allocated 
and reported such items prior to the transaction. Notwithstanding the 
rules in this paragraph (c)(6)(ii)(C)(1), the general inclusion rules 
of paragraph (c) of this section apply to the portion of the 
transaction that is otherwise treated as a sale or exchange under 
paragraph (c) of this section.
    (2) Merger of QOF partnerships. Subject to paragraph (c)(6)(v) of 
this section, a merger or consolidation of a QOF partnership with 
another QOF partnership in a transaction to which section 708(b)(2)(A) 
applies is not an inclusion event under paragraph (c)(2)(i) of this 
section if, immediately after the merger or consolidation, the 
resulting partnership is a QOF. The continuing partnership, as 
determined under Sec.  1.708-1(c)(1), becomes subject to section 1400Z-
2 and the section 1400Z-2 regulations to the same extent that the 
terminated partnership was so subject prior to the transaction, and 
must allocate and report any gain under section 1400Z-2(b) to the same 
extent and to the same partners that the terminated partnership would 
have allocated and reported such items prior to the transaction. 
Notwithstanding the rules in this paragraph (c)(6)(ii)(C)(2), the 
general inclusion rules of paragraph (c) of this section apply to the 
portion of the transaction that is otherwise treated as a sale or 
exchange under paragraph (c) of this section.
    (D) Example. The following example illustrates the rules of this 
paragraph (c)(6)(ii).

    (1) Example--(i) Facts. In 2019, taxpayer A contributes $100 of 
eligible gain to a QOF partnership, X, in exchange for a qualifying 
QOF partnership interest in X, and taxpayer B contributes $100 of 
eligible gain to another QOF partnership, Y, in exchange for a 
qualifying QOF partnership interest in Y. In 2021, in transactions 
governed by section 721(a), A contributes her qualifying QOF 
partnership interest in X, and B contributes her qualifying QOF 
partnership interest in Y, to a newly formed partnership, UTP. In 
2024, C receives a profits interest in UTP for services that she 
will provide to UTP. In 2031, X sells a non-inventory asset and 
allocates X's distributive share of the gain to UTP. No 
distributions are ever made from X, Y, or UTP.
    (ii) Analysis. On December 31, 2026, UTP recognizes $170 of 
remaining deferred gain relating to the QOF interests. Of that gain, 
A is allocated the $85 of gain relating to the $100 of eligible gain 
that she invested in X, and B is allocated the $85 of gain relating 
to the $100 of eligible gain that she invested in Y. C recognizes no 
gain at this time. In 2031, because UTP's holding period in X 
includes A's holding period in X, UTP has a holding period in X that 
exceeds 10 years, and may make an election under Sec.  1.1400Z2(c)-
1(b)(2)(ii) to exclude the gain from X's asset sale. Even though A 
was the original investor in X, she may not make the election. If 
UTP makes the election, UTP will exclude its distributive share of 
gain from the sale of the X asset.

    (2) [Reserved]
    (iii) Partnership distributions. Subject to paragraph (c)(6)(v) of 
this section, an actual or deemed distribution of property, including 
cash, by a QOF partnership to a partner with respect to its qualifying 
investment is an inclusion event only to the extent that the 
distributed property has a fair market value in excess of the partner's 
basis in its qualifying investment. For purposes of this paragraph 
(c)(6)(iii), in the case of a merger or consolidation of a QOF 
partnership with another QOF partnership in a transaction to which 
section 708(b)(2)(A) applies, the fair market value of the distributed 
property is reduced by the fair market value of the QOF partnership 
interest received in the merger or consolidation. A distribution from a 
partnership that directly or indirectly owns a QOF is an inclusion 
event only if the distribution is a liquidating distribution. For 
purposes of this paragraph (c)(6)(iii), the distribution is not in 
complete liquidation if the partnership making the distribution is a 
partnership that terminates in a partnership merger or consolidation 
under Sec.  1.708-1(c), the continuing partnership in the merger or 
consolidation continues to directly or indirectly own an interest in 
the QOF, and the distributee is distributed an interest in the 
resulting partnership as part of the merger or consolidation. See 
paragraph (c)(6)(iv) of this section for special rules relating to 
mixed-funds investments.
    (iv) Special rules for mixed-funds investments--(A) In general. The 
rules of this paragraph (c)(6)(iv) apply solely for purposes of section 
1400Z-2. A partner that holds a mixed-funds investment in a QOF 
partnership (a mixed-funds partner) shall be treated as holding two 
separate interests in the QOF partnership, one a qualifying investment 
and the other a non-qualifying investment (separate interests). The 
basis of each separate interest is determined under the rules described 
in paragraphs (c)(6)(iv)(B) and (g) of this section as if each interest 
were held by different taxpayers.
    (B) Allocations and distributions. All section 704(b) allocations 
of income, gain, loss, and deduction, all section 752 allocations of 
debt, and all distributions made to a mixed-funds partner will be 
treated as made to the separate interests based on the allocation 
percentages of those interests as defined in paragraph (c)(6)(iv)(D) of 
this section. For purposes of this paragraph (c)(6)(iv)(B), in 
allocating income, gain, loss, or deduction between these separate 
interests, section 704(c) principles apply to account for any value-
basis disparities attributable to the qualifying investment or non-
qualifying investment. Any distribution (whether actual or deemed) to 
the holder of a qualifying investment is subject to the rules of 
paragraphs (c)(6)(iii) and (v) of this section, without regard to the 
presence or absence of gain under other provisions of subchapter K of 
chapter 1 of subtitle A of the Internal Revenue Code.
    (C) Subsequent contributions. In the event of an increase in a 
partner's qualifying or non-qualifying investment, as for example, in 
the case of an additional contribution for a qualifying investment or 
for an interest that is a non-qualifying investment or a change in 
allocations for services rendered, the partner's interest in the 
separate interests must be valued immediately prior to the event and 
the allocation percentages adjusted to reflect the relative values of 
these separate interests and the additional contribution, if any.
    (D) Allocation percentages. The allocation percentages of the 
separate

[[Page 1967]]

interests will be determined based on the relative capital 
contributions attributable to the qualifying investment and the non-
qualifying investment. In the event a partner receives a profits 
interest in the QOF partnership for services provided to or for the 
benefit of the QOF partnership, the allocation percentage with respect 
to the profits interest is based on the share of residual profits the 
mixed-funds partner would receive with respect to that interest, 
disregarding any allocation of residual profits for which there is not 
a reasonable likelihood of application.
    (E) Examples. The following examples illustrate the rules of this 
paragraph (c)(6)(iv).

    (1) Example 1. Allocation of residual profits for which there is 
no reasonable likelihood of application--(i) Facts. A realizes $100 
of eligible gain and B realizes $900 of eligible gain. A and B form 
Q, a QOF partnership. B contributes $900 to Q in exchange for a 
qualifying QOF partnership interest (B's capital interest). A 
contributes $100 to Q in exchange for a qualifying QOF partnership 
interest (A's capital interest and, with B's capital interest, the 
capital interests) and agrees to provide services to Q in exchange 
for a profits interest in Q (A's profits interest). Q's partnership 
agreement provides that Q's profits are first allocated to the 
capital interests until the capital interest holders receive a 10 
percent preferred return with respect to those interests. Next, Q's 
profits are allocated 15 percent to A with respect to A's profits 
interest, 10 percent to A with respect to A's capital interest, and 
75 percent to B until the capital interests receive a 1,000% 
preferred return. Thereafter, Q's profits are allocated 1 percent to 
A's profits interest and 99 percent to the capital interests. There 
is not a reasonable likelihood that Q's profits will be sufficient 
to result in an allocation in the last tranche.
    (ii) Analysis. Under paragraph (c)(6)(iv)(D) of this section, 
the allocation percentage with respect to A's profits interest is 
calculated based on the share of residual profits that A would 
receive with respect to A's profits interest, disregarding any 
allocation of residual profits that has no reasonable likelihood of 
being achieved. Under Q's partnership agreement, A's share of Q's 
residual profits with respect to A's profits interest is 1 percent. 
However, there is no reasonable likelihood that this 1 percent 
allocation will apply because it is unlikely that the capital 
interests will receive a 1,000% preferred return. Therefore, under 
paragraph (c)(6)(iv)(D) of this section, A's share of Q's residual 
profits with respect to A's profits interest is 15 percent, the 
final allocation of Q's profits to A's profits interest that is 
reasonably likely to apply. The allocation percentage for A's 
capital interest in Q is 10 percent under paragraph (c)(6)(iv)(D) of 
this section. Thus, allocations and distributions made to A are 
treated as made 60 percent (15/25) to A's non-qualifying profits 
interest and 40 percent (10/25) to A's qualifying QOF partnership 
interest.
    (2) Example 2. Separate entity holding profits interest--(i) 
Facts. The facts are the same as in paragraph (c)(6)(iv)(E)(1) of 
this section (Example 1), except that A is a partnership that has no 
eligible gain and P, a partnership that is owned by the same 
taxpayers who own A, realizes $100 of eligible gain and contributes 
$100 to Q for its qualifying investment.
    (ii) Analysis. Under paragraph (c)(6)(iv)(D) of this section, 
A's profits interest is a non-qualifying investment in Q. Because P 
directly holds only a qualifying QOF partnership interest in Q, P is 
not a mixed-funds partner in Q, and 100 percent of the allocations 
and distributions made to P are attributable to P's qualifying QOF 
partnership interest.

    (v) Remaining deferred gain reduction rule. An inclusion event 
occurs when and to the extent that a transaction has the effect of 
reducing:
    (A) The amount of remaining deferred gain of one or more direct or 
indirect partners; or
    (B) The amount of gain that would be recognized by such partner or 
partners under paragraph (e)(4)(ii) of this section to the extent that 
such amount would reduce such gain to an amount that is less than the 
remaining deferred gain.
    (7) Special rules for S corporations--(i) In general. Except as 
provided in paragraphs (c)(7)(ii), (iii), and (iv) of this section, 
none of the following is an inclusion event:
    (A) An election, revocation, or termination of a corporation's 
status as an S corporation under section 1362;
    (B) A conversion of a QSST to an ESBT, but only if the QSST 
beneficiary is the deemed owner of the grantor portion of the ESBT that 
receives the qualifying investment and if the deemed owner is not a 
nonresident alien;
    (C) A conversion of an ESBT to a QSST, where the qualifying 
investment is held in the grantor portion of the ESBT and the QSST 
beneficiary is the deemed owner of the grantor portion of the ESBT; and
    (D) A valid modification of a trust agreement of an S-corporation 
shareholder whether by an amendment, a decanting, a judicial 
reformation, or a material modification.
    (ii) Distributions by QOF S corporation--(A) General rule. An 
actual or constructive distribution of property by a QOF S corporation 
to a QOF shareholder with respect to its qualifying investment is an 
inclusion event to the extent that the distribution is treated as gain 
from the sale or exchange of property under section 1368(b)(2) and (c). 
For the treatment of a distribution by a QOF S corporation to which 
section 305(a) applies, see paragraph (c)(8)(ii). For the treatment of 
a distribution to which section 302(d) or section 306(a)(2) applies, 
see paragraph (c)(9)(ii) of this section.
    (B) Spill-over rule. For purposes of applying paragraph (c)(7)(ii) 
of this section to the adjusted basis of a qualifying investment, or 
non-qualifying investment, as appropriate, in a QOF S corporation, the 
second sentence of Sec.  1.1367-1(c)(3) applies--
    (1) With regard to multiple qualifying investments, solely to the 
respective bases of such qualifying investments, and does not take into 
account the basis of any non-qualifying investment; and
    (2) With regard to multiple non-qualifying investments, solely to 
the respective bases of such non-qualifying investments, and does not 
take into account the basis of any qualifying investment.
    (iii) Conversion from S corporation to partnership or disregarded 
entity--(A) General rule. Notwithstanding paragraph (c)(7)(i) of this 
section, and except as provided in paragraph (c)(7)(iii)(B) of this 
section, a conversion of an S corporation to a partnership or an entity 
disregarded as separate from its owner under Sec.  301.7701-3(b)(1)(ii) 
of this chapter is an inclusion event.
    (B) Exception for qualifying section 381 transaction. A conversion 
described in paragraph (c)(7)(iii)(A) of this section is not an 
inclusion event if the conversion comprises a step in a series of 
related transactions that together qualify as a qualifying section 381 
transaction.
    (iv) Treatment of separate blocks of stock in mixed-funds 
investments. With regard to a mixed-funds investment in a QOF S 
corporation, if different blocks of stock are created for separate 
qualifying investments to track basis in such qualifying investments, 
the separate blocks are not treated as different classes of stock for 
purposes of S corporation eligibility under section 1361(b)(1).
    (v) Applicability. Paragraph (c)(7) of this section applies 
regardless of whether the S corporation is a QOF or a QOF shareholder.
    (8) Distributions by a QOF corporation--(i) General rule for 
distributions by a QOF C corporation. If a QOF C corporation 
distributes property to a QOF shareholder with respect to a qualifying 
investment, only the amount of the distribution to which section 
301(c)(3) or 1059(a)(2) applies gives rise to an inclusion event. For 
purposes of this paragraph (c)(8)(i), a distribution of property 
includes a distribution of stock in the QOF C corporation making the 
distribution (or rights to acquire such stock) if the distribution is 
treated as a distribution

[[Page 1968]]

of property to which section 301 applies pursuant to section 305(b).
    (ii) Section 305(a) distributions. A distribution with respect to 
qualifying QOF stock to which section 305(a) applies is not an 
inclusion event. QOF stock received in such a distribution is 
qualifying QOF stock. The shareholder's remaining deferred gain is 
allocated pro rata between the new qualifying QOF stock received and 
the qualifying QOF stock with respect to which the distribution was 
made in proportion to the fair market values of each on the date of 
distribution. See Sec.  1.307-1(a).
    (9) Dividend-equivalent redemptions and redemptions of section 306 
stock.--(i) Redemptions by QOF C corporations--(A) In general. Except 
as provided in paragraph (c)(9)(i)(B) of this section, if a QOF C 
corporation redeems its stock from a QOF shareholder in a transaction 
described in section 302(d) or section 306(a)(2), the full amount of 
such redemption gives rise to an inclusion event.
    (B) Redemptions of stock of wholly owned QOF C corporation and pro 
rata redemptions. Paragraph (c)(8)(i) of this section applies to a 
redemption described in paragraph (c)(9)(i)(A) of this section if, at 
the time of such redemption--
    (1) All stock in the QOF C corporation is held directly by a single 
shareholder, or directly by members of a single consolidated group; or
    (2) The QOF C corporation has outstanding only one class of stock, 
as defined in section 1361 and Sec.  1.1361-1(l), and the redemption is 
pro rata as to all shareholders of the redeeming QOF C corporation.
    (ii) Redemptions by QOF S corporations. If a QOF S corporation 
redeems its stock from a QOF shareholder in a transaction described in 
section 302(d) or section 306(a)(2), the amount that gives rise to an 
inclusion event is the amount by which the distribution exceeds basis 
in the QOF stock as adjusted under paragraph (c)(7)(ii) of this 
section.
    (10) Qualifying section 381 transactions--(i) Assets of a QOF are 
acquired--(A) In general. Except to the extent provided in paragraph 
(c)(10)(i)(C) of this section, if the assets of a QOF corporation are 
acquired in a qualifying section 381 transaction, and if the acquiring 
corporation is a QOF immediately after the acquisition, then the 
transaction is not an inclusion event.
    (B) Determination of acquiring corporation's status as a QOF. For 
purposes of paragraph (c)(10)(i)(A) of this section, the acquiring 
corporation is treated as a QOF immediately after the qualifying 
section 381 transaction if the acquiring corporation satisfies the 
certification requirements in Sec.  1.1400Z2(d)-1 immediately after the 
transaction and holds at least 90 percent of its assets in qualified 
opportunity zone property on the first testing date after the 
transaction. See section 1400Z-2(d)(1) and Sec.  1.1400Z2(d)-1.
    (C) Receipt of boot by QOF shareholder in qualifying section 381 
transaction. This paragraph (c)(10)(i)(C) applies if assets of a QOF 
corporation are acquired in a qualifying section 381 transaction and an 
eligible taxpayer that is a QOF shareholder receives boot with respect 
to its qualifying investment. If this paragraph (c)(10)(i)(C) applies, 
the QOF shareholder has an inclusion event and is treated as disposing 
of a portion of its qualifying investment that bears the same 
proportion to the QOF shareholder's total qualifying investment 
immediately before the inclusion event as the fair market value of the 
boot received by the QOF shareholder with respect to its qualifying 
investment in the qualifying section 381 transaction bears to the fair 
market value of the total consideration received by the QOF shareholder 
with respect to its qualifying investment in the qualifying section 381 
transaction.
    (ii) Assets of a QOF shareholder are acquired--(A) In general. 
Except to the extent provided in paragraph (c)(10)(ii)(B) of this 
section, a qualifying section 381 transaction in which the assets of a 
QOF shareholder are acquired is not an inclusion event with respect to 
the qualifying investment and the acquiring corporation succeeds to the 
target corporation's status as the QOF shareholder with respect to the 
qualifying investment.
    (B) Qualifying section 381 transaction in which QOF shareholder's 
qualifying investment is not completely acquired. If the assets of a 
QOF shareholder are acquired in a qualifying section 381 transaction in 
which the acquiring corporation does not acquire all of the QOF 
shareholder's qualifying investment, the QOF shareholder has an 
inclusion event and is treated as disposing of the portion of its 
qualifying investment that is not transferred to the acquiring 
corporation.
    (11) Section 355 transactions--(i) Distribution by a QOF--(A) In 
general. Except as provided in paragraph (c)(11)(i)(B) of this section, 
if a QOF corporation distributes stock or securities of a controlled 
corporation to a QOF shareholder with respect to a qualifying 
investment in the QOF corporation in a transaction to which section 355 
(or so much of section 356 as relates to section 355) applies, the QOF 
shareholder has an inclusion event and is treated as disposing of a 
portion of its qualifying investment equal in value to the fair market 
value of the shares of the controlled corporation and the fair market 
value of any boot received by the QOF shareholder in the distribution 
with respect to its qualifying investment.
    (B) Controlled corporation becomes a QOF--(1) In general. Except as 
provided in paragraph (c)(11)(i)(B)(3) of this section, if a QOF 
corporation distributes stock or securities of a controlled corporation 
in a transaction to which section 355, or so much of section 356 as 
relates to section 355, applies, and if both the distributing 
corporation and the controlled corporation are QOFs immediately after 
the final distribution (qualifying section 355 transaction), then the 
distribution is not an inclusion event with respect to a QOF 
shareholder's qualifying investment in the distributing QOF corporation 
or the controlled QOF corporation. This paragraph (c)(11)(i)(B) does 
not apply unless the distributing corporation distributes all of the 
stock and securities in the controlled corporation held by it 
immediately before the distribution within a 30-day period. For 
purposes of this paragraph (c)(11)(i)(B), the term final distribution 
means the last distribution that satisfies the preceding sentence.
    (2) Determination of distributing corporation's and controlled 
corporation's status as QOFs. For purposes of paragraph 
(c)(11)(i)(B)(1) of this section, each of the distributing corporation 
and the controlled corporation is treated as a QOF immediately after 
the final distribution if the corporation satisfies the certification 
requirements in Sec.  1.1400Z2(d)-1 immediately after the final 
distribution and holds at least 90 percent of its assets in qualified 
opportunity zone property on the first testing date after the final 
distribution. See section 1400Z-2(d)(1) and Sec.  1.1400Z2(d)-1.
    (3) Receipt of boot. If a QOF shareholder receives boot in a 
qualifying section 355 transaction with respect to its qualifying 
investment, and if section 356(a) applies to the transaction, paragraph 
(c)(10)(i)(C) of this section applies. If a QOF shareholder receives 
boot in a qualifying section 355 transaction with respect to its 
qualifying investment, and if section 356(b) applies to the 
transaction, paragraph (c)(8)(i) of this section applies.
    (4) Treatment of controlled corporation stock as qualified 
opportunity zone stock. If stock or securities of a controlled 
corporation are

[[Page 1969]]

distributed in a qualifying section 355 transaction, and if the 
distributing corporation retains a portion of the controlled 
corporation stock after the initial distribution, the retained stock 
will not cease to qualify as qualified opportunity zone stock in the 
hands of the distributing corporation solely as a result of the 
qualifying section 355 transaction. This paragraph (c)(11)(i)(B)(4) 
does not apply unless the distributing corporation distributes all of 
the stock and securities in the controlled corporation held by it 
immediately before the distribution within a 30-day period.
    (ii) Distribution by a QOF shareholder. If a QOF shareholder 
distributes stock or securities of a controlled QOF corporation in a 
transaction to which section 355 applies, then for purposes of section 
1400Z-2(b)(1) and paragraph (b) of this section, the QOF shareholder 
has an inclusion event and is treated as disposing of the portion of 
its qualifying QOF stock over which it no longer has direct Federal 
income tax ownership.
    (12) Recapitalizations and section 1036 transactions--(i) In 
general. Except as otherwise provided in paragraph (c)(12)(ii) of this 
section, if a QOF corporation engages in a transaction that qualifies 
as a reorganization described in section 368(a)(1)(E) (a 
recapitalization), or if a QOF shareholder engages in a transaction 
that is described in section 1036 (a section 1036 exchange), the 
transaction is not an inclusion event.
    (ii) Receipt of property or boot by QOF shareholder. If a QOF 
shareholder receives property or boot, or is treated as having received 
property or boot, with respect to its qualifying investment in a 
recapitalization, then the property or boot is treated as property or 
boot to which section 301 or section 356(a) or (c) applies, as 
determined under general Federal income tax principles. If, in a 
section 1036 exchange, a QOF shareholder receives property with respect 
to its qualifying investment that is not permitted to be received 
without the recognition of gain, then, for purposes of this section, 
the receipt of the property is treated in a similar manner as the 
receipt of such property or boot in a recapitalization. Paragraph 
(c)(8)(i) of this section applies to property to which section 301 
applies. Paragraph (c)(10)(i)(C) of this section applies to boot to 
which section 356(a) or (c) applies.
    (13) Section 304 transactions. If a QOF shareholder transfers its 
qualifying investment in a transaction described in section 304(a), the 
full amount of the consideration gives rise to an inclusion event.
    (14) Deduction for worthlessness. If an eligible taxpayer claims a 
loss for worthless stock under section 165(g) or otherwise claims a 
worthlessness deduction with respect to all or a portion of its 
qualifying investment, then for purposes of section 1400Z-2 and the 
section 1400Z-2 regulations, the eligible taxpayer has an inclusion 
event and is treated as having disposed of that portion of its 
qualifying investment on the date it became worthless. Thus, neither 
section 1400Z-2(b)(2)(B)(iii) or (iv) nor section 1400Z-2(c) applies to 
that portion of the eligible taxpayer's qualifying investment after the 
date it became worthless.
    (15) Decertification of a QOF. The decertification of a QOF, 
whether a self-decertification pursuant to Sec.  1.1400Z2(d)-1(a)(3) or 
an involuntary decertification pursuant to Sec.  1.1400Z2(d)-1(a)(4), 
is an inclusion event.
    (16) Other inclusion and non-inclusion events. Notwithstanding any 
other provision of this paragraph (c), the Commissioner may determine 
in guidance published in the Internal Revenue Bulletin (see Sec.  
601.601(d)(2) of this chapter) that a type of transaction is or is not 
an inclusion event.
    (d) Holding periods--(1) Holding period for qualifying investment--
(i) In general. Solely for purposes of section 1400Z-2(b)(2)(B), 
section 1400Z-2(c), and the section 1400Z-2 regulations, and except as 
otherwise provided in this paragraph (d)(1), the length of time a 
qualifying investment has been held is determined without regard to the 
period for which the eligible taxpayer had held property exchanged for 
such investment (even if such period would be relevant for determining 
the length of time for other Federal income tax purposes).
    (ii) Holding period for qualifying investment received in certain 
transactions with respect to QOFs. For purposes of section 1400Z-
2(b)(2)(B), section 1400Z-2(c), and the section 1400Z-2 regulations, 
the principles of section 1223(1) or (4) apply to determine the holding 
period for a qualifying investment received by a QOF owner in--
    (A) A distribution described in paragraph (c)(2)(ii)(B) of this 
section;
    (B) A distribution to which section 305(a) applies;
    (C) A qualifying section 381 transaction described in paragraph 
(c)(10)(i) or (ii) of this section;
    (D) A qualifying section 355 transaction described in paragraph 
(c)(11)(i)(B) of this section;
    (E) A recapitalization or a section 1036 exchange described in 
paragraph (c)(12) of this section;
    (F) A contribution of a QOF interest to a partnership to the extent 
section 721(a) applies to the transfer; or
    (G) A distribution of a QOF interest to the extent the interest was 
received in a merger of two or more QOF partnerships in a transaction 
described in section 708(b)(2)(A).
    (iii) Tacking with deceased owner or deemed owner of a grantor 
trust. For purposes of section 1400Z-2(b)(2)(B), section 1400Z-2(c), 
and the section 1400Z-2 regulations, the holding period of a qualifying 
investment held by an eligible taxpayer who received that qualifying 
investment by reason of the prior owner's death includes the time 
during which that qualifying investment was held by the deceased owner. 
The rule in the preceding sentence also applies to allow a grantor 
trust to tack the holding period of the deemed owner if the grantor 
trust acquires the qualifying investment from the deemed owner in a 
transaction that is not an inclusion event.
    (2) Status of QOF assets as qualified opportunity zone property. 
For purposes of section 1400Z-2(d) and the section 1400Z-2 regulations, 
including for purposes of determining whether the original use of 
qualified opportunity zone business property commences with the 
acquiring corporation or partnership, qualified opportunity zone 
property does not lose its status as qualified opportunity zone 
property solely as a result of--
    (i) Its transfer by the transferor corporation to the acquiring 
corporation in a qualifying section 381 transaction described in 
paragraph (c)(10)(i) of this section;
    (ii) Its transfer by the distributing corporation to the controlled 
corporation in a qualifying section 355 transaction described in 
paragraph (c)(11)(i)(B) of this section; or
    (iii) Its transfer by the transferor partnership to the acquiring 
partnership in a transaction to which section 708(b)(2)(A) applies, but 
only to the extent section 721(a) applies to the transaction.
    (e) Amount includible. Except as provided in Sec. Sec.  
1.1400Z2(a)-1(b)(7) and 1.1400Z2(f)-1(b), the amount of gain included 
in gross income under section 1400Z-2(a)(1)(B) and this section on a 
date described in paragraph (b) of this section is determined under 
this paragraph (e).
    (1) In general. Except as provided in paragraphs (e)(2) and (4) of 
this section, and subject to paragraph (e)(5) of this section, in the 
case of an inclusion

[[Page 1970]]

event, the amount of gain included in gross income is equal to the 
excess of the amount described in paragraph (e)(1)(i) of this section 
over the eligible taxpayer's basis in the portion of the qualifying 
investment that is disposed of in the inclusion event. See paragraph 
(c) of this section for rules regarding the amount that gave rise to 
the inclusion event, and see paragraph (g) of this section for 
applicable ordering rules.
    (i) The amount described in this paragraph (e)(1)(i) is equal to 
the lesser of--
    (A) An amount which bears the same proportion to the remaining 
deferred gain, as--
    (1) The fair market value of the portion of the qualifying 
investment that is disposed of in the inclusion event bears to--
    (2) The fair market value of the total qualifying investment 
immediately before the inclusion event; or
    (B) The fair market value of the portion of the qualifying 
investment that is disposed of in the inclusion event.
    (ii) For purposes of paragraph (e)(1)(i) of this section, the fair 
market value of the portion of the qualifying investment that is 
disposed of in the inclusion event is determined by multiplying the 
fair market value of the eligible taxpayer's entire qualifying 
investment in the QOF, determined as of the date of the inclusion 
event, by the percentage of the eligible taxpayer's qualifying 
investment that is represented by the portion that is disposed of in 
the inclusion event.
    (2) Property received from a QOF in certain transactions. In the 
case of an inclusion event described in paragraph (c)(6)(iii) or (v), 
(c)(7)(ii), (c)(8)(i), or (c)(9) or (13) of this section (or in 
paragraph (c)(11) or (12) of this section, to the extent the rules in 
paragraph (c)(8)(i) of this section apply to the inclusion event), the 
amount of gain included in gross income is equal to the lesser of--
    (i) The remaining deferred gain; or
    (ii) The amount that gave rise to the inclusion event.
    (3) Gain recognized on December 31, 2026. The amount of gain 
included in gross income on December 31, 2026 is equal to the excess 
of--
    (i) The lesser of--
    (A) The remaining deferred gain; and
    (B) The fair market value of the qualifying investment held on 
December 31, 2026; over
    (ii) The eligible taxpayer's basis in the qualifying investment as 
of December 31, 2026, taking into account only section 1400Z-
2(b)(2)(B).
    (4) Special amount includible rule for partnerships and S 
corporations. For purposes of paragraphs (e)(1) and (3) of this 
section, in the case of an inclusion event involving a qualifying 
investment in a QOF partnership or S corporation, or in the case of a 
qualifying investment in a QOF partnership or S corporation held on 
December 31, 2026, the amount of gain included in gross income is equal 
to the lesser of--
    (i) The product of--
    (A) The percentage of the qualifying investment that gave rise to 
the inclusion event; and
    (B) The remaining deferred gain, less any basis adjustments 
pursuant to section 1400Z-2(b)(2)(B)(iii) and (iv); or
    (ii) The gain that would be recognized on a fully taxable 
disposition at fair market value of the qualifying investment that gave 
rise to the inclusion event.
    (5) Limitation on amount of gain included after statutory five-year 
and seven-year basis increases. The total amount of gain included in 
gross income under this paragraph (e) is limited to the amount deferred 
under section 1400Z-2(a)(1) and the section 1400Z-2 regulations, 
reduced by any increase in the basis of the qualifying investment made 
pursuant to section 1400Z-2(b)(2)(B)(iii) and (iv). See paragraph 
(g)(2) of this section for limitations on the amount of basis 
adjustments under section 1400Z-2(b)(2)(B)(iii) and (iv).
    (f) Examples. The following examples illustrate the rules of 
paragraphs (c), (d) and (e) of this section. For purposes of the 
following examples: A, B, C, W, X, Y, and Z are C corporations that do 
not file a consolidated Federal income tax return; Q is a QOF 
corporation or a QOF partnership, as specified in each example; and 
each divisive corporate transaction satisfies the requirements of 
section 355.

    (1) Example 1. Determination of basis, holding period, and 
qualifying investment --(i) Facts. A wholly and directly owns Q, a 
QOF corporation. On May 31, 2019, A sells a capital asset to an 
unrelated party and realizes $500 of capital gain. On October 31, 
2019, A transfers unencumbered asset N to Q in exchange for a 
qualifying investment. Asset N, which A has held for 10 years, has a 
basis of $500 and a fair market value of $500. A elects to defer the 
inclusion of $500 in gross income under section 1400Z-2(a) and Sec.  
1.1400Z2(a)-1.
    (ii) Analysis. Under Sec.  1.1400Z2(a)-1(c)(6)(ii)(B)(1), A made 
a qualifying investment of $500. Under section 1400Z-2(b)(2)(B)(i), 
A's basis in its qualifying investment in Q is $0. For purposes of 
sections 1400Z-2(b)(2)(B) and 1400Z-2(c), A's holding period in its 
new investment in Q begins on October 31, 2019. See paragraph 
(d)(1)(i) of this section. Other than for purposes of applying 
section 1400Z-2, A has a 10-year holding period in its new Q 
investment as of October 31, 2019.
    (iii) Transfer of built-in gain property. The facts are the same 
as in paragraph (f)(1)(i) of this section (this Example 1), but A's 
basis in transferred asset N is $200. Under Sec.  1.1400Z2(a)-
1(c)(6)(ii)(B)(1), A made a qualifying investment of $200 and a non-
qualifying investment of $300.
    (2) Example 2. Transfer of qualifying investment--(i) Facts. On 
May 31, 2019, taxpayer A sells a capital asset to an unrelated party 
and realizes $500 of capital gain. On October 31, 2019, A transfers 
$500 to newly formed Q, a QOF corporation, in exchange for a 
qualifying investment. On February 29, 2020, A transfers 25 percent 
of its qualifying investment in Q to newly formed Y in exchange for 
100 percent of Y's stock in a transfer to which section 351 applies 
(Transfer), at a time when the fair market value of A's qualifying 
investment in Q is $800.
    (ii) Analysis. Under Sec.  1.1400Z2(a)-1(c)(6)(ii)(A), A made a 
qualifying investment of $500 on October 31, 2019. In the Transfer, 
A exchanged 25 percent of its qualifying investment for Federal 
income tax purposes, which reduced A's direct qualifying investment. 
Under paragraph (c)(1)(i) of this section, the Transfer is an 
inclusion event to the extent of the reduction in A's direct 
qualifying investment. Under paragraph (e)(1) of this section, A 
therefore includes in income an amount equal to the excess of the 
amount described in paragraph (e)(1)(i) of this section over A's 
basis in the portion of the qualifying investment that was disposed 
of, which in this case is $0. The amount described in paragraph 
(e)(1)(i) is the lesser of $125 ($500 x ($200/$800)) or $200. As a 
result, A must include $125 of its deferred capital gain in income 
in 2020. After the Transfer, the Q stock is not qualifying Q stock 
in Y's hands.
    (iii) Disregarded transfer. The facts are the same as in 
paragraph (f)(2)(i) of this section (this Example 2), except that Y 
elects to be treated as an entity that is disregarded as an entity 
separate from its owner for Federal income tax purposes effective 
prior to the Transfer. Since the Transfer is disregarded for Federal 
income tax purposes, A's transfer of its qualifying investment in Q 
is not treated as a reduction in direct tax ownership for Federal 
income tax purposes, and the Transfer is not an inclusion event with 
respect to A's qualifying investment in Q for purposes of section 
1400Z-2(b)(1) and paragraph (b) of this section. Thus, A is not 
required to include in income any portion of its deferred capital 
gain.
    (iv) Election to be treated as a corporation. The facts are the 
same as in paragraph (f)(2)(iii) of this section (this Example 2), 
except that Y (a disregarded entity) subsequently elects to be 
treated as a corporation for Federal income tax purposes. A's deemed 
transfer of its qualifying investment in Q to Y under Sec.  
301.7701-3(g)(1)(iv) of this chapter is an inclusion event for 
purposes of section 1400Z-2(b)(1) and paragraph (b) of this section.
    (3) Example 3. Part sale of qualifying QOF partnership interest 
in Year 6 when value of the QOF partnership interest has increased--

[[Page 1971]]

(i) Facts. In October 2018, A and B each realize $200 of eligible 
gain, and C realizes $600 of eligible gain. On January 1, 2019, A, 
B, and C form Q, a QOF partnership. A contributes $200 of cash, B 
contributes $200 of cash, and C contributes $600 of cash to Q in 
exchange for qualifying QOF partnership interests in Q. A, B, and C 
hold 20 percent, 20 percent, and 60 percent interests in Q, 
respectively. On January 30, 2019, Q obtains a nonrecourse loan from 
a bank for $1,000. Under section 752, the loan is allocated $200 to 
A, $200 to B, and $600 to C. On February 1, 2019, Q purchases 
qualified opportunity zone business property for $2,000. On July 31, 
2024, A sells 50 percent of its qualifying QOF partnership interest 
in Q to B for $400 cash. Prior to the sale, there were no inclusion 
events, distributions, partner changes, income or loss allocations, 
or changes in the amount or allocation of debt outstanding. At the 
time of the sale, the fair market value of Q's qualified opportunity 
zone business property is $5,000.
    (ii) Analysis. Because A held its qualifying QOF partnership 
interest for at least five years, A's basis in its partnership 
interest at the time of the sale is $220 (the original zero basis 
with respect to the contribution, plus the $200 debt allocation, 
plus the 10% increase for interests held for five years). The sale 
of 50 percent of A's qualifying QOF partnership interest to B 
requires A to recognize $90 of gain, the lesser of $90, which is 50 
percent of $180 (the $200 remaining deferred gain less the $20 five-
year basis adjustment), or $390, which is the gain that would be 
recognized on a taxable sale of 50 percent of the interest. A also 
recognizes $300 of gain relating to the appreciation of its interest 
in Q.
    (4) Example 4. Sale of qualifying QOF partnership interest when 
value of the QOF partnership interest has decreased--(i) Facts. The 
facts are the same as in paragraph (f)(3) of this section (Example 
3), except that A sells 50 percent of its qualifying QOF partnership 
interest in Q to B for cash of $50, and at the time of the sale, the 
fair market value of Q's qualified opportunity zone business 
property is $1,500.
    (ii) Analysis. Because A held its qualifying QOF partnership 
interest for at least five years, A's basis at the time of the sale 
is $220. Under section 1400Z-2(b)(2)(A), the sale of 50 percent of 
A's qualifying QOF partnership interest to B requires A to recognize 
$40 of gain, the lesser of $90 (50 percent of the excess of A's $200 
remaining deferred gain over A's $20 five-year adjustment) or $40 
(the gain that would be recognized by A on a sale of 50 percent of 
its QOF interest). A's remaining basis in its qualifying QOF 
partnership interest is $110.
    (5) Example 5. Amount includible on December 31, 2026--(i) 
Facts. The facts are the same as in paragraph (f)(3) of this section 
(Example 3), except that no sale of QOF interests takes place in 
2024. Prior to December 31, 2026, there were no inclusion events, 
distributions, partner changes, income or loss allocations, or 
changes in the amount or allocation of debt outstanding.
    (ii) Analysis. For purposes of calculating the amount includible 
on December 31, 2026, each of A's basis and B's basis is increased 
by $30 to $230, and C's basis is increased by $90 to $690 because 
they held their qualifying QOF partnership interests for at least 
seven years. Each of A and B is required to recognize $170 of gain, 
and C is required to recognize $510 of gain.
    (iii) Sale of qualifying QOF partnership interests. The facts 
are the same as in paragraph (f)(5)(i) of this section (this Example 
5), except that, on March 2, 2030, C sells its entire qualifying QOF 
partnership interest in Q to an unrelated buyer for cash of $4,200. 
Assuming an election under section 1400Z-2(c) is made, the basis of 
C's Q interest is increased to its fair market value immediately 
before the sale by C. C is treated as purchasing the interest 
immediately before the sale and the bases of the partnership's 
assets are increased in the manner they would be if the partnership 
had an election under section 754 in effect.
    (6) Example 6. Mixed-funds investment--(i) Facts. On January 1, 
2019, A and B form Q, a QOF partnership. A contributes $200 to Q, 
$100 of which is in exchange for a qualifying investment, and B 
contributes $200 to Q in exchange for a qualifying investment. All 
the cash is used to purchase qualified opportunity zone property. Q 
has no liabilities. On March 30, 2023, when the values and bases of 
the qualifying investments remain unchanged, Q distributes $50 to A.
    (ii) Analysis. Under paragraph (c)(6)(iv) of this section, A is 
a mixed-funds partner holding two separate interests, a qualifying 
investment and a non-qualifying investment. One half of the $50 
distribution is treated under that provision as being made with 
respect to A's qualifying investment. For the $25 distribution made 
with respect to the qualifying investment, A is required to 
recognize $25 of gain.
    (iii) Basis adjustments. Under paragraph (g)(1)(ii)(B) of this 
section, prior to determining the tax consequences of the 
distribution, A increases its basis in its qualifying QOF 
partnership interest by $25 under section 1400Z-2(b)(2)(B)(ii). The 
distribution of $25 results in no gain under section 731. After the 
distribution, A's basis in its qualifying QOF partnership interest 
is $0 ($25-$25).
    (7) Example 7. Qualifying section 381 transaction of a QOF 
corporation--(i) Facts. X wholly and directly owns Q, a QOF 
corporation. On May 31, 2019, X sells a capital asset to an 
unrelated party and realizes $500 of capital gain. On October 31, 
2019, X contributes $500 to Q in exchange for a qualifying 
investment. In 2020, Q merges with and into unrelated Y (with Y 
surviving) in a transaction that qualifies as a reorganization under 
section 368(a)(1)(A) (Merger). X does not receive any boot in the 
Merger with respect to its qualifying investment in Q. Immediately 
after the Merger, Y satisfies the requirements for QOF status under 
section 1400Z-2(d)(1) (see paragraph (c)(10)(i)(B) of this section).
    (ii) Analysis. The Merger is not an inclusion event for purposes 
of section 1400Z-2(b)(1) and paragraph (b) of this section. See 
paragraph (c)(10)(i)(A) of this section. Accordingly, X is not 
required to include in income in 2020 its $500 of deferred capital 
gain as a result of the Merger. For purposes of section 1400Z-
2(b)(2)(B) and (c), X's holding period for its investment in Y is 
treated as beginning on October 31, 2019. For purposes of section 
1400Z-2(d), Y's holding period in its assets includes Q's holding 
period in its assets, and Q's qualified opportunity zone business 
property continues to qualify as such. See paragraph (d)(2) of this 
section.
    (iii) Merger of QOF shareholder. The facts are the same as in 
paragraph (f)(7)(i) of this section (this Example 7), except that, 
in 2020, X (rather than Q) merges with and into Y in a section 381 
transaction in which Y acquires all of X's qualifying investment in 
Q, and Y does not qualify as a QOF immediately after the merger. The 
merger transaction is not an inclusion event for purposes of section 
1400Z-2(b)(1) and paragraph (b) of this section. See paragraph 
(c)(10)(ii) of this section.
    (iv) Receipt of boot. The facts are the same as in paragraph 
(f)(7)(i) of this section (this Example 7), except that the value of 
X's qualifying investment immediately before the Merger is $1,000, X 
receives $100 of cash in addition to Y stock with a fair market 
value of $900 in the Merger in exchange for its qualifying 
investment, and neither Q nor Y has any earnings and profits. Under 
paragraph (c)(10)(i)(C) of this section, X is treated as disposing 
of 10 percent ($100/$1000) of its qualifying investment. Under 
paragraph (e)(1) of this section, X is required to include $50 ($500 
x ($100/$1000)) of its deferred capital gain in income in 2020.
    (8) Example 8. Section 355 distribution by a QOF--(i) Facts. A 
wholly and directly owns Q, a QOF corporation, which wholly and 
directly owns Y, a corporation that is a qualified opportunity zone 
business. On May 31, 2019, A sells a capital asset to an unrelated 
party and realizes $500 of capital gain. On October 31, 2019, A 
contributes $500 to Q in exchange for a qualifying investment. On 
June 26, 2025, Q distributes all of the stock of Y to A in a 
transaction in which no gain or loss is recognized under section 355 
(Distribution). Immediately after the Distribution, each of Q and Y 
satisfies the requirements for QOF status. (See paragraph 
(c)(11)(i)(B)(2) of this section.)
    (ii) Analysis. Because each of Q, the distributing corporation, 
and Y, the controlled corporation, is a QOF immediately after the 
Distribution, the Distribution is a qualifying section 355 
transaction. Thus, the Distribution is not an inclusion event for 
purposes of section 1400Z-2(b)(1) and paragraph (b) of this section. 
See paragraph (c)(11)(i)(B) of this section. Accordingly, A is not 
required to include in income in 2025 any of its $500 of deferred 
capital gain as a result of the Distribution. For purposes of 
section 1400Z-2(b)(2)(B) and (c), A's holding period for its 
qualifying investment in Y is treated as beginning on October 31, 
2019. See paragraph (d)(1)(ii) of this section.
    (iii) Section 355 distribution by a QOF shareholder. The facts 
are the same as in paragraph (f)(8)(i) of this section (this Example 
8), except that A distributes 80 percent of the stock of Q, all of 
which is a qualifying investment in the hands of A, to A's 
shareholders in a transaction in which no

[[Page 1972]]

gain or loss is recognized under section 355. At the time of the 
distribution, the fair market value of A's Q stock exceeds $500. The 
distribution is an inclusion event for purposes of section 1400Z-
2(b)(1) and paragraph (b) of this section, and A is required to 
include in income $400 (80 percent of its $500 of deferred capital 
gain) as a result of the distribution. See paragraphs (c)(1) and 
(c)(11)(ii) of this section.
    (iv) Distribution of boot. The facts are the same as in 
paragraph (f)(8)(i) of this section (this Example 8), except that A 
receives boot in the Distribution. Under paragraphs (c)(8)(i) and 
(c)(11)(i)(B)(3) of this section, the receipt of boot in the 
Distribution is an inclusion event for purposes of section 1400Z-
2(b)(1) and paragraph (b) of this section to the extent of gain 
recognized pursuant to section 301(c)(3).
    (v) Section 355 split-off. The facts are the same as in 
paragraph (f)(8)(i) of this section (this Example 8), except that Q 
stock is directly owned by both A and B (each of which has made a 
qualifying investment in Q), and Q distributes all of the Y stock to 
B in exchange for B's Q stock in a transaction in which no gain or 
loss is recognized under section 355. The distribution is a 
qualifying section 355 transaction and is not an inclusion event for 
purposes of section 1400Z-2(b)(1) and paragraph (b) of this section. 
Neither A nor B is required to include its deferred capital gain in 
income in 2025 as a result of the distribution.
    (vi) Section 355 split-up. The facts are the same as in 
paragraph (f)(8)(v) of this section (this Example 8), except that Q 
wholly and directly owns both Y and Z; Q distributes all of the Y 
stock to A in exchange for A's Q stock and distributes all of the Z 
stock to B in exchange for B's Q stock in a transaction in which no 
gain or loss is recognized under section 355; Q then liquidates; and 
immediately after the Distribution, each of Y and Z satisfies the 
requirements for QOF status. The distribution is a qualifying 
section 355 transaction and is not an inclusion event for purposes 
of section 1400Z-2(b)(1) and paragraph (b) of this section. Neither 
A nor B is required to include its deferred capital gain in income 
in 2025 as a result of the transaction.
    (vii) Section 355 split-off with boot. The facts are the same as 
in paragraph (f)(8)(v) of this section (this Example 8), except that 
B also receives boot. Under paragraph (c)(11)(i)(B)(3) of this 
section, B has an inclusion event and is treated as disposing of a 
portion of its qualifying investment that bears the same proportion 
to B's total qualifying investment immediately before the inclusion 
event as the fair market value of the boot bears to the fair market 
value of the total consideration received by B.
    (9) Example 9. Recapitalization--(i) Facts. On May 31, 2019, 
each of A and B sells a capital asset to an unrelated party and 
realizes $500 of capital gain. On October 31, 2019, A contributes 
$500 to newly formed Q in exchange for 50 shares of class A stock of 
Q (A's qualifying investment) and B contributes $500 to Q in 
exchange for 60 shares of class B stock of Q (B's qualifying 
investment). A and B are the sole shareholders of Q. In 2020, B 
exchanges all of its class B stock of Q for 40 shares of class A 
stock of Q as well as other property in a transaction that qualifies 
as a reorganization under section 368(a)(1)(E).
    (ii) Analysis. Because A did not receive any boot in the 
transaction, A does not have an inclusion event with respect to its 
qualifying investment in Q. See paragraph (c)(12)(i) of this 
section. Therefore, A is not required to include any of its deferred 
gain in income as a result of this transaction. However, under 
paragraph (c)(12)(ii) of this section, B has an inclusion event. If 
section 301 applies to the boot received by B, B has an inclusion 
event to the extent of its section 301(c)(3) gain. If section 356(a) 
or (c) applies to the boot received by B, B is treated as disposing 
of a portion of its qualifying investment that bears the same 
proportion to B's total qualifying investment immediately before the 
inclusion event as the fair market value of the boot bears to the 
fair market value of the total consideration received by B.
    (10) Example 10. Debt financed distribution--(i) Facts. On 
September 24, 2019, A and B form Q, a QOF partnership, each 
contributing $200 that is deferred under the section 1400Z-2(a) 
election to Q in exchange for a qualifying investment. On November 
18, 2022, Q obtains a nonrecourse loan from a bank for $300. Under 
section 752, the loan is allocated $150 to A and $150 to B. On 
November 30, 2022, when the values and bases of the investments 
remain unchanged, Q distributes $50 to A.
    (ii) Analysis. A is not required to recognize gain under 
paragraph (c) of this section because A's basis in its qualifying 
investment is $150 (the original zero basis with respect to the 
contribution, plus the $150 debt allocation). The distribution 
reduces A's basis to $100.
    (11) Example 11. Debt financed distribution in excess of basis--
(i) Facts. The facts are the same as in paragraph (f)(10) of this 
section (Example 10), except that the loan is entirely allocated to 
B under section 752. On November 30, 2024, when the values of the 
investments remain unchanged, Q distributes $50 to A.
    (ii) Analysis. Under paragraph (c)(6)(iii) of this section, A is 
required to recognize $30 of eligible gain under paragraph (c) of 
this section because the $50 distributed to A exceeds A's $20 basis 
in its qualifying investment (the original zero basis with respect 
to its contribution, plus $20 with regard to section 1400Z-
2(b)(2)(B)(iii)).

    (g) Basis adjustments--(1) Basis adjustments under section 1400Z-
2(b)(2)(B)(ii) resulting from the inclusion of deferred gain--(i) In 
general. Except as provided in paragraph (g)(1)(ii) of this section, 
basis adjustments under section 1400Z-2(b)(2)(B)(ii) are made 
immediately after the amount of gain determined under section 1400Z-
2(b)(2)(A) is included in income under section 1400Z-2(b)(1). If the 
basis adjustment under section 1400Z-2(b)(2)(B)(ii) is being made as a 
result of an inclusion event, then the basis adjustment is made before 
determining the other Federal income tax consequences of the inclusion 
event.
    (ii) Specific application to section 301(c)(3) gain, section 
1059(a)(2) gain, S corporation shareholder gain, or partner gain--(A) 
Applicability. This paragraph (g)(1)(ii) applies if a QOF makes a 
distribution to its owner, and if, without regard to any basis 
adjustment under section 1400Z-2(b)(2)(B)(ii), at least a portion of 
the distribution would be characterized as gain under section 
301(c)(3), section 1059(a)(2), or paragraphs (c)(6)(iii) and (c)(7)(ii) 
of this section with respect to the owner's qualifying investment in 
the QOF.
    (B) Ordering rule. If paragraph (g)(1)(ii) of this section applies, 
an eligible taxpayer is treated as having an inclusion event to the 
extent provided in paragraph (c)(6)(iii), (c)(7)(ii), or (c)(8), (9), 
(11), (12), or (13) of this section, as applicable. Then, the eligible 
taxpayer increases its basis under section 1400Z-2(b)(2)(B)(ii) before 
determining the Federal income tax consequences of the distribution.
    (iii) Shares in QOF C corporations to which section 1400Z-
2(b)(2)(B)(ii) adjustments are made. If a shareholder of a QOF C 
corporation disposes of qualifying QOF stock in an exchange subject to 
section 1001, basis adjustments under section 1400Z-2(b)(2)(B)(ii) are 
made only to the portion of the qualifying investment that is disposed 
of in the inclusion event.
    (2) Amount of basis adjustment under section 1400Z-2(b)(2)(B)(iii) 
and (iv). The increases in basis under section 1400Z-2(b)(2)(B)(iii) 
and (iv) are limited to 10 percent and 5 percent, respectively, of the 
remaining deferred gain with respect to a qualifying investment as of 
the dates on which basis is increased under that section.
    (3) Examples. The following examples illustrate the rules of 
paragraphs (g)(1) and (2) of this section.

    (i) Example 1--(A) Facts. On May 31, 2019, A, a C corporation, 
sells a capital asset to an unrelated party and realizes $500 of 
capital gain. On October 31, 2019, A contributes $500 to Q, a newly 
formed QOF C corporation, in exchange for all of the outstanding Q 
common stock and elects to defer the recognition of $500 of capital 
gain under section 1400Z-2(a) and Sec.  1.1400Z2(a)-1. In 2020, when 
Q has $40 of earnings and profits, Q distributes $100 to A 
(Distribution).
    (B) Recognition of gain. Under paragraph (g)(1)(ii)(B) of this 
section, the Distribution is first evaluated without regard to any 
basis adjustment under section 1400Z-2(b)(2)(B)(ii). Of the $100 
distribution, $40 is treated as a dividend and $60 is treated as 
gain from the sale or exchange of property under section 301(c)(3), 
because A's basis in its Q stock is $0 under section 1400Z-
2(b)(2)(B)(i). Under paragraphs (c)(8)(i) and

[[Page 1973]]

(e)(2) of this section, $60 of A's gain that was deferred under 
section 1400Z-2(a) and Sec.  1.1400Z2(a)-1 is recognized in 2020. 
Pursuant to Sec.  1.312-6(b), A's earnings and profits increase by 
$60.
    (C) Basis adjustments. Under paragraph (g)(1)(ii)(B) of this 
section, prior to determining the further tax consequences of the 
Distribution, A increases its basis in its Q stock by $60 in 
accordance with section 1400Z-2(b)(2)(B)(ii). As a result, the 
Distribution is characterized as a dividend of $40 under section 
301(c)(1) and a return of basis of $60 under section 301(c)(2). 
Therefore, after the section 301 distribution, A's basis in Q is $0 
($60-$60).
    (ii) Example 2--(A) Facts. The facts are the same as in 
paragraph (g)(3)(i) of this section (Example 1), except that, 
instead of receiving a distribution, A sells half of the Q stock for 
$250 in 2020. A continues to hold the remainder of its Q stock 
through 2024.
    (B) Recognition of gain and basis adjustments in 2020. Under 
paragraphs (c)(1) and (e)(1) of this section, $250 of A's gain that 
was deferred under section 1400Z-2(a) and Sec.  1.1400Z2(a)-1 is 
recognized in 2020. Under paragraphs (g)(1)(i) and (iii) of this 
section, A increases its basis to $250 in the sold shares in 
accordance with section 1400Z-2(b)(2)(B)(ii) immediately before the 
sale. Accordingly, A has no gain or loss on the sale ($250-$250). 
Pursuant to Sec.  1.312-6(b), A's earnings and profits increase by 
$250. A's basis in its remaining shares of Q stock remains $0.
    (C) Basis adjustment in 2024. Under paragraph (g)(2) of this 
section, A increases its basis in its remaining shares of Q stock in 
accordance with section 1400Z-2(b)(2)(B)(iii). Pursuant to Sec.  
1.312-6(b), A's earnings and profits are increased by the amount of 
the basis adjustment.

    (4) Special partnership rules--(i) General rule. The initial basis 
under section 1400Z-2(b)(2)(B)(i) of a qualifying investment in a QOF 
partnership is zero, as adjusted to take into account the contributing 
partner's share of partnership debt under section 752.
    (ii) Treatment of basis adjustments. Any basis adjustment to a 
qualifying investment in a QOF partnership described in section 1400Z-
2(b)(2)(B)(iii) and (iv) and section 1400Z-2(c) is basis for all 
purposes, including for purposes of suspended losses under section 
704(d).
    (iii) Tiered arrangements. Any basis adjustment described in 
section 1400Z-2(b)(2)(B)(iii) and (iv) and section 1400Z-2(c) (basis 
adjustment rules) will be treated as an item of income described in 
section 705(a)(1) and must be reported in accordance with the 
applicable forms and instructions. Any amount to which the basis 
adjustment rules or to which section 1400Z-2(b)(1) applies will be 
allocated to the owners of the QOF, and to the owners of any 
partnership that directly or indirectly (solely through one or more 
partnerships) owns the eligible interest, and will track to the owners' 
interests, based on their shares of the remaining deferred gain to 
which such amounts relate.
    (5) Basis adjustments in S corporation stock--(i) Treatment of 
basis adjustments. Any basis adjustment to a qualifying investment in a 
QOF S corporation described in section 1400Z-2(b)(2)(B)(iii) and (iv) 
and section 1400Z-2(c) is basis for all purposes, including for 
purposes of suspended losses under section 1366(d).
    (ii) S corporation investor in QOF--(A) S corporation. If an S 
corporation is an investor in a QOF, the S corporation must adjust the 
basis of its qualifying investment as set forth in this paragraph (g). 
The rule in this paragraph (g)(5)(ii)(A) does not affect adjustments to 
the basis of any other asset of the S corporation.
    (B) S corporation shareholder--(1) In general. The S corporation 
shareholder's pro-rata share of any recognized capital gain that has 
been deferred at the S corporation level will be separately stated 
under section 1366 when recognized and will adjust the shareholders' 
stock bases under section 1367 at that time.
    (2) Basis adjustments to qualifying investments. Any adjustment 
made to the basis of an S corporation's qualifying investment under 
section 1400Z-2(b)(2)(B)(iii) or (iv), or section 1400Z-2(c), will not:
    (i) Be separately stated under section 1366; or
    (ii) Until the date on which an inclusion event with respect to the 
S corporation's qualifying investment occurs, adjust the shareholders' 
stock bases under section 1367.
    (3) Basis adjustments resulting from inclusion events. If the basis 
adjustment under section 1400Z-2(b)(2)(B)(ii) is being made as a result 
of an inclusion event, then the basis adjustment is made before 
determining the tax consequences of the inclusion event other than the 
computation of the tax on the deferred gain.
    (iii) QOF S corporation--(A) Transferred basis of assets received. 
If a QOF S corporation receives an asset in exchange for a qualifying 
investment, the basis of the asset shall be the same as it would be in 
the hands of the transferor, increased by the amount of the gain 
recognized by the transferor on such transfer.
    (B) Basis adjustments resulting from inclusion events. If the basis 
adjustment under section 1400Z-2(b)(2)(B)(ii) for the shareholder of 
the QOF S corporation is being made as a result of an inclusion event, 
then the basis adjustment is made before determining the tax 
consequences of the inclusion event other than the computation of the 
tax on the deferred gain.
    (6) Basis in the hands of a taxpayer who received a qualifying 
investment in a QOF by reason of the prior owner's death--(i) In 
general. The basis of a qualifying investment in a QOF, transferred by 
reason of a decedent's death in a transfer that is not an inclusion 
event, is zero under section 1400Z-2(b)(2)(B)(i), as adjusted for 
increases in basis as provided under section 1400Z-2(b)(2)(B)(ii) 
through (iv) and (c). See paragraph (c)(4) of this section.

    (ii) Examples. The following examples illustrate the rule of 
this paragraph (g)(6).
    (A) Example 1. Taxpayer A, an individual, contributed $50X to a 
QOF in exchange for a qualifying investment in the QOF in January 
2019. This $50X was capital gain that was excluded from A's gross 
income under section 1400Z-2(a)(1)(A). A's basis in the qualifying 
investment is zero. As of January 2024, A's basis in the QOF is 
increased by an amount equal to 10 percent of the amount of gain 
deferred by reason of section 1400Z-2(a)(1)(A), so that A's adjusted 
basis in 2024 is $5X. A dies in 2025 and A's heir inherits this 
qualifying investment in the QOF. A's death is not an inclusion 
event for purposes of section 1400Z-2. The heir's basis in the 
qualifying investment is $5X.
    (B) Example 2. The facts are the same as in paragraph 
(g)(6)(ii)(A) of this section (Example 1), except that A dies in 
November 2027, when the fair market value of the qualifying 
investment was $75X. A was required to pay the tax on the excess of 
the deferred capital gain over A's basis as part of A's 2026 income. 
Therefore, at the time of A's death, A's basis in the qualifying 
investment is the sum of three basis adjustments: The adjustment 
made in January 2024 described in paragraph (g)(6)(ii)(A) (Example 
1) ($5X); an additional adjustment made as of January 2026 equal to 
5 percent of the amount of gain deferred by reason of section 1400Z-
2(a)(1)(A) ($2.5X); and the adjustment as of December 31, 2026, by 
reason of section 1400Z-2(b)(1)(B) and (b)(2)(B)(ii) ($42.5X). 
Accordingly, the basis of the qualifying investment in the hands of 
A's heir is $50X.

    (h) Notifications by partners and partnerships, and shareholders 
and S corporations--(1) Notification of deferral election. A 
partnership that makes a deferral election must notify all of its 
partners of the deferral election and state each partner's distributive 
share of the deferred gain in accordance with applicable forms and 
instructions.
    (2) Notification of deferred gain recognition by indirect QOF 
owner. If an indirect owner of a QOF partnership sells or otherwise 
disposes of all or a portion of its indirect interest in the QOF 
partnership in a transaction that is an inclusion event under paragraph 
(c)

[[Page 1974]]

of this section, such indirect owner must provide to the QOF owner 
notification and information sufficient to enable the QOF owner, in a 
timely manner, to recognize an appropriate amount of deferred gain.
    (3) Notification of section 1400Z-2(c) election. A QOF partner or 
QOF S corporation shareholder must notify the QOF partnership or QOF S 
corporation, as appropriate, of an election under section 1400Z-2(c) to 
adjust the basis of the qualifying QOF partnership interest or 
qualifying QOF stock, as appropriate, that is disposed of in a taxable 
transaction. Notification of the section 1400Z-2(c) election, and the 
adjustments to the basis of the qualifying QOF partnership interest(s) 
or qualifying QOF stock disposed of, or to the QOF partnership asset(s) 
or QOF S corporation asset(s) disposed of, as appropriate, is to be 
made in accordance with applicable forms and instructions.
    (i) [Reserved]
    (j) Applicability dates--(1) In general. The provisions of this 
section are applicable for taxable years beginning after March 13, 
2020.
    (2) Prior periods. With respect to the portion of a taxpayer's 
first taxable year ending after December 21, 2017, that began on 
December 22, 2017, and for taxable years beginning after December 21, 
2017, and on or before March 13, 2020, a taxpayer may choose either--
    (i) To apply section 1400Z-2 regulations, if applied in a 
consistent manner for all such taxable years; or
    (ii) To rely on the rules in proposed Sec.  1.1400Z2(b)-1 contained 
in the notice of proposed rulemaking (REG-120186-18) published on May 
1, 2019, but only if applied in a consistent manner for all such 
taxable years.

0
Par. 5. Section 1.1400Z2(c)-1 is added to read as follows:


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

    (a) Scope. This section provides rules under section 1400Z-2(c) of 
the Internal Revenue Code regarding the election to adjust the basis in 
a qualifying investment in a QOF or in certain eligible property held 
by the QOF. See Sec.  1.1400Z2(b)-1(d) for rules for determining the 
holding period of a qualifying investment for purposes of this section.
    (b) Investment for which an election can be made--(1) In general--
(i) Election by taxpayer. An eligible taxpayer who makes a deferral 
election with respect to, or acquires by reason of a transaction that 
is not an inclusion event, a qualifying investment in a QOF, recognizes 
gain (if any) on December 31, 2026, of an amount determined under Sec.  
1.1400Z2(b)-1(e)(3) (and so much of Sec.  1.1400Z2(b)-1(e)(4) as 
relates to Sec.  1.1400Z2(b)-1(e)(3)) with respect to that qualifying 
investment, and whose holding period in that qualifying investment is 
at least ten years, is eligible to make an election described in 
section 1400Z-2(c) on the sale or exchange of that qualifying 
investment. Except as otherwise provided in this paragraph (b)(1), to 
the extent a taxpayer described in the preceding sentence has an 
inclusion event described in Sec.  1.1400Z2(b)-1(c) with respect to any 
portion of a qualifying investment, that portion is no longer a 
qualifying investment and the taxpayer is not eligible to make an 
election pursuant to section 1400Z-2(c) and this section with respect 
to that portion. See Sec.  1.1400Z2(c)-1(b)(2) for special election 
rules for QOF partnerships and QOF S corporations.
    (ii) Transferee partnership to make an election under section 
1400Z-2(c)--(A) In general. This paragraph (b)(1)(ii)(A) applies if an 
eligible taxpayer (transferor) transfers its qualifying investment to a 
transferee in a transaction described in Sec.  1.1400Z2(b)-1(c)(6)(ii) 
to the extent governed by section 721(a). If this paragraph 
(b)(1)(ii)(A) applies, and if the transferee sells or exchanges a 
qualifying investment that has a holding period of at least 10 years 
under Sec.  1.1400Z2(b)-1(d)(1)(ii)(F), then the transferee can make an 
election described in section 1400Z-2(c) on the sale or exchange of the 
qualifying investment. See Sec.  1.1400Z2(b)-1(c)(6)(ii)(B) (transferee 
partnership makes section 1400Z-2(c) election regarding contributed 
qualifying investment).
    (B) Conditions for transferee partnership or merged partnership to 
make an election described in section 1400Z-2(c). A transferee referred 
to in paragraph (b)(1)(ii)(A) of this section is eligible to make an 
election described in section 1400Z-2(c) with respect to a qualifying 
investment only if the transferee:
    (1) Files a statement, at the time and in the manner that the 
Commissioner of Internal Revenue may prescribe by Internal Revenue 
Service forms and instructions or by publication in the Internal 
Revenue Bulletin (see Sec.  601.601(d)(ii)(b) of this chapter), 
providing the name of the transferor, the date of the transfer, and the 
transferor's holding period in the transferred qualifying investment 
immediately before the transfer; and
    (2) Files form 8997, Initial and Annual Statement of Qualified 
Opportunity Fund (QOF) Investments, with the transferee's timely filed 
Federal Tax Return.
    (iii) Limitation on the 10-year rule. As required by section 1400Z-
2(e)(1) (treatment of investments with mixed funds), section 1400Z-2(c) 
applies only to the portion of an investment in a QOF that is a 
qualifying investment. For rules governing the application of section 
1400Z-2(c) to the portion of an investment in a QOF for which a loss 
has been claimed under section 165(g) or otherwise, see Sec.  
1.1400Z2(b)-1(c)(14).
    (iv) Transactions to which section 301(c)(3), section 1059(a)(2), 
or section 1368(b)(2) or (c)(3) applies. The receipt of amounts treated 
as gain from the sale or exchange of property under section 301(c)(3), 
section 1059(a)(2), or section 1368(b)(2) or (c)(3) with respect to 
qualifying QOF stock in a transaction treated as an inclusion event 
under Sec.  1.1400Z2(b)-1(c) does not prevent the QOF shareholder from 
making a subsequent election described in section 1400Z-2(c) with 
respect to that qualifying QOF stock.
    (v) Partnership distributions in excess of basis. The occurrence of 
an inclusion event described in Sec.  1.1400Z2(b)-1(c)(6)(iii), which 
addresses a distribution of property by a QOF partnership to a QOF 
partner where the distributed property has a fair market value in 
excess of the QOF partner's basis in its qualifying investment, does 
not prevent the QOF partner from making a subsequent election described 
in section 1400Z-2(c) with respect to the QOF partner's qualifying QOF 
partnership interest.
    (2) Special election rules for QOF partnerships and QOF S 
corporations--(i) Dispositions of qualifying QOF partnership interests. 
If a QOF partner's basis in a qualifying QOF partnership interest is 
adjusted under section 1400Z-2(c) upon the disposition of a qualifying 
investment, then the basis of the QOF partnership interest is adjusted 
to an amount equal to the net fair market value of the interest, plus 
the QOF partner's share of QOF partnership indebtedness under section 
752 with respect to that interest, and immediately prior to the sale or 
exchange, the bases of the assets of the QOF partnership and of any 
partnership owned directly or indirectly by the QOF partnership solely 
through one or more partnerships are also adjusted with respect to the 
disposed-of qualifying investment. For purposes of this paragraph 
(b)(2)(i), section 7701(g) will apply in determining the value of a 
qualifying investment in a QOF partnership. The adjustments in this 
paragraph (b)(2)(i) are calculated in a manner similar to the section 
743(b) adjustments that would

[[Page 1975]]

have been made if the transferor QOF partner had purchased its interest 
in the QOF partnership for cash equal to the fair market value of the 
interest immediately prior to the sale or exchange, assuming that valid 
section 754 elections had been in place with respect to the QOF 
partnership and any partnerships directly or indirectly owned by the 
QOF partnership, whether or not an actual section 754 election is in 
place for any of the partnerships. This paragraph (b)(2)(i) applies 
without regard to the amount of deferred gain that was included under 
section 1400Z-2(b)(1) or the timing of that inclusion.
    (ii) Sales or exchanges of QOF property by QOF partnerships or QOF 
S corporations--(A) Election to exclude gains and losses. If a taxpayer 
has held a qualifying investment in a QOF partnership or QOF S 
corporation for at least 10 years, as determined under Sec.  
1.1400Z2(b)-1(d), and the QOF partnership or QOF S corporation or any 
partnership that is owned directly, or indirectly solely through one of 
more partnerships, by the QOF partnership or QOF S corporation sells or 
exchanges property, the taxpayer may make an election under this 
paragraph (b)(2)(ii)(A) to exclude from the taxpayer's income all gains 
and losses allocable to the qualifying investment that arise from all 
such sales or exchanges for the QOF partnership's or QOF S 
corporation's taxable year. In order for the election to be valid, the 
requirements set forth in paragraph (b)(2)(ii)(B) of this section must 
be satisfied. For purposes of paragraph (b)(2)(ii) of this section, 
gains and losses include all gains and losses other than gains or 
losses from the sale or exchange of any item of inventory, as defined 
in section 1221(a)(1), in the ordinary course of business.
    (B) Deemed distribution and recontribution--(1) In general. If any 
partner of a QOF partnership, or shareholder of a QOF S corporation, 
makes an election under paragraph (b)(2)(ii)(A) of this section, the 
taxpayer is treated as receiving a distribution of cash as calculated 
under paragraph (b)(2)(ii)(B)(2) of this section, from the QOF 
partnership or QOF S corporation at the end of the QOF partnership's or 
QOF S corporation's taxable year and immediately recontributing the 
cash to the QOF partnership or QOF S corporation in exchange for a non-
qualifying investment in the QOF partnership or QOF S corporation. In 
determining the post-contribution qualifying investment and non-
qualifying investment, the QOF will value each interest based on the 
underlying values of the QOF's assets determined at the end of its 
taxable year in accordance with the principles of Sec.  1.704-
1(b)(2)(iv) (in the case of a QOF partnership) or fair market value (in 
the case of a QOF S corporation). If the QOF partner or QOF S 
corporation shareholder is a mixed-funds partner or shareholder prior 
to the sale or exchange, the deemed distribution will be treated as 
made proportionately with respect to the partner's or shareholder's 
qualifying investment and non-qualifying investment in the QOF 
partnership in accordance with Sec.  1400Z2(b)-1(c)(6)(iv)(B), or the 
QOF S corporation. The distribution and recontribution rule of 
paragraph (b)(2)(ii)(B) of this section is solely for purposes of 
determining the taxpayer's interests in the QOF partnership or QOF S 
corporation that constitute a qualifying investment and a non-
qualifying investment, and has no other Federal income tax consequence 
(for example, the rule does not affect the accumulated adjustments 
account of an S corporation and cannot be treated as a disproportionate 
distribution by an S corporation).
    (2) Amount of deemed distribution and re-contribution. The amount 
of cash referred to in paragraph (b)(2)(ii)(B)(1) of this section that 
is deemed distributed by and recontributed to the QOF partnership or 
QOF S corporation is equal to--
    (i) The partner's or shareholder's share of net proceeds from all 
sales and exchanges of property described in paragraph (b)(2)(ii)(A) of 
this section (other than sales of inventory in the ordinary course of 
business) for the taxable year for which the election under paragraph 
(b)(2)(ii)(A) is made (calculated without regard to whether any gain or 
loss is recognized with regard to such property); less
    (ii) All actual distributions of cash by the QOF partnership or QOF 
S corporation with respect to any such sale or exchange that is made 
within 90 days of the sale or exchange.
    (3) Meaning of net proceeds--(i) QOF partnerships. For purposes of 
paragraph (b)(2)(ii)(B)(2)(i) of this section, with respect to QOF 
partnerships, the term ``net proceeds'' means the amount realized from 
the sale of property described in paragraph (b)(2)(ii)(A) of this 
section less any indebtedness included in the amount realized that 
would constitute a qualified liability under Sec.  1.707-5(a)(6) if the 
sold or exchanged property had been contributed to a lower-tier 
partnership subject to the debt.
    (ii) QOF S corporations. For purposes of paragraph 
(b)(2)(ii)(B)(2)(i) of this section, with respect to QOF S 
corporations, the term ``net proceeds'' means the amount realized from 
the sale of property described in paragraph (b)(2)(ii)(A) of this 
section less any indebtedness included in the amount realized that 
would constitute a qualified liability under the principles of Sec.  
1.707-5(a)(6).
    (C) Treatment as exempt income--(1) General rule. With respect to 
the taxpayer making an election under paragraph (b)(2)(ii) of this 
section, the excess of any gains over losses excluded from income under 
paragraph (b)(2)(ii) of this section is treated as income of the 
partnership or S corporation that is exempt from tax under the Internal 
Revenue Code for purposes of section 705(a)(1)(B) or section 
1367(a)(1)(A). Section 265 or any similar provisions do not apply to 
disallow any deductions otherwise allowable under subtitle A for 
amounts paid or incurred by a taxpayer that are allocable to any gain 
excluded from income under paragraph (b)(2)(ii) of this section.
    (2) Special rule regarding accumulated adjustments account. Solely 
for purposes of determining whether an adjustment must be made to the 
accumulated adjustments account of an S corporation, the excess amount 
described in paragraph (b)(2)(ii)(C)(1) of this section is not treated 
as tax exempt income.
    (D) Time and manner of making the election to exclude gain. An 
election under paragraph (b)(2)(ii)(A) of this section is made by 
filing the applicable form with the taxpayer's timely filed income tax 
return, without extensions, for its taxable year that includes the 
taxable year end of the QOF partnership or QOF S corporation. A 
taxpayer must make the election under paragraph (b)(2)(ii)(A) of this 
section for each taxable year in which it wishes to exclude gains and 
losses of a QOF partnership or QOF S corporation.
    (3) Basis adjustments upon sale or exchange of qualifying QOF 
stock--(i) In general. Except as provided in paragraph (b)(3)(ii) of 
this section, if a QOF shareholder's basis in qualifying QOF stock is 
adjusted under section 1400Z-2(c), then the basis of the qualifying QOF 
stock is adjusted to an amount equal to the fair market value of the 
qualifying QOF stock immediately prior to the sale or exchange. This 
paragraph (b)(3)(i) applies without regard to the amount of deferred 
gain that was included under section 1400Z-2(b)(1) or the timing of 
that inclusion.
    (ii) Specific application to transactions to which section 
301(c)(3), section 1059(a)(2), or section 1368(b)(2) or (c)(3) 
applies--(A) Applicability. This paragraph (b)(3)(ii) applies if a QOF

[[Page 1976]]

corporation makes a distribution to a QOF shareholder, at least a 
portion of the distribution would be characterized as gain from a sale 
or exchange under section 301(c)(3), section 1059(a)(2), or section 
1368(b)(2) or (c)(3) with respect to the QOF shareholder's qualifying 
QOF stock without regard to any basis adjustment under section 1400Z-
2(c), and the QOF shareholder elects to adjust the basis of its 
qualifying QOF stock under section 1400Z-2(c).
    (B) Ordering rule. If paragraph (b)(3)(ii) of this section applies 
with respect to a QOF corporation, the QOF shareholder increases its 
basis by the lesser of the amount of the distribution characterized as 
gain from a sale or exchange or the fair market value of the QOF 
shareholder's qualifying QOF stock before determining the Federal 
income tax consequences of the distribution.
    (c) 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.
    (d) Examples. The following examples illustrate the principles of 
paragraphs (a) through (c) of this section.

    (1) Example 1--(i) Facts. In 2020, taxpayer A invests $100 in 
QOF S, a QOF S corporation, in exchange for a qualifying investment 
and defers $100 of gain. 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, A 
sells all of its QOF S shares, realizes gain, and makes an election 
to increase the qualifying basis in its QOF S shares to fair market 
value. But for the expiration of the designated zones in section 
1400Z-1(f), QOF S and A's conduct is consistent with continued 
eligibility to make the election under section 1400Z-2(c).
    (ii) Analysis. Under paragraph (c) of this section, although the 
designation expired on December 31, 2028, the expiration of the 
zone's designation does not, without more, invalidate A's ability to 
make an election under section 1400Z-2(c). Accordingly, pursuant to 
that election, A's basis in the QOF stock is increased to its fair 
market value and A recognizes no gain or loss on the sale.
    (2) Example 2--(i) Facts. In 2019, taxpayer A realizes $100 of 
eligible gain and contributes $100 to a QOF partnership, X, in 
exchange for a qualifying QOF partnership interest in X, and 
taxpayer B contributes $100 of eligible gain to another QOF 
partnership, Y, in exchange for a qualifying QOF partnership 
interest in Y. In 2021, in transactions governed by section 721(a), 
A contributes her qualifying QOF partnership interest in X, and B 
contributes her qualifying QOF partnership interest in Y, to a newly 
formed partnership, UTP. In 2024, C receives a profits interest in 
UTP for services that she will provide to UTP. In 2031, X sells a 
non-inventory asset and allocates X's distributive share of the gain 
to UTP. No distributions are ever made from X, Y, or UTP.
    (ii) Analysis. On December 31, 2026, UTP recognizes $170 of 
remaining deferred gain relating to the QOF interests. Of that gain, 
A is allocated the $85 of gain relating to the $100 of eligible gain 
that she invested in X, and B is allocated the $85 of gain relating 
to the $100 of eligible gain that she invested in Y. C recognizes no 
gain at this time. In 2031, because UTP's holding period in X 
includes A's holding period in X, UTP has a holding period in X that 
exceeds 10 years, and may make an election under Sec.  1.1400Z2(c)-
1(b)(2)(ii)(A) to exclude the gain from X's asset sale. Even though 
A was the original investor in X, she may not make the election. If 
UTP makes the election, UTP will exclude its distributive share of 
gain from the sale of the X asset.
    (3) Example 3--(i) Facts. In 2019, taxpayer B invests $100 in P, 
a QOF partnership, in exchange for a qualifying investment and 
properly makes an election under section 1400Z-2(a) to defer $100 of 
eligible gain. B's interest in the partnership is 50 percent. In 
2030, when B's interest in P has a value of $130 and a basis of 
$100, B sells the interest, recognizing $30 of gain, $15 of which is 
attributable to inventory assets of P. B makes an election under 
section 1400Z-2(c) with respect to the sale.
    (ii) Analysis. Because B's election under section 1400Z-2(c) is 
in effect with respect to the sale, the bases of B's interest in P 
and of P's assets with respect to the interest sold are adjusted to 
fair market value immediately before B's sale under paragraph 
(b)(2)(i) of this section, and B recognizes no gain or loss on the 
sale.
    (4) Example 4--(i) Facts. The facts are the same as in paragraph 
(d)(3) of this section (Example 3), except that P sells qualified 
opportunity zone property that is not inventory sold in the ordinary 
course of business and distributes all of the proceeds from the sale 
to partners within 90 days of the sale (the qualified opportunity 
zone property was the only property sold by P in the taxable year). 
The sold property has a value of $60 and a basis of $40. P 
recognizes $20 of gain, $10 of which is allocable to B, and B makes 
an election under paragraph (b)(2)(ii)(A) of this section for the 
year in which B's allocable share of the partnership's recognized 
gain would be included in B's gross income.
    (ii) Analysis. Because B's election under paragraph 
(b)(2)(ii)(A) of this section is in effect, B will exclude its 
entire $10 allocable share of the partnership's $20 of recognized 
gain. Because $10 of the sale proceeds were actually distributed to 
B within 90 days of the sale, P is not treated as making a deemed 
distribution and receiving a recontribution under paragraph 
(b)(2)(ii)(B) of this section with respect to B.
    (5) Example 5--(i) Facts. In 2019, taxpayer C invests $100 in Q, 
a QOF partnership, in exchange for a qualifying investment and 
properly makes an election under section 1400Z-2(a) to defer $100 of 
eligible gain. C's interest in Q is 50%. Q's taxable year ends on 
December 31. In 2025, Q purchases three qualified opportunity zone 
properties, X, Y, and Z. On January 22, 2031, Q sells property X for 
$200, recognizing $140 of gain. On July 31, 2031, Q sells property Y 
for $80, recognizing $20 of loss. Q makes no distributions to its 
partners in 2031, has no indebtedness, and has no other gain or loss 
other than from the sales of properties X and Y. Property Z has a 
value of $280 at all times throughout 2031. C's share of Q's gain 
and loss is $70 and $10, respectively, for a net gain of $60, and C 
makes an election under paragraph (b)(2)(ii)(A) of this section to 
exclude the gains and losses from its income.
    (ii) Analysis. Because C has made an election under paragraph 
(b)(2)(ii)(A) of this section, under paragraph (b)(2)(ii)(B) of this 
section, C is treated as receiving a cash distribution of $140 from 
Q, C's share of the net proceeds from the sales of properties X and 
Y, on December 31, 2031, and immediately recontributing $140 to Q in 
exchange for a non-qualifying investment in Q. Beginning on January 
1, 2032, 50 percent of A's interest in Q is a qualifying investment, 
and 50 percent of A's investment in Q is a non-qualifying 
investment. This amount is calculated as a fraction, the numerator 
of which is $140, the amount deemed distributed and recontributed, 
and the denominator of which is $280, the value of C's interest 
prior to the deemed distribution.
    (6) Example 6--(i) Facts. The facts are the same as in paragraph 
(d)(5) of this section (Example 5), except that Q distributes all of 
the proceeds from the sale of property X to its partners on March 
30, 2031. Q does not make any distribution of proceeds from the sale 
of property Y.
    (ii) Analysis. Under paragraph (b)(2)(iii)(B)(2)(ii) of this 
section, the actual distribution of cash to C on March 30, 2031, 
reduces the amount of the deemed distribution and recontribution 
with respect to C on December 31, 2031. Accordingly, the amount of 
C's deemed distribution and recontribution is $40, which increases 
C's non-qualifying investment to 22 percent. This amount is 
calculated as a fraction, the numerator of which is $40, the amount 
deemed distributed and recontributed, and the denominator of which 
is $180, the value of C's interest.
    (7) Example 7. Section 301(c)(3) gain--(i) Facts. In 2020, 
taxpayer X makes an investment in Q, a QOF corporation, in exchange 
for a qualifying investment. In 2031, when X's qualifying Q stock is 
worth $1000x, Q makes a distribution to X with respect to X's 
qualifying QOF stock, $500x of which is treated as gain from a sale 
or exchange under section 301(c)(3). In 2032, X disposes of all of 
its qualifying QOF stock in Q.
    (ii) Analysis--(A) Section 301(c)(3) distribution. X is eligible 
to make an election described in section 1400Z-2(c) in 2031 with 
respect to its $500x gain. Under paragraph (b)(3)(ii) of this 
section, the basis adjustment is $500x, the lesser of $500x, the 
amount of

[[Page 1977]]

the distribution treated as gain from the sale or exchange of 
property, and $1000x, the fair market value of the qualifying QOF 
stock before the distribution. As a result of the election, X 
increases its basis in its qualifying QOF stock in Q by $500x 
immediately before the distribution; consequently, the $500x is 
treated as a return of basis under section 301(c)(2).
    (B) Disposition of qualifying QOF stock. X is eligible to make 
an election described in section 1400Z-2(c) in 2032 with respect to 
all of its qualifying QOF stock in Q, notwithstanding X's receipt of 
a section 301(c)(3) distribution in 2031. See paragraph (b)(1)(iv) 
of this section.

    (e) Capital gain dividends paid by a QOF RIC or QOF REIT that some 
shareholders may be able to elect to receive tax free under section 
1400Z-2(c)--(1) Eligibility. For purposes of paragraph (b) of this 
section, if a shareholder of a QOF RIC or QOF REIT receives a capital 
gain dividend identified with a date, as defined in paragraph (e)(2) of 
this section, then, to the extent that the shareholder's shares in the 
QOF RIC or QOF REIT paying the capital gain dividend are a qualifying 
investment in the QOF RIC or QOF REIT--
    (i) The shareholder may treat the capital gain dividend, or part 
thereof, as gain from the sale or exchange of a qualifying investment 
on the date that the QOF RIC or QOF REIT identified with the dividend; 
and
    (ii) If, on the date identified, the shareholder had held that 
qualifying investment in the QOF RIC or QOF REIT for at least 10 years, 
then the shareholder may exclude that capital gain dividend, or part 
thereof, from its taxable income for the taxable year.
    (2) Definition of capital gain dividend identified with a date. A 
capital gain dividend identified with a date means an amount of a 
capital gain dividend, as defined in section 852(b)(3)(C) or 
857(b)(3)(B), or part thereof, and a date that the QOF RIC reports or 
QOF REIT designates in a notice provided to the shareholder not later 
than one week after the QOF RIC reports or QOF REIT designates the 
capital gain dividend pursuant to section 852(b)(3)(C) or 857(b)(3)(B). 
The notice must be mailed to the shareholder unless the shareholder has 
provided the QOF RIC or QOF REIT with an email address to be used for 
this purpose. In the manner and at the time determined by the 
Commissioner, the QOF RIC or QOF REIT must provide the Commissioner all 
data that the Commissioner specifies with respect to the amounts of 
capital gain dividends and the dates reported or designated by the QOF 
RIC or QOF REIT for each shareholder.
    (3) General limitations on the amounts of capital gain with which a 
date may be identified--(i) No identification in the absence of any 
capital gains with respect to qualified opportunity zone property. If, 
during its taxable year, the QOF RIC or QOF REIT did not recognize 
long-term capital gain on any sale or exchange of qualified opportunity 
zone property, then no date may be identified with any capital gain 
dividends, or parts thereof, with respect to that year.
    (ii) Proportionality. Reportings and designations of capital gain 
dividends identified with a date must be proportional for all capital 
gain dividends paid with respect to the taxable year. See section 
857(g)(2). Greater than de minimis violation of proportionality 
invalidates all of the purported identifications for a taxable year.
    (iii) Undistributed capital gains. If section 852(b)(3)(D)(i) or 
857(b)(3)(C)(i) requires a shareholder of a QOF RIC or QOF REIT to 
include a reported or designated amount in the shareholder's long-term 
capital gain for a taxable year, then inclusion of this amount in this 
manner is treated as receipt of a capital gain for purposes of this 
paragraph (e) and may be identified with a date.
    (iv) Gross gains. The amount determined under paragraph (e)(4) of 
this section is determined without regard to any losses that may have 
been recognized on other sales or exchanges of qualified opportunity 
zone property. The losses do, however, limit the total amount of 
capital gain dividends that may be reported or designated under section 
852(b)(3) or section 857(b)(3).
    (4) Determination of the amount of capital gain with which a date 
may be identified. A QOF RIC or QOF REIT may choose to identify the 
date for an amount of capital gain in one of the following manners:
    (i) Simplified determination. If, during its taxable year, the QOF 
RIC or QOF REIT recognizes long-term capital gain on one or more sales 
or exchanges of qualified opportunity zone property, then the QOF RIC 
or QOF REIT may identify the first day of that taxable year as the date 
identified with each reported or designated amount with respect to the 
capital gain dividends for that taxable year. A reported or designated 
identification is invalid in its entirety if the amount of gains that 
the QOF RIC or QOF REIT identifies with that date exceeds the aggregate 
long-term capital gains recognized on those sales or exchanges for that 
taxable year.
    (ii) Sale date determination--(A) In general. If, during its 
taxable year, the QOF RIC or QOF REIT recognizes long-term capital gain 
on one or more sales or exchanges of qualified opportunity zone 
property, then the QOF RIC or QOF REIT may identify capital gain 
dividends, or a part thereof, with the latest date on which there was 
such a recognition. The amount of capital gain dividends so identified 
must not exceed the aggregate long-term capital gains recognized on 
that date from sales or exchanges of qualified opportunity zone 
property. A reported or designated identification is invalid in its 
entirety if the amount of gains that the QOF RIC or QOF REIT identifies 
with that date violates the preceding sentence.
    (B) Iterative application. The process described in paragraph 
(e)(4)(ii)(A) of this section is applied iteratively to increasingly 
earlier transaction dates (from latest to earliest) until all capital 
gain dividends are identified with dates or there are no earlier dates 
in the taxable year on which the QOF RIC or QOF REIT recognized long-
term capital gains with respect to a sale or exchange of qualified 
opportunity zone property, whichever comes first.
    (f) Applicability dates. The provisions of this section are 
applicable for taxable years beginning after March 13, 2020.

0
Par. 6. Section 1.1400Z2(d)-1 is added to read as follows:


Sec.  1.1400Z2 (d)-1  Qualified opportunity funds and qualified 
opportunity zone businesses.

    (a) Overview. This section provides rules that an eligible entity 
(as defined in paragraph (a)(1) of this section) must satisfy to be a 
qualified opportunity fund (QOF) or a qualified opportunity zone 
business. Paragraphs (a)(2) through (4) of this section provide rules 
that eligible entities must follow to be certified as QOFs, as well as 
rules for the de-certification of QOFs. Paragraph (b) of this section 
provides rules for determining whether the property held by a QOF 
satisfies the 90-percent investment standard of section 1400Z-2(d)(1) 
or the property held by a qualified opportunity zone business satisfies 
the 70-percent tangible property standard of section 1400Z-
2(d)(3)(A)(i). Paragraph (c) of this section provides rules regarding 
qualified opportunity zone property that a QOF must hold to satisfy the 
90-percent investment standard. Paragraph (d) of this section provides 
rules that an eligible entity must satisfy to be a qualified 
opportunity zone business that is owned, in whole or in part, by one or 
more QOFs. Paragraph (e) of this section provides applicability dates 
for this section. See Sec.  1.1400Z2(d)-2 for rules that must be 
satisfied for tangible property of an eligible entity to be

[[Page 1978]]

treated as qualified opportunity zone business property.
    (1) Eligible entity--(i) In general. Except as provided in 
paragraph (a)(1)(ii) of this section, the term eligible entity means an 
entity that is classified as a corporation or partnership for Federal 
income tax purposes. In order to be treated as a QOF, an eligible 
entity must self-certify on an annual basis that it satisfies the 
requirements of paragraphs (b) and (c) of this section, as appropriate. 
An eligible entity is a qualified opportunity zone business if it 
satisfies the requirements of paragraph (d) of this section.
    (ii) Exceptions based on where an entity is created, formed, or 
organized--(A) QOFs. An entity classified as a corporation or 
partnership for Federal income tax purposes (an entity) but that is not 
organized under the law of the United States or the law of one of the 
50 states, a government of a federally recognized tribe (Indian tribal 
government), the District of Columbia, or a U.S. territory, is not an 
eligible entity and is ineligible to be a QOF. An entity described in 
the preceding sentence is also ineligible to be a qualified opportunity 
zone business, and therefore an equity interest in the entity is 
neither qualified opportunity zone stock nor a qualified opportunity 
zone partnership interest for purposes of section 1400Z-2(d)(2).
    (B) Entities organized in a U.S. territory--(1) In general. If an 
entity is organized in a U.S. territory but not in one of the 50 States 
or the District of Columbia, the entity may be a QOF only if the entity 
is organized for investing in qualified opportunity zone property that 
relates to a trade or business operated in the U.S. territory in which 
the entity is organized. If an entity is organized in a U.S. territory 
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. territory in which the entity is organized. An entity 
described in the preceding sentence is treated as satisfying the 
requirement, as applicable, of being a domestic corporation for 
purposes of section 1400Z-2(d)(2)(B)(i) or of being a domestic 
partnership for purposes of section 1400Z-2(d)(2)(C).
    (2) U.S. territory defined. For purposes of this paragraph (a)(1), 
the term U.S. territory means American Samoa, Guam, the Commonwealth of 
the Northern Mariana Islands, the Commonwealth of Puerto Rico, the U.S. 
Virgin Islands, and any other territory not under the jurisdiction of 
one of the 50 States, an Indian tribal government, or the District of 
Columbia where a qualified opportunity zone has been designated under 
section 1400Z-1.
    (iii) Pre-existing entities. There is no legal barrier to a pre-
existing eligible entity qualifying as a QOF or a qualified opportunity 
zone business, but the pre-existing eligible entity must satisfy all of 
the applicable requirements of section 1400Z-2, this section, and Sec.  
1.1400Z2(d)-2.
    (2) Self-certification as a QOF. The following rules apply to the 
required self-certification of an eligible entity as a QOF:
    (i) Time, form, and manner. The self-certification must be timely-
filed and effected annually in such form and manner as may be 
prescribed by the Commissioner of Internal Revenue (Commissioner) in 
the Internal Revenue Service (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 for which the self-certification takes effect.
    (iii) First month. The self-certification may identify the first 
month (in that initial taxable year) in which the self-certification 
takes effect.
    (A) Failure to specify first month. If the self-certification fails 
to specify the month in the initial taxable year that the self-
certification takes effect, then the self-certification is treated as 
taking effect in the first month of that taxable year.
    (B) Investments before entity's first month as QOF 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 and the investment is a non-qualifying investment.
    (iv) Becoming a QOF in a month that is not the first month of the 
taxable year. This paragraph (a)(2)(iv) applies to an eligible entity 
if its self-certification as a QOF is first effective for a month that 
is not the first month of that entity's taxable year.
    (A) For purposes of applying section 1400Z-2(d)(1)(A) and (B) in 
the first year of the QOF's existence, the phrase first six-month 
period of the taxable year of the fund means the first six 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 investment standard in 
section 1400Z-2(d)(1) takes into account only the QOF's assets on the 
last day of the QOF's taxable year.
    (B) 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) Self-decertification of a QOF. If a QOF chooses to self-
decertify as a QOF, the following rules apply:
    (i) Form and manner. The self-decertification must be effected 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) Time. The self-decertification becomes effective at the 
beginning of the month following the month specified by the taxpayer, 
which month must not be earlier than the month in which the taxpayer 
files its self-decertification as provided in paragraph (a)(3)(i) of 
this section.
    (4) [Reserved]
    (b) Valuation of property for purposes of the 90-percent investment 
standard and the 70-percent tangible property standard--(1) In general. 
An eligible entity may value its owned or leased property using the 
valuation methods provided in paragraphs (b)(3) and (4) of this section 
to determine whether--
    (i) In the case of an eligible entity that has self-certified as a 
QOF, the assets owned or leased by the QOF satisfy the 90-percent 
investment standard in section 1400Z-2(d)(1); and
    (ii) In the case of an eligible entity that has issued qualified 
opportunity zone partnership interests or qualified opportunity zone 
stock to a QOF, the tangible property owned or leased by the eligible 
entity satisfies the 70-percent tangible property standard in section 
1400Z-2(d)(3)(A)(i).
    (2) Special rules--(i) QOFs--(A) In general. To meet the 90-percent 
investment standard in section 1400Z-2(d)(1), on a semiannual basis, a 
QOF may value its assets using the applicable financial statement 
valuation method set forth in paragraph (b)(3) of this section, if the 
QOF has an applicable financial statement within the meaning of Sec.  
1.475(a)-4(h), or the alternative valuation method set forth in 
paragraph (b)(4) of this section. During each taxable year, a QOF must 
apply consistently the valuation method that it selects under paragraph 
(b) of this section to all assets valued with respect to the taxable 
year.
    (B) Option for QOFs to disregard recently contributed property. A 
QOF

[[Page 1979]]

may choose to determine compliance with the 90-percent investment 
standard by excluding from both the numerator and denominator of the 
test any property that satisfies all the criteria in paragraphs 
(b)(2)(i)(B)(1) through (3) of this section. A QOF need not be 
consistent from one semiannual test to another in whether it avails 
itself of the option in this paragraph (b)(2)(i)(B).
    (1) The amount of the property was received by the QOF partnership 
as a contribution or by the QOF corporation solely in exchange for 
stock of the corporation;
    (2) The contribution or exchange occurred not more than 6 months 
before the test from which it is being excluded; and
    (3) Between the date of the fifth business day after the 
contribution or exchange and the date of the semiannual test, the 
amount was held continuously in cash, cash equivalents, or debt 
instruments with a term of 18 months or less.
    (C) Safe harbor for QOFs to determine whether equity in an entity 
is qualified opportunity zone property. A QOF may choose to determine 
compliance with the 90-percent investment standard for each semiannual 
testing date of the QOF by including in both the numerator and 
denominator of the test the equity of each entity the QOF holds on that 
testing date that satisfies all the criteria in paragraph 
(b)(2)(i)(C)(1) or (2) of this section.
    (1) The entity was a qualified opportunity zone business for at 
least 90 percent of the QOF's cumulative holding period for that equity 
of the entity--
    (i) Beginning on the date the QOF's self-certification as a QOF is 
first effective; and
    (ii) Ending on the last day of the entity's most recent taxable 
year ending on or before the semiannual testing date of the QOF.
    (2) An entity that would not be a qualified opportunity zone 
business as of the end of its last taxable year ending on or before a 
semiannual testing date of the QOF is a qualified opportunity zone 
business with respect to the QOF for that taxable year of the entity 
if--
    (i) A cure is achieved for the entity under paragraph (d)(6) of 
this section; and
    (ii) The QOF files its Federal income tax return for the taxable 
year of the QOF containing the testing date on a date that is timely 
(taking extensions into account) and that is not later than when that 
cure is achieved.
    (ii) Qualified opportunity zone businesses--(A) In general. For 
purposes of the fraction set forth in paragraph (d)(2)(ii)(A) of this 
section, the owned or leased tangible property of a qualified 
opportunity zone business may be valued using the applicable financial 
statement valuation method set forth in paragraph (b)(3) of this 
section, if the qualified opportunity zone business has an applicable 
financial statement within the meaning of Sec.  1.475(a)-4(h), or the 
alternative valuation method set forth in paragraph (b)(4) of this 
section. During each taxable year, the valuation method selected under 
this paragraph (b) must be applied consistently to all tangible 
property valued with respect to the taxable year.
    (B) Five-percent zone taxpayer. If a taxpayer both has self-
certified as a QOF and holds an equity interest in an eligible entity 
that is tested as a qualified opportunity zone business, then that 
taxpayer may value the eligible entity's tangible property for purposes 
of satisfying the 70-percent tangible property standard using the same 
valuation methodology under this paragraph (b) that the taxpayer uses 
for determining its own compliance with the 90-percent investment 
standard (compliance methodology), provided that no other equity holder 
in the eligible entity is a five-percent zone taxpayer. If two or more 
taxpayers that have self-certified as QOFs hold equity interests in the 
eligible entity and at least one of them is a five-percent zone 
taxpayer, then the values of the eligible entity's tangible property 
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 eligible entity 
for purposes of the 70-percent tangible property standard. 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).
    (1) Example. The example in paragraph (b)(2)(ii)(B)(2) of this 
section illustrates the principles of paragraph (b)(2)(ii)(B) of this 
section.

    (2) Example. Entity JH is a corporation that has issued only one 
class of stock and that conducts a trade or business. Taxpayer X 
holds 94% of the JH stock, and Taxpayer Y holds the remaining 6% of 
that stock. (Thus, both X and Y are five percent zone taxpayers 
within the meaning of paragraph (b)(2)(ii)(B) of this section.) JH 
does not have an applicable financial statement, and, for that 
reason, a determination of whether JH 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 (b)(2)(i)(A) of this section for purposes of satisfying 
the 90-percent investment standard 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 JH'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 JH'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 JH (73%), both X 
and Y may use Y's compliance methodology to value JH's owned or 
leased tangible property. If JH'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 JH is qualified opportunity zone stock in the 
hands of a taxpayer that has self-certified as a QOF.

    (iii) Inventory. In determining whether the 90-percent investment 
standard in section 1400Z-2(d)(1) or the 70-percent tangible property 
standard in section 1400Z-2(d)(3)(A)(i) is satisfied, an eligible 
entity may choose to exclude from both the numerator and denominator of 
the applicable test the value of all inventory (including raw 
materials) of the trade or business, if applied consistently within a 
taxable year of the eligible entity.
    (3) Applicable financial statement valuation method--(i) In 
general. Under the applicable financial statement valuation method set 
forth in this paragraph (b)(3), the value of each property that is 
owned or leased by an eligible entity is the value of that asset as 
reported on the eligible entity's applicable financial statement for 
the relevant reporting period.
    (ii) Requirement for selection of method. An eligible entity may 
select the applicable financial statement valuation method set forth in 
this paragraph (b)(3) to value an asset leased by the eligible entity 
only if the applicable financial statement of the eligible entity is 
prepared according to U.S. generally accepted accounting principles 
(GAAP) and requires an assignment of value to the lease of the asset.
    (4) Alternative valuation method--(i) In general. Under the 
alternative valuation method set forth in this paragraph (b)(4), the 
value of the property owned by an eligible entity is calculated under 
paragraph (b)(4)(ii) of this section, and the value of the property 
leased by an eligible entity is

[[Page 1980]]

calculated under paragraph (b)(4)(iii) of this section.
    (ii) Property owned by an eligible entity--(A) Property purchased 
or constructed. The value of each property owned by an eligible entity 
that is acquired by purchase for fair market value or constructed for 
fair market value is the eligible entity's unadjusted cost basis of the 
asset under section 1012 or section 1013.
    (B) Other property. The value of each item of property owned by an 
eligible entity that is not purchased or constructed for fair market 
value is the item of property's fair market value, determined on the 
last day of the first 6 month period of the taxable year and on the 
last day of the taxable year.
    (iii) Property leased by an eligible entity--(A) In general. The 
value of each property that is leased by an eligible entity is equal to 
the present value of the leased property as defined in paragraph 
(b)(4)(iii)(C) of this section.
    (B) Discount rate. For purposes of calculating present value under 
paragraph (b)(4)(iii) of this section, the discount rate is the short-
term applicable Federal rate under section 1274(d)(1), based on 
semiannual compounding, for the month in which the eligible entity 
enters into the lease. For purposes of the preceding sentence, the 
three month rule in section 1274(d)(2) does not apply to determine the 
applicable Federal rate.
    (C) Present value. For purposes of paragraph (b)(4)(iii) of this 
section, present value of a leased property--
    (1) Is equal to the sum of the present values of each payment under 
the lease for the property;
    (2) Is calculated at the time the eligible entity enters into the 
lease for the property; and
    (3) Once calculated, is used as the value for the property by the 
eligible entity for all testing dates during the term of the lease for 
purposes of the 90-percent investment standard or the 70-perecent 
tangible property standard.
    (D) Term of a lease. For purposes of paragraph (b)(4)(iii) of this 
section, the term of a lease includes periods during which the lessee 
may extend the lease at a pre-defined market rate rent. For 
nonresidential real property or residential real property, pre-defined 
rent does not include the option to renew at fair market value, 
determined at the time of renewal. The terms of the pre-defined rent 
must satisfy the following criteria:
    (1) General rule. The terms of the pre-defined rent are market rate 
(that is, the terms of the pre-defined rent reflect common, arms-length 
market pricing in the locale that includes the qualified opportunity 
zone as determined under section 482 and all section 482 regulations in 
this chapter) at the time the lease is entered into.
    (2) Rebuttable presumption regarding leases not between related 
persons. There will be a rebuttable presumption that the terms of the 
extension of the lease are market rate for leases not between related 
persons (within the meaning of section 1400Z-2(e)(2)), and thus, the 
parties to the lease are not required to perform a section 482 
analysis.
    (3) Exception for state, local, and Indian tribal governments. For 
purposes of this paragraph (b)(4)(iii)(D), tangible property acquired 
by lease from a state or local government, or an Indian tribal 
government, is not considered tangible property acquired by lease from 
a related person.
    (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 
Sec.  1.1400Z2(d)-2.
    (2) Qualified opportunity zone stock--(i) In general. Except as 
provided in paragraph (c)(2)(ii) of this section, if an eligible entity 
is classified as a corporation for Federal income tax purposes 
(corporation), then an equity interest (stock) in the eligible entity 
is qualified opportunity zone stock if the requirements described in 
this paragraph (c)(2)(i) are satisfied:
    (A) Date of acquisition. 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) Qualified opportunity zone business. 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) 90-percent qualified opportunity zone property holding period--
(1) Cumulative holding period test. During at least 90 percent of the 
QOF's holding period for the corporation's stock, determined on a 
cumulative basis in accordance with paragraph (c)(2)(i)(C)(2) of this 
section, the corporation qualified as a qualified opportunity zone 
business.
    (2) Semiannual qualified opportunity zone business test. For 
purposes of determining satisfaction of the cumulative 90-percent 
qualified opportunity zone property holding period test described in 
paragraph (c)(2)(i)(C)(1) of this section, the determination of whether 
a corporation engaged in a trade or business qualifies as a qualified 
opportunity zone business is made by the QOF on a semiannual basis 
pursuant to section 1400Z-2(d)(1). However, a QOF may choose to apply 
the safe harbor rule in paragraph (b)(2)(i)(C) of this section to make 
this determination.
    (ii) Redemptions of stock. Pursuant to section 1400Z-
2(d)(2)(B)(ii), the following rules 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 
either directly or indirectly any of its stock from the QOF or from a 
person related (within the meaning of section 1400Z-2(e)(2)) to the 
QOF. Even if the purchase occurs after the issuance, the stock was 
never qualified opportunity zone stock.
    (B) Significant redemptions--(1) In general. 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 one year before 
the issuance of the stock, the corporation made one or more purchases 
of more than a de minimis amount of its stock and the purchased stock 
has 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. The aggregate value is determined 
as of the time of the stock purchases. Even if one or more of the 
disqualifying purchases occurs after the issuance, the stock was never 
qualified opportunity zone stock.
    (2) De minimis amount. For purposes of this paragraph 
(c)(2)(ii)(B), stock acquired from the taxpayer or a related person 
exceeds a de minimis amount only if the aggregate amount paid for the 
stock exceeds $10,000 and more than 2 percent of the stock held by the 
taxpayer and related persons (within the meaning of section 1400Z-
2(e)(2)) is acquired. The rules in the following sentences of this 
paragraph (c)(2)(ii)(B)(2) apply for purposes of determining whether 
the 2-

[[Page 1981]]

percent limit is exceeded. The percentage of stock acquired in any 
single purchase is determined by dividing the stock's value (as of the 
time of purchase) by the value (as of the time of purchase) of all 
stock held (directly or indirectly) by the taxpayer and related persons 
immediately before the purchase. The percentage of stock acquired in 
multiple purchases is the sum of the percentages determined for each 
separate purchase.
    (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).
    (D) Principles of Sec.  1.1202-2(c) and (d). The principles of 
Sec.  1.1202-2(c) and (d) apply in determining whether stock is 
redeemed or purchased for purposes of paragraph (c)(2)(ii) of this 
section.
    (iii) Reorganizations of corporations otherwise qualifying as 
qualified opportunity zone businesses--(A) Qualification as qualified 
opportunity zone stock. Stock that meets all of the requirements of 
paragraph (c)(2)(i) of this section except for the requirement in 
paragraph (c)(2)(i)(A) of this section is qualified opportunity zone 
stock if it is received solely in exchange for qualified opportunity 
zone stock in a transaction described in section 381(a)(2). The 
requirements in paragraphs (c)(2)(i)(B) and (C) of this section must be 
met with respect to both the stock held before such transaction and the 
stock for which it is exchanged in such transaction.
    (B) Satisfaction of original use and substantial improvement tests. 
The requirements of Sec.  1.1400Z2(d)-2 apply to property of a 
qualified opportunity zone business acquired from a qualified 
opportunity zone business in a transaction described in section 
381(a)(2) as if the acquiring corporation had held the property during 
the period in which the target corporation held the property. For 
example, an item of property must be substantially improved by the same 
date by which the target corporation was required to satisfy the 
substantial improvement test for such property.
    (C) Reorganizations of qualified opportunity zone businesses within 
a consolidated group. See Sec. Sec.  1.1502-14Z and 1.1504-3 for 
special rules applicable to consolidated groups.
    (3) Qualified opportunity zone partnership interest--(i) In 
general. If an eligible entity is classified as a partnership for 
Federal tax purposes (partnership), any capital or profits interest 
(partnership interest) in the eligible entity is a qualified 
opportunity zone partnership interest if--
    (A) Date of acquisition. The partnership interest is acquired by a 
QOF after December 31, 2017, from the partnership solely in exchange 
for cash;
    (B) Qualified opportunity zone business. 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
    (C) 90-percent qualified opportunity zone property holding period--
(1) Cumulative holding period test. During at least 90-percent of the 
QOF's holding period for the partnership interest, determined on a 
cumulative basis in accordance with paragraph (c)(3)(i)(C)(2) of this 
section, the partnership qualified as a qualified opportunity zone 
business.
    (2) Semiannual qualified opportunity zone business test. For 
purposes of determining satisfaction of the cumulative 90-percent 
qualified opportunity zone property holding period test described in 
paragraph (c)(3)(i)(C)(1) of this section, the determination of whether 
a partnership engaged in a trade or business qualifies as a qualified 
opportunity zone business is made by the QOF on a semiannual basis 
pursuant to section 1400Z-2(d)(1). However, a QOF may choose to apply 
the safe harbor rule in paragraph (b)(2)(i)(C) of this section to make 
this determination.
    (ii) Reorganizations of partnerships otherwise qualifying as 
qualified opportunity zone businesses--(A) Qualification as a qualified 
opportunity zone partnership interest. A partnership interest that 
meets all of the requirements of paragraph (c)(3)(i) of this section 
except for the requirement in paragraph (c)(3)(i)(A) of this section is 
a qualified opportunity zone partnership interest if it is received 
solely in exchange for a qualified opportunity zone partnership 
interest in a merger or consolidation transaction described in section 
708(b)(2)(A). The requirements in paragraphs (c)(3)(i)(B) and (C) of 
this section must be met with respect to both the partnership interest 
held before the transaction and the partnership interest for which it 
is exchanged in the transaction.
    (B) Satisfaction of original use and substantial improvement tests. 
The requirements of Sec.  1.1400Z2(d)-2 apply to property of a 
qualified opportunity zone business acquired from a qualified 
opportunity zone business in a transaction described in section 
708(b)(2)(A) as if the resulting partnership had held the property 
during the period in which the merging or consolidating partnership 
held the property. For example, an item of property must be 
substantially improved by the same date by which the merging or 
consolidating partnership was required to satisfy the substantial 
improvement test for such property.
    (d) Qualified opportunity zone business--(1) In general. An 
eligible entity engaged in a trade or business within the meaning of 
section 162 is a qualified opportunity zone business if the entity 
satisfies, as determined at the end of its taxable year, all the 
criteria in paragraphs (d)(1)(i) through (iii) of this section. An 
eligible entity's status as a qualified opportunity zone business 
applies for the entire taxable year of the entity.
    (i) Pursuant to section 1400Z-2(d)(3)(A)(i), the eligible entity 
engaged in the trade or business satisfies the 70-percent tangible 
property standard with respect to its tangible property, as provided in 
paragraph (d)(2) of this section;
    (ii) Pursuant to section 1400Z-2(d)(3)(A)(ii), the eligible entity 
engaged in the trade or business satisfies the requirements of section 
1397C(b)(2), (4), and (8), as provided in paragraph (d)(3) of this 
section; and
    (iii) Pursuant to section 1400Z-2(d)(3)(A)(iii), the eligible 
entity engaged in the trade or business is not described in section 
144(c)(6)(B) as provided in paragraph (d)(4) of this section.
    (2) Satisfaction of 70-percent tangible property standard--(i) In 
general. A trade or business of an eligible entity satisfies the 70-
percent tangible property standard 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 Sec.  1.1400Z2(d)-2).
    (ii) Calculating percent of tangible property owned or leased in a 
trade or business--(A) In general. Whether a trade or business of the 
eligible entity satisfies the 70-percent tangible property standard set 
forth in paragraph (d)(2)(i) of this section is determined by a 
fraction--
    (1) The numerator of which is the total value of all tangible 
property owned or leased by the qualified opportunity zone business 
that is qualified opportunity zone business property; and

[[Page 1982]]

    (2) The denominator of which is the total value of all tangible 
property owned or leased by the qualified opportunity zone business, 
whether located inside or outside of a qualified opportunity zone.
    (B) Valuation. See paragraph (b)(2)(ii) of this section for rules 
regarding the valuation of tangible property for purposes of the 70-
percent tangible property standard.
    (3) Operation of section 1397C requirements adopted by reference--
(i) Gross income requirement. Section 1400Z-2(d)(3)(A)(ii) 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 (or in multiple qualified opportunity zones). A trade 
or business meets the 50-percent gross income requirement in the 
preceding sentence if the trade or business satisfies any one of the 
four criteria described in paragraph (d)(3)(i)(A), (B), (C), or (D) of 
this section, or any criteria identified in published guidance issued 
by the Commissioner under Sec.  601.601(d)(2) of this chapter.
    (A) Services performed in qualified opportunity zone based on 
hours. At least 50 percent of the services performed for the trade or 
business are performed in a qualified opportunity zone, determined by 
the fraction described in paragraphs (d)(3)(i)(A)(1) and (2) of this 
section. Amounts paid to partners that provide services to the trade or 
business of a partnership are taken into account in the numerator and 
denominator set forth in paragraphs (d)(3)(i)(A)(1) and (2) of this 
section only to the extent the amounts paid to the partners are 
guaranteed payments for services provided to the partnership within the 
meaning of section 707(c).
    (1) The numerator of the fraction is the total number of hours of 
services performed for the trade or business in a qualified opportunity 
zone during the taxable year by employees, partners that provide 
services to a partnership, independent contractors, and employees of 
independent contractors; and
    (2) The denominator of the fraction is the total number of hours of 
services performed for the trade or business during the taxable year by 
employees, partners that provide services to a partnership, independent 
contractors, and employees of independent contractors.
    (B) Services performed in qualified opportunity zone based on 
amounts paid for services. At least 50 percent of the services 
performed for the trade or business are performed in a qualified 
opportunity zone, determined by the fraction described in paragraphs 
(d)(3)(i)(B)(1) and (2) of this section. Amounts paid to partners that 
provide services to the trade or business of a partnership are taken 
into account in the numerator and denominator set forth in paragraphs 
(d)(3)(i)(B)(1) and (2) of this section only to the extent the amounts 
paid to the partners are guaranteed payments for services provided to 
the partnership within the meaning of section 707(c).
    (1) The numerator of the fraction is the total amount paid by the 
entity for services performed in a qualified opportunity zone during 
the taxable year, whether by employees, partners that provide services 
to a partnership, independent contractors, or employees of independent 
contractors; and
    (2) The denominator of the fraction is the total amount paid by the 
entity for services performed during the taxable year, whether by 
employees, partners that provide services to a partnership, independent 
contractors, or employees of independent contractors.
    (C) Necessary tangible property and business functions. The 
tangible property of the trade or business located in a qualified 
opportunity zone and the management or operational functions performed 
in a qualified opportunity zone are each necessary for the generation 
of at least 50 percent of the gross income of the trade or business.
    (D) Facts and circumstances. Based on all the facts and 
circumstances, 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 a qualified opportunity zone.
    (E) Examples. The following examples illustrate the principles of 
paragraphs (d)(3)(i)(C) and (D) of this section.

    (1) Example 1. A landscaping business has its headquarters in a 
qualified opportunity zone, its officers and employees manage the 
daily operations of the business (inside and outside the qualified 
opportunity zone) from its headquarters, and all its equipment and 
supplies are stored in the headquarters facilities. The activities 
occurring and the storage of equipment and supplies in the qualified 
opportunity zone are, taken together, necessary for the generation 
of the income of the business.
    (2) Example 2. A trade or business is formed or organized under 
the laws of the jurisdiction within which a qualified opportunity 
zone is located, and the business has a P.O. Box located in the 
qualified opportunity zone. The mail received at that P.O. Box is 
fundamental to the income of the trade or business, but there is no 
other basis for concluding that the income of the trade or business 
is derived from activities in the qualified opportunity zone. The 
mere location of the P.O. Box is not necessary for the generation of 
gross income by the trade or business.
    (3) Example 3. In 2019, Taxpayer X realized $w million of 
capital gains and within the 180-day period invested $w million in 
QOF Y, a qualified opportunity fund. QOF Y immediately acquired from 
partnership P a partnership interest in P, solely in exchange for $w 
million of cash. P is a real estate developer that has written plans 
to acquire land in a qualified opportunity zone on which it plans to 
construct a commercial building for lease to other trades or 
businesses. In 2023, P's commercial building is placed in service 
and is fully leased up to other trades or businesses. For the 2023 
taxable year, at least 50 percent of P's gross income is derived 
from P's rental of its tangible property in the qualified 
opportunity zone. Thus, under P's facts and circumstances, P 
satisfies the gross income test under section 1397C(b)(2).

    (ii) Use of intangible property requirement--(A) In general. 
Section 1400Z-2(d)(3)(A)(ii) incorporates section 1397C(b)(4), 
requiring that, with respect to any taxable year, a substantial portion 
of the intangible property of a qualified opportunity zone business is 
used in the active conduct of a trade or business in a qualified 
opportunity zone. For purposes of section 1400Z-2(d)(3)(A)(ii) and the 
preceding sentence, the term substantial portion means at least 40 
percent.
    (B) Use of intangible property. For purposes of section 1400Z-
2(d)(3)(A)(ii) and paragraph (d)(3)(ii)(A) of this section, intangible 
property of a qualified opportunity zone business is used in the active 
conduct of a trade or business in a qualified opportunity zone if--
    (1) The use of the intangible property is normal, usual, or 
customary in the conduct of the trade or business; and
    (2) The intangible property is used in the qualified opportunity 
zone in the performance of an activity of the trade or business that 
contributes to the generation of gross income for the trade or 
business.
    (iii) Active conduct of a trade or business--(A) Operating real 
property. Solely for purposes of section 1400Z-2(d)(3)(A), the 
ownership and operation (including leasing) of real property is the 
active conduct of a trade or business.
    (B) Lessee is responsible for certain costs. Merely entering into a 
triple-net-lease with respect to real property owned by a taxpayer does 
not constitute the active conduct of a trade or business by such 
taxpayer.
    (C) Examples. The following examples illustrate the rules of 
paragraph (d)(3)(iii) of this section.


[[Page 1983]]


    (1) Example 1. Mere triple-net-lease not active conduct of trade 
or business--(i) Facts. Company N constructs and places into service 
a new, three-story office building in a qualified opportunity zone 
and leases the entire building to tenant X, an unrelated person, 
which uses the building as office space for its software development 
firm. This building is the only property owned by Company N. The 
lease agreement between Company N and tenant X is a triple-net-lease 
under which tenant X is responsible for all of the costs relating to 
the office building (for example, paying all taxes, insurance, and 
maintenance expenses) in addition to paying rent. Company N also 
maintains an office in the building with staff members to address 
any issues that may arise with respect to the triple-net-lease.
    (ii) Analysis. Solely for purposes of section 1400Z-2(d)(3)(A), 
Company N is treated as not engaged in the active conduct of a trade 
or business with respect to the leased office building. Company N 
leases the building to tenant X under a triple-net-lease, and 
therefore the employees of Company N do not meaningfully participate 
in the management or operations of the building. The fact that 
Company N maintains an office in the leased building with staff 
members to address any issues that may arise with respect to the 
triple-net-lease does not alter this result. Therefore, Company N 
does not conduct an active trade or business in a qualified 
opportunity zone.
    (2) Example 2. Triple-net-lease and managerial and operational 
activities can constitute active conduct of trade or business--(i) 
Facts. Company N constructs and places into service a new, three-
story mixed-use building in a qualified opportunity zone and leases 
a floor to each of unrelated tenants X, Y, and Z, respectively. This 
building is the only property owned by Company N. The lease 
agreement between Company N and tenant X is a triple-net-lease under 
which tenant X is responsible for all of the costs relating to the 
third floor of the building (for example, paying all such taxes, 
insurance, and maintenance expenses) in addition to paying rent. The 
lease agreement between Company N and tenant Y is not a triple-net-
lease and employees of Company N manage and operate the second floor 
of the building. Likewise, the lease agreement between Company N and 
tenant Z is not a triple-net-lease and employees of Company N manage 
and operate the first floor of the building. Company N maintains an 
office in the building, which the employees regularly use to carry 
out their managerial and operational duties with respect to the 
first and second floors, and address any other issues that may arise 
with respect to the three leases.
    (ii) Analysis. Solely for purposes of section 1400Z-2(d)(3)(A), 
Company N is treated as engaged in the active conduct of a trade or 
business with respect to the leased mixed-use building. While 
Company N leases the third floor of the building to tenant X merely 
under a triple-net-lease, and therefore the employees of Company N 
do not meaningfully participate in the management or operations of 
that floor, the employees of Company N meaningfully participate in 
the management and operations of the first and second floors of the 
leased building. Therefore, in carrying out the overall leasing 
business of Company N with respect to the mixed-use building, 
employees of Company N conduct meaningful managerial and operational 
activities. As a result, Company N conducts an active trade or 
business in a qualified opportunity zone.

    (iv) Nonqualified financial property limitation. Section 1400Z-
2(d)(3)(A)(ii) incorporates section 1397C(b)(8), which requires that in 
each taxable year less than 5 percent of the average of the aggregate 
unadjusted bases of the property of a qualified opportunity zone 
business is 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) 
and debt instruments described in section 1221(a)(4).
    (v) 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 
requirements in paragraphs (d)(3)(v)(A) through (C) of this section are 
satisfied.
    (A) Designated in writing. These amounts are designated in writing 
for the development of a trade or business in a qualified opportunity 
zone (as defined in section 1400Z-1(a)), including when appropriate the 
acquisition, construction, and/or substantial improvement of tangible 
property in such a zone.
    (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 the 
writing and written schedule described in paragraphs (d)(3)(v)(A) and 
(B) of this section. If consumption of the working capital assets is 
delayed by waiting for governmental action the application for which is 
complete, that delay does not cause a failure of this paragraph 
(d)(3)(v)(C).
    (D) Federally declared disasters. If the qualified opportunity zone 
business is located in a qualified opportunity zone within a federally 
declared disaster (as defined in section 165(i)(5)(A)), the qualified 
opportunity zone business may receive up to an additional 24 months to 
consume its working capital assets, as long as it otherwise meets the 
requirements of paragraph (d)(3)(v) of this section.
    (E) Ability of a single business to benefit from more than a single 
application of the safe harbor. A business may benefit from multiple 
overlapping or sequential applications of the working capital safe 
harbor, provided that each application independently satisfies all of 
the requirements in paragraphs (d)(3)(v)(A) through (C) of this 
section.
    (F) Ability of tangible property to benefit from more than a single 
application of the safe harbor. Tangible property may benefit for an 
additional 31-month period, for a total of 62 months, in the form of 
multiple overlapping or a sequential application of the working capital 
safe harbor, provided that each application independently satisfies all 
of the requirements in paragraphs (d)(3)(v)(A) through (C) of this 
section, the working capital assets from an expiring 31-month period 
were expended in accordance with the requirements in paragraphs 
(d)(3)(v)(A) through (C) of this section, and the subsequent infusions 
of working capital assets form an integral part of the plan covered by 
the initial working capital safe harbor period. An overlapping or 
sequential application of the working capital safe harbor must include 
a substantial amount of working capital assets (which may include debt 
instruments described in section 1221(a)(4)).
    (G) Examples. The following examples illustrate the rules of 
paragraph (d)(3)(v) of this section.

    (1) Example 1. General application of working capital safe 
harbor--(i) Facts. QOF F creates a domestic C corporation E to open 
a fast-food restaurant and acquires almost all of the equity of E in 
exchange for cash. E has a written plan and a 20-month schedule for 
the use of this cash to establish the restaurant. Among the planned 
uses for the cash are identification of favorable locations in the 
qualified opportunity zone, leasing a building suitable for such a 
restaurant, outfitting the building with appropriate equipment and 
furniture (both owned and leased), necessary security deposits, 
obtaining a franchise and local permits, and the hiring and training 
of kitchen and wait staff. Not-yet-disbursed amounts were held in 
assets described in section 1397C(e)(1), and these assets were 
eventually expended in a manner consistent with the plan and 
schedule.

[[Page 1984]]

    (ii) Analysis. E's use of the cash qualifies for the working 
capital safe harbor described in paragraph (d)(3)(v) of this 
section.
    (2) Example 2. Multiple applications of working capital safe 
harbor--(i) Facts. QOF G creates a domestic C corporation H to start 
a new technology company and acquires equity of H in exchange for 
cash on Date 1. In addition to H's rapid deployment of capital 
received from other equity investors, H writes a plan with a 30-
month schedule for the use of the Date 1 cash. The plan describes 
use of the cash to research and develop a new technology 
(Technology), including paying salaries for engineers and other 
scientists to conduct the research, purchasing, and leasing 
equipment to be used in research and furnishing office and 
laboratory space. Approximately 18 months after Date 1, on Date 2, G 
acquires additional equity in H for cash, and H writes a second 
plan. This new plan has a 25-month schedule for the development of a 
new application of existing software (Application), to be marketed 
to government agencies. Among the planned uses for the cash received 
on Date 2 are paying development costs, including salaries for 
software engineers, other employees, and third-party consultants to 
assist in developing and marketing the new application to the 
anticipated customers. Not-yet-disbursed amounts that were scheduled 
for development of the Technology and the Application were held in 
assets described in section 1397C(e)(1), and these assets were 
eventually expended in a manner substantially consistent with the 
plans and schedules for both the Technology and the Application.
    (ii) Analysis. H's use of both the cash received on Date 1 and 
the cash received on Date 2 qualifies for the working capital safe 
harbor described in paragraph (d)(3)(v) of this section.
    (3) Example 3. General application of working capital safe 
harbor--(i) 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-
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.
    (ii) Analysis--P met the three requirements of the safe harbor 
provided in paragraphs (d)(3)(v)(A) through (C) 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. First, 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). Second, 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). Third, 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. Fourth, 
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 investment standard in section 1400Z-
2(d)(1).
    (iii) Analysis if P had purchased an existing building. The 
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 would not cause the building to fail to satisfy section 
1400Z-2(d)(2)(D)(i)(III).

    (vi) 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)(3)(v) of this section treats as a 
reasonable amount of working capital, then that gross income is counted 
toward satisfaction of the 50-percent test.
    (vii) 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), intangible property purchased or licensed by the trade 
or business, pursuant to the reasonable written plan with a written 
schedule for the expenditure of the working capital, satisfies the use 
requirement during any period in which the business is proceeding in a 
manner that is substantially consistent with paragraphs (d)(3)(v)(A) 
through (C) of this section.
    (viii) Safe harbor for property on which working capital is being 
expended--(A) In general. If paragraph (d)(3)(v) of this section treats 
property that would otherwise be nonqualified financial property as 
being a reasonable amount of working capital because of compliance with 
the three requirements of paragraphs (d)(3)(v)(A) through (C) of this 
section and if the tangible property referred to in paragraph 
(d)(3)(v)(A) is expected to satisfy the requirements of section 1400Z-
2(d)(2)(D)(i) as a result of the planned expenditure of those working 
capital assets, then tangible property purchased, leased, or improved 
by the trade or business, pursuant to the written plan for the 
expenditure of the working capital assets, is treated as qualified 
opportunity zone business property satisfying the requirements of 
section 1400Z-2(d)(2)(D)(i), during that and subsequent working capital 
periods the property is subject to, for purposes of the 70-percent 
tangible property standard in section 1400Z-2(d)(3).

    (B) Example. Multiple applications of working capital safe 
harbor to tangible property--(i) Facts. B also borrows cash and 
forms a domestic C corporation B to develop a large mixed-use real 
estate development that will consist of commercial and residential 
real property, owning almost all of the equity of B in exchange for 
cash. QOF A has a master written plan for the completion of the 
commercial and residential real property over a 55 month period. The 
plan provides that the commercial real property will be completed 
over a 30 month schedule and subsequently, the residential real 
property will be completed over a 25 month schedule. The plan 
further provides that a portion of the commercial real property is 
unable to be used in a trade or business after the completion of the 
commercial real property since that portion of the commercial real 
property will be unusable during the residential construction phase. 
Pursuant to B's original master plan for the completion of the real 
estate development, QOF A acquires additional equity in B for cash 
after the completion of the commercial development phase, and B 
commences use of those working capital assets for residential 
development phase.
    (ii) Analysis. B's use of the cash for the commercial and 
residential phase qualified for the working capital safe harbor 
described in paragraph (d)(3)(v) of this section. In addition, all 
of B's commercial real property developed pursuant to B's original 
master plan is treated as qualified opportunity zone business 
property under paragraph (d)(3)(viii) of this section.

    (ix) Real property straddling a qualified opportunity zone. For 
purposes of satisfying the requirements in this paragraph (d)(3) in the 
case of

[[Page 1985]]

real property that straddles a qualified opportunity zone, a qualified 
opportunity zone is the location of services, tangible property, or 
business functions if--
    (A) The trade or business uses the portion of the real property 
located within a qualified opportunity zone in carrying out its 
business activities;
    (B) The trade or business uses the real property located outside of 
a qualified opportunity zone in carrying out its business activities;
    (C) The amount of the real property located within a qualified 
opportunity zone is substantial compared to the amount of real property 
located outside of a qualified opportunity zone; and
    (D) The real property located in the qualified opportunity zone is 
contiguous to part, or all, of the real property located outside of the 
qualified opportunity zone.
    (E) In general, one of the two methods in paragraph 
(d)(3)(ix)(E)(1) and (2) of this section may be chosen to determine 
whether the amount of real property located in the qualified 
opportunity zone is substantial compared to the amount of real property 
located outside the qualified opportunity zone.
    (1) Square footage test. If the amount of real property based on 
square footage located within the qualified opportunity zone is greater 
than the amount of real property based on square footage outside of the 
qualified opportunity zone, and the real property outside of the 
qualified opportunity zone is contiguous to part or all of the real 
property located inside the qualified opportunity zone, then all of the 
property is deemed to be located within a qualified opportunity zone. 
The test in this paragraph (d)(3)(ix)(E)(1) is carried out at the time 
at which the subject real property is acquired.
    (2) Unadjusted cost test. If the unadjusted cost of the real 
property located inside a qualified opportunity zone is greater than 
the unadjusted cost of the real property outside the qualified 
opportunity zone, and the real property outside of the qualified 
opportunity zone is contiguous to all or part of the real property 
located inside the qualified opportunity zone, then all of the property 
is deemed to be located within a qualified opportunity zone. The 
unadjusted cost basis of property acquired as a single tract is 
presumed to be allocated on the basis of the square footage of the 
property. The test in this paragraph (d)(3)(ix)(E)(2) is carried out at 
the time at which the subject real property is acquired.
    (F) For purposes of the two tests described in paragraph 
(d)(3)(ix)(E)(1) and (2) of this section, two or more tracts or parcels 
of land are contiguous if they share common boundaries or would share 
common boundaries but for the interposition of a road, street, 
railroad, stream or similar property. Tracts or parcels of land which 
touch only at a common corner are not contiguous.
    (x) Example. The following example illustrates the rules of 
paragraph (d)(3) of this section--

    (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-
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--(1) P met the three requirements of the safe 
harbor provided in paragraph (d)(3)(v) 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 investment 
standard in section 1400Z-2(d)(1).
    (C) Analysis if P had purchased an existing building. The 
conclusions in paragraph (d)(3)(x)(B) of this section 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 would not cause the building to 
fail to satisfy section 1400Z-2(d)(2)(D)(i)(III).

    (4) Trade or businesses described in section 144(c)(6)(B) not 
eligible--(i) Pursuant to section 1400Z-2(d)(3)(A)(iii), the following 
trades or businesses, and businesses leasing more than a de minimis 
amount of property to the following trades or businesses, cannot 
qualify as a qualified opportunity zone business:
    (A) Any private or commercial golf course;
    (B) Country club;
    (C) Massage parlor;
    (D) Hot tub facility;
    (E) Suntan facility;
    (F) Racetrack or other facility used for gambling; or
    (G) Any store the principal business of which is the sale of 
alcoholic beverages for consumption off premises.
    (ii) De minimis amounts of gross income attributable to a business 
described in section 144(c)(6)(B) will not cause a trade or business to 
fail to be a qualified opportunity zone business.
    (iii) The term de minimis amount of property, used in paragraph 
(d)(4)(i) of this section, means less than 5 percent of the net 
rentable square feet for real property and less than 5 percent of the 
value for all other tangible property. The term de minimis amount of 
gross income, used in paragraph (d)(4)(ii) of this section, means less 
than 5 percent of the gross income of the qualified opportunity zone 
business may be attributable to the types of business described in 
section 144(c)(6)(B).
    (iv) The following examples illustrate the rules of paragraph 
(d)(4) of this section:

    (A) Example 1. Entity A is a QOF that meets the requirements of 
section 1400Z-2(d)(1). Entity A owns qualified opportunity zone 
stock in a domestic corporation described in section 1400Z-
2(d)(2)(B), which operates a hotel located in a qualified 
opportunity zone that qualifies as a trade or business. As part of 
that trade or business, the hotel operates a spa that provides 
massages and other therapies. Less than 5 percent of the hotel's 
total gross income is

[[Page 1986]]

attributable to the spa, and less than 5 percent of the net rentable 
square feet for real property and less than 5 percent of the value 
for all other tangible property is attributable to the spa. As a 
result, the operation of the spa, which is a business described in 
section 144(c)(6)(B), will not prevent the operation of the hotel 
from qualifying as a qualified opportunity zone business.
    (B) Example 2--(1) Facts. Entity B is a qualified opportunity 
zone business that meets the requirements of section 1400Z-2(d)(3). 
Entity B plans to acquire a commercial golf course that consists of 
land and other related buildings and equipment in a qualified 
opportunity zone, that will satisfy each requirement for qualified 
opportunity zone business property set forth in section 1400Z-
2(d)(2)(D). Instead of directly managing and operating the 
commercial golf course business, Entity B will lease the land and 
other related buildings and equipment to a third party to manage and 
operate the commercial golf course. The leased real property 
represents more than 5 percent of the net rentable square feet of 
Entity B's real property and the leased and other tangible property 
represents more than 5 percent of the value for all other tangible 
property of Entity B.
    (2) Analysis. Because a golf course is prohibited from being a 
qualified trade or business under section 1400Z-2(d)(3)(A)(iii), the 
leasing arrangement will cause Entity B to fail to be a qualified 
opportunity zone business regardless of the satisfaction of each 
requirement set forth in section 1400Z-2(d)(2)(D).
    (C) Example 3--(1) Facts. Entity B meets the explicit 
requirements of section 1400Z-2(d)(1) and has certified itself as a 
QOF. Entity B owns a commercial golf course that consists of land 
and other related buildings and equipment in a qualified opportunity 
zone, and the land and buildings satisfy all explicit requirements 
(in section 1400Z-2(d)(2)(D)) to be qualified opportunity zone 
business property. Entity B manages and operates the commercial golf 
course business, but does not manage or operate any other trade or 
business not described in section 144(c)(6)(B) (listing businesses 
not eligible to be a qualified opportunity zone business pursuant to 
section 1400Z-2(d)(3)(A)(iii)). Entity B chose to operate the 
commercial golf course through Entity B, rather than through a 
qualified opportunity zone business, in order to avoid the 
requirement in section 1400Z-2(d)(3)(A)(iii), which provides that a 
qualified opportunity zone business cannot operate a commercial golf 
course due to the inclusion of that trade or business in section 
144(c)(6)(B).
    (2) Analysis. The ownership and operation of the golf course at 
the QOF level will not disqualify the QOF because the prohibition on 
businesses described in section 144(c)(6)(B) is not applicable at 
the QOF level. In addition, if each requirement set forth in section 
1400Z-2(d)(2)(D) is satisfied, the property used in the commercial 
golf course will qualify as qualified opportunity zone business 
property held by Entity B for purposes of section 1400Z-2(d)(2)(A).

    (5) Tangible property of a qualified opportunity zone business that 
ceases to be qualified opportunity zone business property. For 
qualified opportunity zone businesses, tangible property that ceases to 
be qualified opportunity zone business property shall continue to be 
treated as qualified opportunity zone business property for the lesser 
of five years after the date on which such tangible property ceases to 
be so qualified or the date on which such tangible property is no 
longer held by the qualified opportunity zone business. However, 
tangible property is not eligible for the benefits provided in this 
paragraph (d)(5) unless the tangible property ceasing to qualify as 
qualified opportunity zone business property was qualified opportunity 
zone business property used by a qualified opportunity zone business in 
a qualified opportunity zone for two years. For purposes of this 
paragraph (d)(5), tangible property purchased, leased, or improved by a 
trade or business, that is treated as satisfying the requirements of 
section 1400Z-2(d)(2)(D)(i) during that working capital safe harbor 
period pursuant to paragraph (d)(3)(v) of this section or that 30-month 
substantial improvement period described in Sec.  1.1400Z2(d)-2(b)(4), 
is not treated as used by a qualified opportunity zone business in a 
qualified opportunity zone for any portion of the two year period 
described in this paragraph (d)(5).
    (6) Cure period for qualified opportunity zone businesses. (i) For 
purposes of the 90-percent qualified opportunity zone business holding 
period requirements set forth in sections 1400Z-2(d)(2)(B)(i)(III), 
1400Z-2(d)(2)(C)(iii), and 1400Z-2(d)(2)(D)(i)(III), if a trade or 
business causes the QOF to fail the 90-percent investment standard on a 
semiannual testing date, the QOF may treat the stock or partnership 
interest in that business as qualified opportunity zone property for 
that semiannual testing date provided the business corrects the failure 
within 6 months of the date on which the stock or partnership interest 
lost its qualification.
    (ii) If the failure occurs on the last testing date of the taxable 
year, the six-month cure period described in paragraph (d)(6)(i) of 
this section is available to the QOF only if the QOF files a valid 
application for an extension of time to file its tax return.
    (iii) Each QOF is permitted only one correction pursuant to 
paragraph (d)(6) of this section. If the entity, at the end of the 
additional six-month cure period, fails to qualify as a qualified 
opportunity zone business, then the QOF becomes subject to the penalty 
under section 1400Z-2(f)(1) for each month the entity failed to qualify 
as a qualified opportunity zone business beginning with the first month 
following the last month that the QOF met the 90-percent investment 
standard.
    (e) Applicability dates--(1) In general. The provisions of this 
section are applicable for taxable years beginning after March 13, 
2020.
    (2) Prior periods. With respect to the portion of a taxpayer's 
first taxable year ending after December 21, 2017, that began on 
December 22, 2017, and for taxable years beginning after December 21, 
2017, and on or before March 13, 2020, a taxpayer may choose either--
    (i) To apply the section 1400Z-2 regulations, if applied in a 
consistent manner for all such taxable years; or
    (ii) To rely on the rules in proposed Sec.  1.1400Z2(d)-1 contained 
in the notice of proposed rulemaking (REG-115420-18) published on 
October 29, 2018, as amplified by the notice of proposed rulemaking 
(REG-120186-18) published on May 1, 2019, but only if applied in a 
consistent manner for all such taxable years.

0
Par. 7. Section 1.1400Z2(d)-2 is added to read as follows:


Sec.  1.1400Z2(d)-2   Qualified opportunity zone business property.

    (a) Qualified opportunity zone business property--(1) In general. 
This section provides rules for determining whether owned or leased 
tangible property held by an eligible entity (within the meaning of 
Sec.  1.1400Z2(d)-1(a)(1)) is qualified opportunity zone business 
property within the meaning of section 1400Z-2(d)(2)(D). Paragraph 
(a)(2) of this section provides general requirements that tangible 
property must satisfy to be qualified opportunity zone business 
property. Paragraph (b) of this section provides rules related to owned 
tangible property. Paragraph (c) of this section provides rules related 
to leased tangible property (that is, tangible property that the 
eligible entity acquires by lease from a lessor). Paragraph (d) of this 
section provides rules related to the 90-percent qualified opportunity 
zone business property holding period requirement and the 70-percent 
use test of section 1400Z-2(d)(2)(D)(i)(III). Paragraph (e) of this 
section provides the dates of applicability of this section.
    (2) Qualified opportunity zone business property requirements. The 
term qualified opportunity zone business property means tangible 
property owned or leased by an eligible entity (as defined in Sec.  
1.1400Z2(d)-1(a)(1)) that--
    (i) Is used by the eligible entity in a trade or business within 
the meaning of section 162; and

[[Page 1987]]

    (ii) Satisfies the requirements of paragraphs (b), (c), and (d) of 
this section, as applicable.
    (b) Tangible property owned by an eligible entity--(1) Purchase 
requirement--(i) In general. In the case of tangible property that is 
owned by an eligible entity, the tangible property must be acquired by 
the eligible entity after December 31, 2017, by purchase as defined by 
section 179(d)(2) from a person that is not a related person within the 
meaning of section 1400Z-2(e)(2) (providing that persons are related to 
each other if such persons are described in section 267(b) or section 
707(b)(1), determined by substituting ``20 percent'' for ``50 percent'' 
each place it appears in such sections).
    (ii) Plan, intent, or expectation for seller to repurchase acquired 
property. In the case of real property that is purchased by an eligible 
entity, if, at the time of the purchase, there was a plan, intent, or 
expectation for the acquired real property to be repurchased by the 
seller of the real property for an amount of consideration other than 
the fair market value of the real property, determined at the time of 
the repurchase by the seller, the purchased real property is not 
qualified opportunity zone business property.
    (iii) Property manufactured, constructed, or produced for use in a 
qualified opportunity zone--(A) In general. In the case of tangible 
property manufactured, constructed, or produced by an eligible entity, 
if the property is manufactured, constructed, or produced for use by an 
eligible entity with the intent to use such property in a trade or 
business in a qualified opportunity zone, then such property satisfies 
the requirements of paragraph (b)(1)(i) of this section if the 
manufacture, construction, or production begins after December 31, 
2017. The materials and supplies used to manufacture, construct, or 
produce qualified opportunity zone business property by the eligible 
entity must also be qualified opportunity zone business property.
    (B) Time when manufacture, construction or production considered to 
begin. For purposes of paragraph (b)(1)(iii) of this section, the 
acquisition date of such property is the date on which the manufacture, 
construction, or production of property (as defined in paragraph 
(b)(1)(iii) of this section) begins. The manufacture, construction, or 
production of property begins when physical work of a significant 
nature begins. Physical work does not include preliminary activities 
such as planning or designing, securing financing, exploring or 
researching. The determination of when physical work of a significant 
nature begins depends on the facts and circumstances. For example, if a 
factory is to be constructed on-site, construction begins when physical 
work of a significant nature commences at the site; this could occur, 
for example, when work begins on the excavation of footings, or the 
pourings of pads for the factory. Preliminary work, such as clearing or 
testing of soil condition, does not constitute the beginning of 
construction.
    (C) Safe harbor. For purposes of paragraph (b)(1)(iii)(B) of this 
section, a taxpayer may choose to determine when physical work of a 
significant nature begins in accordance with this paragraph 
(b)(1)(iii)(C). Physical work of a significant nature will not be 
considered to begin before the taxpayer incurs or pays more than 10 
percent of the total cost of the property (excluding the cost of any 
land and preliminary activities such as planning or designing, securing 
financing, exploring, or researching).
    (2) Original use or substantial improvement requirement--(i) In 
general. In the case of tangible property owned by the eligible entity 
either--
    (A) The original use of the owned tangible property in the 
qualified opportunity zone, within the meaning of paragraph (b)(3) of 
this section, must commence with the eligible entity; or
    (B) The eligible entity must substantially improve the owned 
tangible property within the meaning of paragraph (b)(4) of this 
section (which defines substantial improvement in this context).
    (ii) Inventory. Inventory (including raw materials) of a trade or 
business produced by an eligible entity after December 31, 2017, is 
deemed to satisfy the requirements set forth in paragraphs (b)(1) and 
(b)(2)(i) of this section.
    (3) Original use of tangible property acquired by purchase--(i) 
Original use--(A) In general. For purposes of paragraph (b)(2) of this 
section, the original use of tangible property in a qualified 
opportunity zone commences on the date any person first places the 
property in service in the qualified opportunity zone for purposes of 
depreciation or amortization, or first uses it in a manner that would 
allow depreciation or amortization if that person were the property's 
owner.
    (B) Commencement of original use of vacant property. For purposes 
of this paragraph (b)(3), if real property, including land and 
buildings, has been vacant for an uninterrupted period of at least one 
calendar year beginning on a date prior to the date on which the 
qualified opportunity zone in which the property is located is listed 
as a designated qualified opportunity zone in a QOZ designation notice 
and the property has remained vacant through the date on which the 
property was purchased by the eligible entity, or if the property has 
been vacant for an uninterrupted three calendar year period beginning 
on a date after the date of publication of the QOZ designation notice 
that lists as designated the qualified opportunity zone in which the 
property is located and the property has remained vacant through the 
date on which the property was purchased by the eligible entity, 
original use in the qualified opportunity zone commences on the date 
after that period when any person first so uses or places the property 
in service in the qualified opportunity zone. Such property must 
satisfy the definition of vacancy under paragraph (b)(3)(iii) of this 
section.
    (C) Used tangible property. Used tangible property satisfies the 
original use requirement if the property has not been previously so 
used or placed in service in the qualified opportunity zone. If the 
tangible property had been so used or placed in service in the 
qualified opportunity zone before it is acquired by purchase, it must 
be substantially improved in order to satisfy the requirements of 
section 1400Z-2(d)(2)(D)(i)(II).
    (D) Example. The following example illustrates the principles of 
paragraph (b)(3)(i)(A) of this section.

    (1) Facts. On January 1, 2019, QOF A purchases from a developer 
a newly constructed hotel building located in a qualified 
opportunity zone for $10 million. The developer purchased a parcel 
of land in that qualified opportunity zone, and constructed the 
hotel building thereon, with the intent and expectation to sell the 
building to a QOF. As of the time of the purchase, the developer had 
not placed the hotel building in service in the qualified 
opportunity zone for purposes of depreciation. Other than the 
original use requirement, assume that the hotel building satisfies 
all requirements under section 1400Z-2(d)(2)(D). In addition, assume 
that, at the time of the purchase, the developer had no plan, 
intent, or expectation to repurchase the hotel building.
    (2) Analysis. At the time of QOF A's purchase of the hotel 
building, the original use of the hotel building had not commenced 
because the developer had not yet placed the hotel building into 
service for purposes of depreciation in a qualified opportunity 
zone. See paragraph (b)(3)(i)(A) of this section. Therefore, the 
original use of the hotel building in the qualified opportunity zone 
in which the building is located is treated as commencing with QOF 
A. See paragraph (b)(3)(i)(A) of this section. As a result, the 
hotel building purchased by QOF A is treated as satisfying the 
original use requirement of section 1400Z-2(d)(2)(D)(i)(II).


[[Page 1988]]


    (ii) Lessee improvements to leased property. Improvements made by a 
lessee to leased property satisfy the original use requirement in 
section 1400Z-2(d)(2)(D)(i)(II) as purchased property for the amount of 
the unadjusted cost basis under section 1012 of such improvements.
    (iii) Vacancy. Solely for purposes of meeting the requirements of 
section 1400Z-2, real property, including land and buildings, is 
considered to be in a state of vacancy if the property is significantly 
unused. A building or land will be considered significantly unused if 
more than 80 percent of the building or land, as measured by the square 
footage of useable space, is not currently being used.
    (iv) Brownfield sites. An eligible entity that purchases a parcel 
of land that is a brownfield site, as defined by section 101 of the 
Comprehensive Environmental Response, Compensation, and Liability Act 
of 1980 (42 U.S.C. 9601) (brownfield site), may treat all property 
composing the brownfield site (including the land and structures 
thereon) as satisfying the original use requirement of section 1400Z-
2(d)(2)(D)(i)(II), if, within a reasonable period, the eligible entity 
makes investments in the brownfield site to ensure that all property 
composing the brownfield site meets basic safety standards for both 
human health and the environment.
    (v) Property involuntarily transferred to local government. An 
eligible entity that purchases real property from a local government 
that the local government holds as the result of an involuntary 
transfer (including through abandonment, bankruptcy, foreclosure, or 
receivership) may treat all property composing the real property 
(including the land and structures thereon) as satisfying the original 
use requirement of section 1400Z-2(d)(2)(D)(i)(II).
    (4) Substantial improvement of tangible property acquired by 
purchase--(i) In general. Except as provided in paragraph (b)(4)(iv) of 
this section, for purposes of paragraph (b)(2) of this section, 
tangible property is treated as substantially improved by an eligible 
entity only if it meets the requirements of section 1400Z-
2(d)(2)(D)(ii) during the 30-month substantial improvement period. The 
property has been substantially improved when the additions to basis of 
the property in the hands of the QOF exceed an amount equal to the 
adjusted basis of such property at the beginning of such 30-month 
period in the hands of the QOF (substantial improvement requirement).
    (ii) Treatment of property in the 30-month substantial improvement 
period. For purposes of the 90-percent investment standard under 
section 1400Z-2(d)(1), tangible property purchased, leased, or improved 
by a trade or business that is undergoing the substantial improvement 
process but has not yet been placed in service by the eligible entity 
or used in the eligible entity's trade or business is treated as 
satisfying the requirements of section 1400Z-2(d)(2)(D)(i) and 
paragraph (b)(2) of this section for the 30-month substantial 
improvement period with respect to that property provided the eligible 
entity reasonably expects that the property will be substantially 
improved as defined in paragraph (b)(4)(i) of this section and used in 
the eligible entity's trade or business in a qualified opportunity zone 
by the end of such 30-month period. Tangible property described in the 
preceding sentence is not considered qualified opportunity zone 
business property for purposes of the special rule in section 1400Z-
2(d)(3)(B) unless the tangible property is qualified opportunity zone 
business property for at least two years without regard to this 
paragraph (b)(4)(ii).
    (iii) Aggregation of original use property that improves the 
functionality of non-original use property--(A) General rule. The cost 
of purchased property that would otherwise qualify as qualified 
opportunity zone business property may be taken into account in 
determining whether additions to the basis of non-original use property 
acquired by purchase satisfy the substantial improvement requirement 
under section 1400Z-2(d)(2)(D)(ii), so long as the purchased property 
is located in the same qualified opportunity zone (or a contiguous 
qualified opportunity zone) as the non-original use property, is used 
in the same trade or business as the non-original use property, and 
improves the functionality of the non-original use property.
    (B) Improvement of non-original use real property. If an eligible 
entity chooses to apply this paragraph (b)(4)(iii) to non-original use 
real property, the eligible entity must improve the non-original use 
real property by more than an insubstantial amount within the meaning 
of paragraph (b)(4)(iv)(C) of this section.
    (C) Effect on purchased property. If an eligible entity chooses to 
apply this paragraph (b)(4)(iii), the purchased property that would 
otherwise qualify as qualified opportunity zone business property will 
not be treated as original use property, and instead the basis of that 
purchased property will be taken into account in determining whether 
additions to the basis of the non-original use property satisfy the 
requirements under section 1400Z-2(d)(2)(D)(i)(II) and (d)(2)(D)(ii).
    (D) Examples. The following examples illustrate the principles of 
paragraph (b)(4)(iii) of this section.

    (1) Example 1--(i) Facts. On January 1, 2019, QOF A purchases 
the assets of a hotel business located in a qualified opportunity 
zone for $5 million. The purchased assets include land, a building, 
linens, furniture and other fixtures attached to the building. $1 
million of the purchase price is allocated to land and the remaining 
$4 million is allocated to the building, furniture and fixtures. 
During the course of renovations over the 30-month substantial 
improvement period, the QOF spent $1 million replacing linens, 
mattresses and furniture, $500,000 on the purchase of new exercise 
equipment for a gym located in the hotel building, $1 million on 
renovations for a restaurant (including restaurant equipment) 
attached to the hotel, and $1.5 million on structural renovations to 
the hotel. The QOF chooses to apply paragraph (b)(4)(iii) of this 
section to determine whether the substantial improvement requirement 
in section 1400Z-2(d)(2)(D)(ii) is met.
    (ii) Analysis. In order for the hotel to be considered qualified 
opportunity zone business property, QOF A must substantially improve 
the hotel as the hotel had previously been placed in service in the 
qualified opportunity zone. (QOF A was not required to substantially 
improve the land on which the hotel was located pursuant to 
paragraph (b)(4)(iv) of this section.) Because the amount of basis 
allocated to the hotel was $4 million, QOF A must expend $4 million 
to improve the hotel within the 30-month substantial improvement 
period provided in section 1400Z-2(d)(2)(D)(ii). The new linens, 
mattresses and furniture, new exercise equipment, and new restaurant 
equipment all qualify as original use assets under section 1400Z-
2(d)(2)(D)(i)(II). QOF A also substantially improved the hotel, 
which was the asset that needed to be improved under section 1400Z-
2(d)(2)(D)(i)(II). QOF A chose, at the start of the 30-month period, 
to include the costs of the newly purchased assets that improve the 
functionality of the hotel to the basis of the hotel. Thus, the cost 
of these items is eligible to be added to the hotel's basis pursuant 
to paragraph (b)(4)(iii) of this section. Therefore, QOF A has met 
the substantial improvement requirement under section 1400Z-
2(d)(2)(D)(i)(II) by doubling its basis in the hotel and its 
fixtures within the 30-month substantial improvement period. The 
amounts spent replacing linens, mattresses, furniture, exercise 
equipment, and new restaurant equipment that were counted toward the 
substantial improvement requirement for the hotel are not considered 
original use assets for purposes of the 90-percent investment 
standard.
    (2) Example 2--(i) Purchase of unrelated property. The facts are 
the same as in paragraph (b)(4)(iii)(D)(1)(i) of this section, 
except that in addition to purchasing the

[[Page 1989]]

hotel and the related land, QOF A also purchases an apartment 
building one block away from the hotel for $10 million. The 
apartment building is located in the same qualified opportunity zone 
as the hotel.
    (ii) Analysis. QOF A may not include any improvements made to 
the apartment building, including purchased property that improves 
the functionality of the apartment building, to the basis of the 
hotel. QOF A may choose, under paragraph (b)(4)(iii) of this 
section, to include the purchased property that improves the 
functionality of the apartment building in the basis of the 
apartment building for purposes of the substantial improvement 
requirement under section 1400Z-2(d)(2)(D)(i)(II).

    (iv) Special rules for land and improvements on land--(A) Buildings 
located in a qualified opportunity zone. In accordance with the rules 
set forth in this paragraph (b)(4)(iv)(A), if an eligible entity 
purchases a building located on a parcel of land within the geographic 
borders of a qualified opportunity zone, for purposes of section 1400Z-
2(d)(2)(D)(ii), a substantial improvement to the building is measured 
by the eligible entity's additions to the basis of the building, as 
determined under section 1012.
    (B) Unimproved land. Unimproved land that is within a qualified 
opportunity zone and acquired by purchase in accordance with section 
1400Z-2(d)(2)(D)(i)(I) is not required to be substantially improved 
within the meaning of section 1400Z-2(d)(2)(D)(i)(II) and 
(d)(2)(D)(ii).
    (C) Exception for insubstantially improved land. Notwithstanding 
paragraph (b)(4)(iv)(B) of this section, if the land is unimproved or 
minimally improved and the eligible entity purchases the land with an 
expectation or an intention to not improve the land by more than an 
insubstantial amount within 30 months after the date of purchase, 
paragraph (b)(4)(iv)(B) of this section does not apply with respect to 
such land and such land is not considered qualified opportunity zone 
business property unless it is substantially improved within the 
meaning of sections 1400Z-2(d)(2)(D)(i)(II) and (d)(2)(D)(ii). In 
determining whether an eligible entity had an expectation or an 
intention to improve the land by more than an insubstantial amount, 
improvements to the land by the eligible entity (including grading, 
clearing of the land, remediation of the contaminated land, or 
acquisition of related qualified opportunity zone business property 
that facilitates the use of the land in a trade or business of the 
eligible entity) will be taken into account.
    (D) Remediation of contaminated land. Betterments to land within 
the meaning of Sec.  1.263(a)-3(j)(1)(i) may be added to the basis of 
the purchased land and included for purposes of section 1400Z-
2(d)(2)(D)(ii) if the betterments are paid for by the eligible entity.
    (E) Separate improvement to underlying land not required. In 
determining whether the substantial improvement test under section 
1400Z-2(d)(2)(D) has been met with respect to a building, there is no 
requirement that the eligible entity separately substantially improve 
the land upon which the building is located.
    (v) Aggregation of purchased buildings--(A) Substantial improvement 
requirement for eligible building group. For purposes of applying the 
substantial improvement requirement under sections 1400Z-
2(d)(2)(D)(i)(II) and 1400Z-2(d)(2)(D)(ii), an eligible entity may 
apply paragraph (b)(4)(v)(D) of this section with respect to two or 
more buildings located within a qualified opportunity zone or a single 
series of contiguous qualified opportunity zones, as described in 
paragraph (b)(4)(v)(B) or (C) of this section (eligible building 
group), respectively.
    (B) Eligible building group located entirely within parcel of land 
described in single deed. All buildings comprising an eligible building 
group may be treated as a single property as that term is used in 
section 1400Z-2(d)(2)(D)(ii) (single property), if each building 
comprising the eligible building group is located entirely within the 
geographic borders of a parcel of land described in a single deed.
    (C) Eligible building group spanning contiguous parcels of land 
described in separate deeds. An eligible entity may treat all buildings 
comprising an eligible building group located entirely within the 
geographic borders of contiguous parcels of land described in separate 
deeds as a single property to the extent each building is operated as 
part of one or more trades or businesses that--
    (1) Are operated exclusively by the eligible entity;
    (2) Share facilities or share significant centralized business 
elements, such as personnel, accounting, legal, manufacturing, 
purchasing, human resources, or information technology resources; and
    (3) Are operated in coordination with, or reliance upon, one or 
more of the trades or businesses (for example, supply chain 
interdependencies or mixed-use facilities).
    (D) Calculation of aggregate building basis and additions to basis 
of single property--(1) In general. For purposes of the substantial 
improvement requirement under section 1400Z-2(d)(2)(D)(ii), the amount 
of basis required to be added to the portion of an eligible building 
group treated as a single property equals the total amount of basis 
calculated by adding the basis of each building comprising the single 
property at the beginning of the 30-month period and additions to the 
basis of each building comprising the single property are aggregated to 
determine satisfaction of the substantial improvement requirement.
    (2) Aggregation of original use property that improves the 
functionality of single property. In applying paragraph (b)(4)(v)(D)(1) 
of this section, purchased property that would otherwise qualify as 
qualified opportunity zone business property may be taken into account 
in determining whether additions to the basis of a single property 
described in paragraph (b)(4)(v)(B) or (C) of this section satisfy the 
substantial improvement requirement under section 1400Z-2(d)(2)(D)(ii).
    (c) Tangible property leased by an eligible entity. In the case of 
tangible property with respect to which an eligible entity is a 
lessee--
    (1) Qualifying acquisition of possession. The tangible property 
must be acquired by the eligible entity under a lease entered into 
after December 31, 2017.
    (2) Arms-length terms--(i) General rule. The terms of the lease 
must be market rate (that is, the terms of the lease reflect common, 
arms-length market pricing in the locale that includes the qualified 
opportunity zone as determined under section 482 and all section 482 
regulations in this chapter) at the time that the lease was entered 
into.
    (ii) Rebuttable presumption regarding unrelated persons. There will 
be a rebuttable presumption that the terms of the lease were market 
rate for leases between persons not related within the meaning of 
section 1400Z-2(e)(2) (unrelated persons), and thus, the parties to the 
lease are not required to perform a section 482 analysis.
    (iii) Exception for state, local, and Indian tribal governments. 
For purposes of this paragraph (c)(2), tangible property acquired by 
lease from a state or local government, or an Indian tribal government, 
is not considered tangible property acquired by lease from a related 
person within the meaning of section 1400Z-2(e)(2) (related person).
    (3) Additional requirements for tangible property leased from a 
related person. If the lessor is a related person with respect to an 
eligible entity that is the lessee of tangible property, the 
requirements of paragraphs (c)(3)(i) and (ii) of this section, as 
applicable, must

[[Page 1990]]

be satisfied in order for the tangible property to be treated as 
qualified opportunity zone business property.
    (i) Prepayments of not more than one year. The lessee at no time 
makes any prepayment in connection with the lease relating to a period 
of use of the tangible property that exceeds 12 months.
    (ii) Purchase of other qualified opportunity zone business 
property. In the case of leased tangible property that is personal 
property, if the original use of the leased tangible personal property 
in a qualified opportunity zone (within the meaning of paragraph 
(c)(3)(iii) of this section) does not commence with the lessee, the 
property is not qualified opportunity zone business property unless, 
during the relevant testing period (as defined in paragraph (c)(3)(iv) 
of this section), the lessee becomes the owner of tangible property 
that is qualified opportunity zone business property having a value not 
less than the value of that leased tangible personal property. There 
must be substantial overlap of the qualified opportunity zone(s) in 
which the owner of the tangible property so acquired uses it and the 
qualified opportunity zone(s) in which that person uses the leased 
tangible personal property.
    (iii) Original use of leased tangible property--(A) In general. For 
purposes of paragraph (c)(3)(ii) of this section, the original use of 
leased tangible property in a qualified opportunity zone commences on 
the date any person first places the property in service in the 
qualified opportunity zone for purposes of depreciation (or first uses 
the property in the qualified opportunity zone in a manner that would 
allow depreciation or amortization if that person were the property's 
owner).
    (B) Used leased tangible property. Used leased tangible personal 
property can satisfy the original use requirement if the property has 
not been previously so used or placed in service in the qualified 
opportunity zone.
    (iv) Relevant testing period. For purposes of paragraph (c)(3)(ii) 
of this section, the relevant testing period is the period that begins 
on the date that the lessee receives possession under the lease of the 
leased tangible personal property and ends on the earlier of--
    (A) The date 30-months after the date the lessee receives 
possession of the leased tangible personal property under the lease; or
    (B) The last day of the term of the lease (within the meaning of 
Sec.  1.1400Z2(d)-1(b)(4)(iii)(D)).
    (4) Plan, intent, or expectation for purchases not for fair market 
value. In the case of real property that is leased by an eligible 
entity, if, at the time the lease is entered into, there was a plan, 
intent, or expectation for the real property to be purchased by the 
eligible entity for an amount of consideration other than the fair 
market value of the real property determined at the time of the 
purchase without regard to any prior lease payments, the leased real 
property is not qualified opportunity zone business property.
    (d) Holding period and use within a qualified opportunity zone of 
owned or leased tangible property--(1) In general. In the case of 
tangible property that is owned or leased by an eligible entity, during 
substantially all of the eligible entity's holding period for the 
tangible property, substantially all of the use of the tangible 
property must be in a qualified opportunity zone.
    (2) Valuation of owned and leased property. For purposes of the 70-
percent use test in paragraph (d)(4) of this section, the value of 
owned and leased property is required to be determined in accordance 
with the valuation methodologies provided in Sec.  1.1400Z2(d)-1(b), 
and such value in the case of leased tangible personal property is to 
be determined on the date the lessee receives possession of the 
tangible personal property under the lease.
    (3) Substantially all of an eligible entity's holding period for 
owned or leased tangible property--(i) In general. For purposes of 
determining whether the holding period requirement in paragraph (d)(1) 
of this section is satisfied, the term substantially all means at least 
90 percent. The holding period requirement is applied on a semiannual 
basis, based on the entire amount of time the eligible entity has owned 
or leased such property. Thus, on each semiannual testing date of the 
eligible entity, the tangible property satisfies the 90-percent 
qualified opportunity zone business property holding period requirement 
of section 1400Z-2(d)(2)(D)(i)(III) only if, during at least 90 percent 
of the period during which the QOF has owned or leased the property, 
the property has satisfied the 70-percent use test in paragraph (d)(4) 
of this section.
    (ii) Semiannual qualified opportunity zone business test. For 
purposes of determining satisfaction of the 90-percent qualified 
opportunity zone business property holding period test described in 
paragraph (d)(3)(i) of this section in the case of a QOF, the 
determination of whether property satisfies the 70-percent use test is 
made on a semiannual basis pursuant to section 1400Z-2(d)(1) and 
paragraph (d)(4) of this section.
    (4) Substantially all of the use of owned or leased tangible 
property in a qualified opportunity zone--(i) 70-percent use test. 
Tangible property used in a trade or business of an eligible entity 
satisfies the substantially all requirement of paragraph (d)(2)(i) of 
this section (that is, the 70-percent use test) if and only if the 
tangible property is qualified tangible property. Qualified tangible 
property is tangible property that satisfies the requirements of 
paragraph (d)(4)(ii), (iii) (subject to the limitation in paragraph 
(d)(4)(iv) of this section), or (v) of this section.
    (ii) Qualified tangible property. Tangible property held by a trade 
or business is qualified tangible property to the extent, based on the 
number of days between two consecutive semiannual testing dates, not 
less than 70 percent of the total utilization of the tangible property 
by the trade or business occurs at a location within the geographic 
borders of a qualified opportunity zone.
    (iii) Safe harbor for tangible property utilized in rendering 
services inside and outside of a qualified opportunity zone. Subject to 
the limitation described in paragraph (d)(4)(iv) of this section, 
tangible property utilized by a trade or business in rendering services 
both inside and outside of the geographic borders of a qualified 
opportunity zone may be treated as qualified tangible property if--
    (A) The tangible property utilized in rendering the service 
directly generates gross income for the trade or business both inside 
and outside of the geographic borders of a qualified opportunity zone;
    (B) The trade or business has an office or other facility located 
within the geographic borders of a qualified opportunity zone (QOZ 
office);
    (C) The tangible property is operated by employees of the trade or 
business who--
    (1) Regularly use a QOZ office of the trade or business in the 
course of carrying out their duties; and
    (2) Are managed directly, actively, and substantially on a day-to-
day basis by one or more employees of the trade or business who carry 
out their duties at a QOZ office; and
    (D) The tangible property is not operated exclusively outside of 
the geographic borders of a qualified opportunity zone for a period 
longer than 14 consecutive days for the generation of gross income for 
the trade or business.
    (iv) Limitation. For purposes of the 70-percent tangible property 
standard, the safe harbor provided in paragraph (d)(4)(iii) of this 
section may not be used

[[Page 1991]]

to treat more than 20 percent of the tangible property of the trade or 
business as qualified tangible property.
    (v) Safe harbor for tangible property owned by leasing businesses 
with QOZ offices. Tangible property of a trade or business, the 
employees of which use a QOZ office of the trade or business to 
regularly lease such tangible property to customers of the trade or 
business, may be treated as qualified tangible property if--
    (A) Consistent with the normal, usual, or customary conduct of the 
trade or business, when not subject to a lease to a customer of the 
trade or business, the tangible property is parked or otherwise stored 
at a QOZ office; and
    (B) No lease under which a customer of the trade or business 
acquires possession of the tangible property is for a duration 
(including extensions) longer than 30 consecutive days.
    (vi) Use of tangible property in one or more qualified opportunity 
zones. In accordance with paragraphs (d)(4)(ii) through (v) of this 
section, if qualified tangible property is utilized by the trade or 
business in one or more qualified opportunity zones, satisfaction of 
the 70-percent use test is determined by aggregating the number of days 
the tangible property is utilized by the trade or business in each 
qualified opportunity zone.
    (vii) Real property straddling a qualified opportunity zone. For 
purposes of satisfying the requirements in this paragraph (d), the 
rules of Sec.  1.1400Z2(d)-1(d)(3)(ix) apply to a QOF or qualified 
opportunity zone business for determining whether real property is 
situated in a qualified opportunity zone.
    (viii) Safe harbor for inventory in transit--(A) In general. In 
determining whether tangible property is used in a qualified 
opportunity zone for purposes of applying the 70-percent use test under 
paragraph (d)(4) of this section, inventory (including raw materials) 
of a trade or business does not fail to be used in a qualified 
opportunity zone solely because the inventory is in transit--
    (1) From a vendor to a facility of the trade or business that is in 
a qualified opportunity zone; or
    (2) From a facility of the trade or business that is in a qualified 
opportunity zone to customers of the trade or business that are not 
located in a qualified opportunity zone.
    (B) No effect from certain events in transit. The distance traveled 
by the inventory while it is in transit, or the fact that the inventory 
is briefly warehoused while in transit, does not affect the application 
of the safe harbor described in paragraph (d)(4)(viii) of this section.
    (e) Applicability dates--(1) In general. The provisions of this 
section are applicable for taxable years beginning after March 13, 
2020.
    (2) Prior periods. With respect to the portion of a taxpayer's 
first taxable year ending after December 21, 2017, that began on 
December 22, 2017, and for taxable years beginning after December 21, 
2017, and on or before March 13, 2020, a taxpayer may choose either--
    (i) To apply the section 1400Z-2 regulations, if applied in a 
consistent manner for all such taxable years; or
    (ii) To rely on the rules in proposed Sec.  1.1400Z2(d)-1 contained 
in the notice of proposed rulemaking (REG-115420-18) published on 
October 29, 2018, as amplified by the notice of proposed rulemaking 
(REG-120186-18) published on May 1, 2019, but only if applied in a 
consistent manner for all such taxable years.


Sec.  1.1400Z2(e)-1  [Added and Reserved]

0
Par. 8. Reserved Sec.  1.1400Z2(e)-1 is added.

0
Par. 9. Section 1.1400Z2(f)-1 is added to read as follows:


Sec.  1.1400Z2(f)-1  Administrative rules- penalties, anti-abuse, etc.

    (a) In general. Except as provided by Sec.  1.1400Z2(d)-
1(a)(2)(iv)(B) with respect to a taxpayer's first taxable year as a 
QOF, if a QOF fails to satisfy the 90-percent investment standard in 
section 1400Z-2(d)(1), then the QOF must pay the statutory penalty set 
forth in section 1400Z-2(f) for each month it fails to meet the 90-
percent investment standard.
    (b) Time period for a QOF to reinvest certain proceeds--(1) In 
general. If a QOF receives proceeds from the return of capital or the 
sale or disposition of some or all of its qualified opportunity zone 
property within the meaning of section 1400Z-2(d)(2)(A), and if the QOF 
reinvests some or all of the proceeds in qualified opportunity zone 
property by the last day of the 12-month period beginning on the date 
of the distribution, sale, or disposition, then the proceeds, to the 
extent that they are so reinvested, are treated as qualified 
opportunity zone property for purposes of the 90-percent investment 
standard in section 1400Z-2(d)(1), but only to the extent that prior to 
the reinvestment in qualified opportunity zone property the proceeds 
are continuously held in cash, cash equivalents, or debt instruments 
with a term of 18 months or less. If reinvestment of the proceeds is 
delayed by waiting for governmental action the application for which is 
complete, that delay does not cause a failure of the 12-month 
requirement in this paragraph (b).
    (2) Federally declared disasters. If the QOF's plan to reinvest 
some or all of the proceeds described in paragraph (b)(1) of this 
section in qualified opportunity zone property is delayed due to a 
federally declared disaster (as defined in section 165(i)(5)(A)), the 
QOF may receive up to an additional 12 months to reinvest such 
proceeds, provided that the QOF invests such proceeds in the manner 
originally intended before the disaster.
    (c) Anti-abuse rules--(1) General anti-abuse rule. Pursuant to 
section 1400Z-2(e)(4)(C), the rules of section 1400Z-2 and Sec. Sec.  
1.1400Z2(a)-1 through 1.1400Z2(d)-(2), 1.1400Z2(f)-1, 1.1502-14Z, and 
1.1504-3 must be applied in a manner consistent with the purposes of 
section 1400Z-2 and the section 1400Z-2 regulations (as defined in 
Sec.  1.1400Z2(a)-1(b)(41)). The purposes of section 1400Z-2 and the 
section 1400Z-2 regulations are to provide specified Federal income tax 
benefits to owners of QOFs to encourage the making of longer-term 
investments, through QOFs and qualified opportunity zone businesses, of 
new capital in one or more qualified opportunity zones and to increase 
the economic growth of such qualified opportunity zones. Accordingly, 
if a significant purpose of a transaction is to achieve a Federal 
income tax result that is inconsistent with the purposes of section 
1400Z-2 and the section 1400Z-2 regulations, a transaction (or series 
of transactions) will be recast or recharacterized for Federal tax 
purposes as appropriate to achieve tax results that are consistent with 
the purposes of section 1400Z-2 and the section 1400Z-2 regulations. 
This recasting and recharacterization may include, as appropriate, 
treating an investment as other than a qualifying investment. A 
determination of whether a Federal income tax result is inconsistent 
with the purposes of section 1400Z-2 and the section 1400Z-2 
regulations must be based on all facts and circumstances.
    (2) Special anti-abuse rule for partnerships--(i) In general. In 
addition to being subject to the general anti-abuse rule of paragraph 
(c)(1) of this section, the application of the rules of section 1400Z-2 
and Sec. Sec.  1.1400Z2(a)-1 through 1.1400Z2(d)-2, 1.1400Z2(f)-1, 
1.1502-14Z, and 1.1504-3 to partnerships is also subject to the special 
anti-abuse rule set forth in paragraph (c)(2)(ii) of this section.
    (ii) Special partnership anti-abuse rule. If a partnership is 
formed or availed of with a significant purpose of

[[Page 1992]]

avoiding the requirements of Sec.  1.1400Z2(a)-1(b)(11)(i)(B) that a 
gain be subject to Federal income tax in order to be an eligible gain, 
the partnership will be disregarded in whole or in part for purposes of 
Sec.  1.1400Z2(a)-1(b)(11)(i)(B) and (b)(11)(ix)(B) to prevent the 
creation of a qualifying investment by the partnership with respect to 
any partner or partners that would not otherwise satisfy such 
requirements.
    (3) Examples. The following examples illustrate the anti-abuse rule 
of paragraph (c) of this section.

    (i) Example 1--(A) Facts. Two nonresident alien individuals 
(collectively, the individuals) plan to sell stock at a gain of $50, 
to invest the amount of the resulting capital gain in a QOF, and to 
make a deferral election under section 1400Z-2(a). They make this 
election with the intent of holding the QOF investment for 10 years 
and then making an election to increase the qualifying basis to fair 
market value under section 1400Z-2(c). A gain on a sale of the stock 
by the individuals, however, would not be subject to Federal income 
tax, and so the gain would not support their making a deferral 
election as a result of the requirement in Sec.  1.1400Z2(a)-
1(b)(11)(i)(B). Instead of selling the stock themselves, the 
individuals form a domestic partnership with a significant purpose 
of using that partnership to make a deferral election with respect 
to the stock under the exception in Sec.  1.1400Z2(a)-
1(b)(11)(ix)(B). The individuals contribute their stock to the 
partnership in exchange for partnership interests, after which the 
partnership sells the stock and invests the $50 gain in a QOF. Had 
the partnership not made a deferral election, the individuals would 
not be subject to tax on their allocated portion of the 
partnership's recognized gain on the sale of the stock.
    (B) Analysis. Based on these facts, the partnership is formed 
and availed of with a significant purpose to avoid the requirements 
of Sec.  1.1400Z2(a)-1(b)(11)(i)(B). Thus, under paragraph (c)(2) of 
this section, the partnership is disregarded for purposes of 
applying Sec.  1.1400Z2(a)-1(b)(11)(ix)(B) to the $50 gain, and 
therefore the partnership's investment in the QOF is not a 
qualifying investment.
    (ii) Example 2--(A) Facts. The facts are the same as in 
paragraph (c)(3)(i)(A) of this section (Example 1), except the 
individuals contribute their stock to an existing partnership, the 
sole partners of which are U.S. citizens, with a significant purpose 
of the individuals' use of the partnership being to make an 
investment in a QOF and a deferral election under the Sec.  
1.1400Z2(a)-1(b)(11)(ix)(B) exception for partnerships. During the 
year, the partnership sells property it owned before the 
individuals' contribution, resulting in capital gain of $100, all of 
which is eligible to be invested in a QOF. It also sells the stock 
contributed by the individuals, resulting in $50 of capital gain. 
The partnership invests $150 in a QOF and makes the requisite gain 
deferral election.
    (B) Analysis. Based on these facts, the partnership is availed 
of by the individuals with a significant purpose to avoid the 
requirements of Sec.  1.1400Z2(a)-1(b)(11)(i)(B). Thus, under 
paragraph (c)(2) of this section, the partnership is disregarded for 
purposes of applying Sec.  1.1400Z2(a)-1(b)(11)(i)(B) and 
(b)(11)(ix)(B) with respect to the $50 capital gain from the sale of 
the individuals' contributed stock and that gain fails to be 
eligible gain. Under Sec.  1.1400Z2(a)-1(b), no section 1400Z-2(a) 
election is available for that gain and the partnership will have a 
mixed-funds investment, $100 of which is a qualifying investment and 
$50 of which is a non-qualifying investment.
    (iii) Example 3--(A) Facts. Entity C is a QOF that meets the 
requirements of section 1400Z-2(d)(1). Entity C owns qualified 
opportunity zone stock in a domestic corporation described in 
section 1400Z-2(d)(2)(B) (Corporation C), which operates a qualified 
opportunity zone business. Entity C also owns Corporation D stock, 
which is not qualified opportunity zone stock, which stock is less 
than 10% of the assets of Entity C. Under section 1400Z-2(e)(2), 
these stock holdings cause Entity C to be related to both 
Corporation C and Corporation D. On date 1, under section 1400Z-
2(e)(2), Individual S is not a related person with respect to Entity 
C, Corporation C, or Corporation D. On that date, Individual S sells 
tangible property to Corporation C for use in Corporation C's 
qualified opportunity zone business and sells a second asset to 
Corporation D. Both items sold were capital assets (as defined in 
section 1221). As a result, Individual S realizes gain of $100 from 
the sale to Corporation C and $75 from the sale to Corporation D. At 
the time of the sale Individual S has a plan or intent to invest 
$175 in Entity C and to make deferral elections under section 1400Z-
2(a)(1) with respect to the gain from the two sales. On date 2, for 
$175 Individual S acquired an eligible interest in Entity C, an 
acquisition that causes Individual S to become a related person with 
respect to Entity C within the meaning of section 1400Z-2(e)(2).
    (B) Analysis. Under paragraph (c)(1) of this section, Individual 
S's $175 gain is not an eligible gain and cannot be the subject a 
deferral election under section 1400Z-2(a)(1). The gain fails to 
satisfy Sec.  1.1400Z2a-1(b)(11)(i)(C) because of Individual S's 
plan to acquire sufficient equity in Entity C to become related to 
Corporations C and D. Moreover, for the same reason, the tangible 
property that Corporation C purchased from Individual S fails to 
satisfy the requirement that a purchase of qualified opportunity 
zone business property must be from an unrelated person. See 
sections 1400Z-2(d)(2)(D)(i)(I) and 179(d)(2)(A).
    (iv) Example 4--(A) Facts. Entity D is a QOF that meets the 
requirements of section 1400Z-2(d)(1). Entity D owns a majority 
qualified opportunity zone partnership interest in a domestic 
partnership, Partnership D described in section 1400Z-2(d)(2)(C). 
Entity D organized Partnership D for the purpose of being a 
qualified opportunity zone business. Partnership D acquires a tract 
of land located in a qualified opportunity zone. At the time of the 
acquisition of that land, there was no plan or intent to develop or 
otherwise utilize the land in a trade or business that would 
increase substantially the economic productivity of the land. 
Instead, there was a plan to pave the land for use as a parking lot. 
Partnership D planned to install a gate to the paved parking area, a 
small structure that would serve as an office for a parking 
attendant, and two self-pay stations for use by customers. The 
parking lot was not reasonably expected to expand significantly, and 
the initial small number of employees was not reasonably expected 
significantly to increase. A significant purpose for the acquisition 
of the land was to sell the land at a profit and to exclude any gain 
from appreciation by making an election under section 1400Z-2(c).
    (B) Analysis. Under paragraph (c)(1) of this section, the 
acquisition of the land is a transaction carried out to achieve a 
tax result that is inconsistent with the purposes of section 1400Z-2 
and the section 1400Z-2 regulations. Consequently, the land is not 
qualified opportunity zone business property and gain from the sale 
of the land will not be eligible to be excluded from gross income 
under section 1400Z-2(c). This recharacterization of the 
qualification of the land for Federal tax purposes is appropriate to 
ensure that the tax results of the transaction, including the status 
of Partnership D as a qualified opportunity zone business, are 
consistent with the purposes of section 1400Z-2 and the section 
1400Z-2 regulations. Partnership D fails to be a qualified 
opportunity zone business unless other assets that it owns or leases 
are qualified opportunity zone business property that satisfy 
section 1400Z-2(d)(3)(A)(i), and the other requirements of section 
1400Z-2 and the section 1400Z-2 regulations.
    (v) Example 5--(A) Facts. The facts are the same as in paragraph 
(c)(3)(iv) of this section, except that Partnership D, in year 1, 
acquired a tract of land located in a qualified opportunity zone 
that was previously used for hog and pig farming. On its Form 1065T 
the previous owner, also a partnership, properly described those 
activities with the principal business activity code 112210. During 
the several-year period ending on the date of the acquisition of the 
land, the value of the land had significantly increased and D 
projected the land to continue to increase in value by ten-fold 
during the following 10-year period. At the time of the acquisition, 
Partnership D intended to conduct sheep and goat farming activities 
on the land and, accordingly, planned to use principal business 
activity code 112400 on its Form 1065. According to its plan, 
Partnership D conducted sheep and goat farming activities on the 
land during the 10-year period beginning on the date of acquisition 
of the land. During the 10-year period, Partnership D made 
significant capital improvements to the land, including improvements 
to existing farm structures, construction of new farm structures, 
and installation of a new irrigation system. As expected, the value 
of the land substantially increased during the following decade. The 
owners' entire interest in Partnership D was a qualifying 
investment, and, after having held it for at least 10 years

[[Page 1993]]

the owners sold the entire interest at a large gain. As planned the 
owners made an election under section 1400Z-2(c) in order to avoid 
tax on the gain from the sale.
    (B) Analysis. The modification of the land to suit sheep and 
goat farming activity from its previous use of hog and pig farming 
and the significant capital improvements made to land, is a 
significant investment in the business activities on the land. Thus, 
Partnership D did not hold the land solely for speculative 
investment. As a result, under paragraph (c)(1) of this section, the 
acquisition of the land, the activities conducted on the land, the 
capital improvements made to the land, and the later disposition of 
the land for a significant profit are not inconsistent with the 
purposes of section 1400Z-2 and the section 1400Z-2 regulations.
    (vi) Example 6--(A) Facts. Individuals intend to sell stock at a 
capital gain and invest the resulting gain in a QOF pursuant to a 
deferral election under section 1400Z-2(a). The individuals form 
Entity F and file Form 8996 certifying that Entity F is a QOF 
organized for the purpose of investing in qualified opportunity zone 
property. Individuals have no intention of investing in qualified 
opportunity zone property. Instead individuals intend to invest in 
property other than qualified opportunity zone property hoping that 
the property will appreciate substantially in value and the 
individuals will be able to exclude any appreciation on their 
investment from gross income by making an election under section 
1400Z-2(c). Each year Entity F files Form 8996 and pays the 
applicable penalty under section 1400Z-2(f). After holding their 
interests in Entity F for 10 years, individuals sell their interest 
in Entity F to an unrelated third party for a substantial gain and 
make an election to exclude the appreciation on their investment 
under section 1400Z-2(c).
    (B) Analysis. A significant purpose of the transaction is to 
achieve a tax result that is inconsistent with the purposes of 
section 1400Z-2 and the section 1400Z-2 regulations, and the 
transaction will be recast and recharacterized for Federal tax 
purposes so that Entity F is not a QOF and the individuals are not 
eligible for the elections under sections 1400Z-2(a) and (c).
    (vii) Example 7--(A) Facts. Entity E treats itself as a QOF that 
meets the requirements of section 1400Z-2(d)(1). Entity E owns all 
of the stock in a domestic corporation, Corporation E, and Entity E 
treats this stock as qualified opportunity zone stock. Corporation E 
uses the majority of the cash invested by Entity E to purchase gold 
bars from unrelated parties within the meaning of section 1400Z-
2(e)(2). The aggregate value of the gold bars is $1000. Corporation 
E rents a safe deposit box in a qualified opportunity zone and hires 
one employee to manage the purchase and sale of the gold bars. Each 
year Corporation E purchases a small number of additional gold bars 
and sells to customers a portion of the gold bars on hand. The 
aggregate value of both the purchases and sales approximates half 
the value of the bars held at the beginning of the year. Corporation 
E seeks to treat the gold bars as qualified opportunity zone 
business property within the meaning of section 1400Z-2(d)(3). At 
the time that Corporation E began the gold bar business, it did not 
reasonably expect the business to expand significantly, nor was the 
number of employees reasonably expected to increase. Gold, however, 
was reasonably expected to appreciate. Ten years after the formation 
of Entity E, the investors in Entity E sell all of their interests 
in the entity and seek to make an election under section 1400Z-2(c) 
to exclude any gain from appreciation.
    (B) Analysis. Under paragraph (c)(1) of this section, a 
significant purpose of Corporation E's activities is to achieve a 
tax result that is inconsistent with the purposes of section 1400Z-2 
and the section 1400Z-2 regulations. The gold bar business carried 
out by Corporation E was merely speculative in nature and was not 
expected to increase economic activity in the subject qualified 
opportunity zone in a manner consistent with the purposes of section 
1400Z-2 and the section 1400Z-2 regulations. As a result, 
Corporation E's activities are carried on to achieve tax results 
that are inconsistent with the purposes of section 1400Z-2 and the 
section 1400Z-2 regulations. Consequently, the gold bars are not 
qualified opportunity zone property. Corporation E fails to be a 
qualified opportunity zone business unless other assets that it owns 
or leases are qualified opportunity zone business property that 
satisfy section 1400Z-2(d)(3)(A)(i) (along with other requirements). 
If Corporation E fails to be a qualified opportunity zone business, 
Corporation E's stock fails to be qualified opportunity zone 
property in the hands of Entity E.

    (d) Applicability date--(1) In general. The provisions of this 
section are applicable for taxable years beginning after March 13, 
2020.
    (2) Prior periods. With respect to the portion of a taxpayer's 
first taxable year ending after December 21, 2017, that began on 
December March 13, 2020, a taxpayer may choose either--
    (i) To apply the section 1400Z-2 regulations, if applied in a 
consistent manner for all such taxable years, or
    (ii) To rely on the rules in proposed Sec.  1.1400Z2(f)-1 contained 
in the notice of proposed rulemaking (REG-115420-18) published on 
October 29, 2018, as amplified by the notice of proposed rulemaking 
(REG-120186-18) published on May 1, 2019, but only if applied in a 
consistent manner for all such taxable years.

0
Par. 10. Section 1.1502-14Z is added to read as follows:


Sec.  1.1502-14Z  Application of opportunity zone rules to members of a 
consolidated group.

    (a) Scope and definitions--(1) Scope. This section provides rules 
regarding the Federal income tax treatment of QOFs owned by members of 
a consolidated group (as defined in Sec.  1.1502-1(b) and (h), 
respectively). Rules in the section 1400Z-2 regulations (as defined in 
Sec.  1.1400Z2(a)-1(b)(41)) apply to consolidated groups except as 
modified in this section. Paragraph (b) of this section generally 
provides rules regarding the effects of an election under Sec.  1.1504-
3(b)(2) to treat a subsidiary QOF C corporation as a member of a 
consolidated group. Paragraph (c) of this section provides rules 
regarding qualifying investments made by members of a consolidated 
group (including an election to treat the investment by one member as a 
qualifying investment by another member) and the application of Sec.  
1.1502-13 to intercompany transfers of a qualifying investment. 
Paragraph (d) of this section provides coordinating rules for basis 
adjustments within a consolidated group. Paragraph (e) of this section 
provides coordinating rules for Sec.  1.1502-36(d). Paragraph (f) of 
this section provides elective transition relief to taxpayers that 
consolidated a subsidiary QOF C corporation prior to May 1, 2019. 
Paragraph (g) of this section provides rules regarding the consequences 
of a deconsolidation of a QOF C corporation. Paragraph (h) of this 
section provides instructions for making the elections provided by 
paragraphs (c) and (f) of this section. Paragraph (i) of this section 
is reserved. Paragraph (j) of this section provides examples. Paragraph 
(k) of this section provides the applicability dates.
    (2) Definitions--(i) In general. The definitions provided in 
Sec. Sec.  1.1400Z2(a)-1(b) and 1.1400Z2(d)-1 apply for purposes of 
this section.
    (ii) Definitions for consolidated groups--(A) Day one. The term day 
one means the date members of the consolidated group formed or acquired 
section 1504 control of the pre-existing QOF sub. If a pre-existing QOF 
sub was a member of the consolidated group prior to becoming a QOF C 
corporation, day one is the first day of the first month in which the 
member self-certified as, or is treated as, a QOF C corporation, 
whichever is earlier.
    (B) Election date. The term election date means the date on which 
an election under paragraph (c) or (f) of this section is made.
    (C) Pre-existing QOF sub. The term pre-existing QOF sub means a 
subsidiary QOF C corporation that meets the affiliation requirements in 
section 1504 (without regard to Sec.  1.1504-3(b)(1)) as of May 1, 
2019.
    (D) QOF investor member. The term QOF investor member means any 
member holding a qualifying investment in the QOF member.
    (E) QOF member. The term QOF member means a subsidiary QOF C

[[Page 1994]]

corporation that is treated as a member of a consolidated group 
pursuant to an election in Sec.  1.1504-3(b)(2).
    (F) QOF member stock. The term QOF member stock means the QOF stock 
of a QOF member.
    (G) QOF SAG. The term QOF SAG means, with respect to a QOF member, 
the affiliated group that would be determined under section 1504(a) if 
the QOF member were the common parent.
    (H) Subsidiary QOF C corporation. The term subsidiary QOF C 
corporation means a QOF C corporation that meets the requirements to be 
a member of an affiliated group (as defined in section 1504(a)(1), and 
without regard to Sec.  1.1504-3(b)(1)) other than the common parent of 
such consolidated group.
    (b) Subsidiary QOF C corporation treated as member of the 
consolidated group--(1) Effects of election to treat a subsidiary QOF C 
corporation as a member--(i) Determining whether a distribution is an 
inclusion event. A distribution of property with respect to qualifying 
QOF stock by a QOF member to a QOF investor member is an inclusion 
event to the extent the distribution would create or increase an excess 
loss account (ELA) in the qualifying QOF stock, without regard to any 
inclusion resulting from application of this paragraph (b)(1)(i). 
Solely for purposes of determining whether a distribution creates or 
increases an ELA during a taxable year, investment adjustments 
pertaining to a distribution on qualifying QOF stock by a QOF member 
are made after all other investment adjustments under Sec.  1.1502-32 
for that year.
    (ii) Determining the amount of deferred gain includible by the QOF 
investor member. The amount of gain included in gross income of a QOF 
investor member under section 1400Z-2(a)(1)(B) on a date described in 
Sec.  1.1400Z2(b)-1(b) (modified by paragraph (c)(3) of this section, 
as applicable) is determined under this paragraph (b)(1)(ii). The 
amount of gain included in gross income of the QOF investor member is 
the lesser of:
    (A) The product of:
    (1) The percentage of the qualifying investment that gave rise to 
the inclusion event; and
    (2) The remaining deferred gain (see Sec.  1.1400Z2(a)-1(b)(40)), 
less any basis adjustments pursuant to section 1400Z-2(b)(2)(B)(iii) 
and (iv); or
    (B) The gain that would be recognized on a fully taxable 
disposition of the qualifying investment that gave rise to the 
inclusion event.
    (iii) Application of ELA rules on the disposition of QOF member 
stock. When a QOF investor member disposes of a share of qualifying QOF 
member stock, any ELA in the share is taken into account as income or 
gain from the disposition under Sec.  1.1502-19(b)(1) before the basis 
of the share is increased under section 1400Z-2(c), if applicable. See 
paragraph (g)(3)(i) of this section for the general rule regarding the 
treatment of an ELA upon the deconsolidation of a QOF member.
    (iv) Transactions between the QOF member and other members of the 
consolidated group--(A) In general. This paragraph (b)(1)(iv) governs 
transactions between a member of the QOF SAG and other members of the 
consolidated group.
    (B) Sale or exchange of property. A sale or exchange of property 
between a member of the QOF SAG and a member of the consolidated group 
that is not a member of such QOF SAG is not treated as an intercompany 
transaction (as defined in Sec.  1.1502-13(b)(1)) and is not subject to 
the rules in Sec.  1.1502-13. In contrast, a sale or exchange of 
property between members of the QOF SAG is an intercompany transaction 
that is subject to the rules in Sec.  1.1502-13.
    (C) Other transactions. Any transaction between a member of the QOF 
SAG and a member of the consolidated group that is not a member of such 
QOF SAG that is not a sale or exchange of property is an intercompany 
transaction subject to the rules in Sec.  1.1502-13.
    (v) Separate-entity application of QOF qualifying rules to QOF 
member. A consolidated group is not treated as a single entity for 
purposes of determining whether a QOF member or a qualified opportunity 
zone business that is a consolidated group member satisfies the 
investment standard rules in section 1400Z-2(d) and (f) and Sec. Sec.  
1.1400Z2(d)-1 and 1.1400Z2(f)-1; instead, the rules in this paragraph 
(b)(1)(v) apply on a separate-entity basis. Therefore, for example, the 
QOF member's satisfaction of the requirements under section 1400Z-2(d) 
is determined by taking into account only property (including qualified 
opportunity zone stock or qualified opportunity zone partnership 
interests) held by the QOF member, without regard to property 
transferred by the QOF member to other members of the consolidated 
group.
    (2) Anti-avoidance rule. The purposes of section 1400Z-2 and the 
section 1400Z-2 regulations are to provide specified tax benefits to 
owners of QOFs to encourage the making of longer-term investments, 
through QOFs and qualified opportunity zone businesses, of new capital 
in one or more qualified opportunity zones and to increase the economic 
growth of such qualified opportunity zones. If a transaction is engaged 
in or structured with a view to avoid the application of the rules of 
section 1400Z-2, the section 1400Z-2 regulations, or the regulations in 
this part under section 1502 of the Code (including this section), 
appropriate adjustments will be made to carry out the purposes of 
section 1400Z-2 and the section 1400Z-2 regulations. For example, if a 
consolidated group engages in a restructuring (such as a distribution 
described in section 355) with a view to using stock basis adjustments 
under Sec.  1.1502-32 resulting from increases in the basis of stock 
under section 1400Z-2(b) in a sale or exchange transaction without 
disposing of any part of the consolidated group's direct ownership of 
the relevant qualifying investment, the transaction will be treated as 
an inclusion event with regard to an appropriate amount of deferred 
gain.
    (c) Qualifying investments by members of a consolidated group--(1) 
In general. Except as otherwise provided in this section or in Sec.  
1.1400Z2(b)-1 (see, for example, Sec.  1.1400Z2(b)-1(c)(9)(i)(B)(1)), 
section 1400Z-2 applies separately to each member of a consolidated 
group. Therefore, for example, the same member of the consolidated 
group generally must both engage in the sale of a capital asset giving 
rise to eligible gain and timely invest an amount equal to some or all 
of such gain in a QOF (as provided in section 1400Z-2(a)(1)) in order 
to qualify for deferral of such gain under section 1400Z-2.
    (2) Election to treat investment of one member as a qualifying 
investment by another member--(i) Availability of election. If members 
of a consolidated group satisfy the requirements of this paragraph 
(c)(2), the consolidated group may elect to treat the investment by one 
member as a qualifying investment by another member. The election 
provided by this paragraph (c)(2) is available when a member of a 
consolidated group (M1) has eligible gain and a second member (M2) 
makes an investment in a QOF that would be a qualifying investment if 
M1, rather than M2, had made the investment. For example, if M1 has 
$100x of eligible gain but M2 has none, and M2 makes a $120x investment 
in a QOF C corporation, only $100x of M2's investment in the QOF C 
corporation is eligible for the election under this paragraph (c)(2). 
See paragraph (h)(2) of this section for the form and manner of making 
this election. If M2 has its own eligible gain, M2 may make a 
qualifying investment on its own behalf and defer such eligible

[[Page 1995]]

gain under section 1400Z-2(a)(1)(A) and Sec.  1.1400Z2(a)-1.
    (ii) Effect of election. If a consolidated group makes an election 
under this paragraph (c)(2), then M1 is treated as having made the 
investment in the QOF that is actually made by M2. M1 is then treated 
as having immediately sold such investment to M2 for fair market value. 
The deemed sale by M1 is subject to the rules in paragraph (c)(3) of 
this section. The consolidated group must treat the deemed investment 
by M1 and the deemed sale by M1 to M2 as having occurred for all 
Federal income tax purposes.
    (3) Intercompany transfers of a qualifying investment--(i) In 
general. Except as otherwise provided in this paragraph (c)(3), when 
one member (S) transfers its qualifying investment to another member 
(B), the transaction is not treated as an intercompany transaction 
within the meaning of Sec.  1.1502-13(b)(1) for purposes of applying 
the rules of section 1400Z-2 and the section 1400Z-2 regulations. 
Therefore, Sec.  1.1502-13(c) does not apply to treat S and B as 
divisions of a single entity for purposes of section 1400Z-2. For 
example, if S transfers its qualifying investment to B in a section 351 
transaction, the transfer is an inclusion event for S under Sec.  
1.1400Z2(b)-1(c). In addition, because the transfer is not an 
intercompany transaction for purposes of section 1400Z-2, Sec.  1.1502-
13 does not apply to continue S's deferral under Sec.  1.1400Z2(b)-
1(b).
    (ii) Application of Sec.  1.1502-13 to fully taxable intercompany 
transfers of a qualifying investment--(A) Applicable transactions. 
Notwithstanding paragraph (c)(3)(i) of this section, if S transfers its 
qualifying investment to B in a fully taxable transaction, the 
transaction is treated as an intercompany transaction, and Sec.  
1.1502-13(c) applies to treat S and B as divisions of a single entity 
for purposes of applying section 1400Z-2.
    (B) Treatment of S's intercompany gain on its qualifying 
investment. If a transaction is described in paragraph (c)(3)(ii)(A) of 
this section, Sec.  1.1502-13(c)(6)(ii) is inapplicable in determining 
the excludability of S's gain (or the treatment of such gain as tax-
exempt income) on the application of section 1400Z-2(b) and (c) to S 
and B as a single entity. Thus, S's gain on the qualifying investment 
(including the amount includible under Sec.  1.1400Z2(b)-1(e)) may be 
redetermined to be excluded from gross income (or treated as tax-exempt 
income), as appropriate, to achieve single-entity treatment between S 
and B with regard to the ownership and disposal of the qualifying 
investment. To qualify for benefits under section 1400Z-2, S and B must 
otherwise satisfy the requirements of section 1400Z-2. See also Sec.  
1.1502-13(j)(4) (concerning multiple or successive intercompany 
transactions).
    (C) Investment adjustments and adjustments to earnings and profits. 
Income of S excluded under section 1400Z-2 by application of paragraphs 
(c)(3)(ii)(A) and (B) of this section and Sec.  1.1502-13 results in 
adjustments to S's earnings and profits and is treated as tax-exempt 
income to S for purposes of Sec.  1.1502-32(b)(2)(ii).
    (D) Election under section 1400Z-2(c). To the extent paragraph 
(c)(3)(ii)(A) of this section applies to S's transfer of its qualifying 
investment to B, B (and not S) is entitled to make the election under 
section 1400Z-2(c) at the time when, treating S and B as divisions of a 
single entity, the single entity would be entitled to make such an 
election. For example, pursuant to Sec.  1.1502-13(c)(1)(ii), B takes 
S's holding period into account in determining whether B is treated as 
holding the transferred qualifying investment for 10 years. In 
addition, the attributes of S's intercompany item on the transfer of 
the qualifying investment may be redetermined based on B's election.
    (4) Intercompany transfer as qualifying investment in a QOF member. 
A transfer by a consolidated group member with an eligible gain to a 
QOF member before January 1, 2027, is not treated as an intercompany 
transaction within the meaning of Sec.  1.1502-13 and may constitute a 
qualifying investment. But see Sec.  1.1504-3(b)(2) regarding 
conditions for consolidating a QOF C corporation.
    (5) Intercompany gain as eligible gain. When S sells property to B, 
Sec.  1.1502-13 applies to determine if, and when, S's intercompany 
gain and B's corresponding gain constitute eligible gain. S's gain and 
B's gain are treated as eligible gain only to the extent such gain 
would be eligible gain if S and B were divisions of a single entity. 
For example, if S sells a piece of property to B at a gain, B 
subsequently sells that property to an unrelated party at a further 
gain, and the gains are treated as capital gain under Sec.  1.1502-
13(c)(1) and (4), then both S's gain and B's gain are eligible gains at 
the time B sells the property to the unrelated party. In contrast, if S 
sells a piece of property to B at a loss, and B subsequently sells that 
property to an unrelated party at a gain, then B's corresponding gain 
on the property is eligible gain only to the extent that S and B, if 
treated as divisions of a single entity, would have eligible gain on 
the sale of property to the unrelated party. See Sec.  1.1502-13(a)(1).
    (d) Tiering-up of investment adjustments provided by section 1400Z-
2. Basis increases in a qualifying investment in a QOF under sections 
1400Z-2(b)(2)(B)(iii), 1400Z-2(b)(2)(B)(iv), and 1400Z-2(c) are treated 
as satisfying the requirements of Sec.  1.1502-32(b)(3)(ii)(A) and thus 
qualify as tax-exempt income to the QOF owner. Therefore, if the QOF 
owner is a member of a consolidated group and is owned by other members 
of the same consolidated group (upper-tier members), the upper-tier 
members increase their bases in the shares of the QOF owner under Sec.  
1.1502-32(b)(2)(ii). However, there is no basis adjustment under Sec.  
1.1502-32(b)(2)(ii) or (iii) in shares of upper-tier members with 
regard to a basis adjustment under section 1400Z-2(c) and Sec.  
1.1400Z2(c)-1 unless and until the basis of the qualifying investment 
is adjusted to its fair market value, as provided in section 1400Z-2(c) 
and Sec.  1.1400Z2(c)-1.
    (e) Application of Sec.  1.1502-36(d). This paragraph (e) clarifies 
how Sec.  1.1502-36(d) applies if a member (M) transfers a loss share 
of another member (S) that is a QOF owner that owns a qualifying 
investment. To determine S's attribute reduction amount under Sec.  
1.1502-36(d)(3), S's basis in its qualifying investment is included in 
S's net inside attribute amount to compute S's aggregate inside loss 
under Sec.  1.1502-36(d)(3)(iii)(A). However, S's basis in the 
qualifying investment is not included in S's Category D attributes 
available for attribute reduction under Sec.  1.1502-36(d)(4). Thus, 
S's basis in the qualifying investment cannot be reduced under Sec.  
1.1502-36(d). If S's attribute reduction amount exceeds S's attributes 
available for reduction, then to the extent of the lesser of S's basis 
in the qualifying investment or the remaining attribute reduction 
amount, the common parent is treated as making the election under Sec.  
1.1502-36(d)(6) to reduce M's basis in the transferred loss S shares.
    (f) Transition relief--(1) Overview. This paragraph (f) provides 
options for elective relief to pre-existing QOF subs. An election under 
this paragraph (f) is made in the manner provided in paragraph (h)(3) 
of this section. If a timely election under this paragraph (f) is not 
made, the pre-existing QOF sub is treated as deconsolidating on March 
13, 2020.
    (2) Reclassification election--(i) In general. A consolidated group 
may make one of the alternative, irrevocable elections provided in 
paragraphs (f)(2)(ii) through (iv) of this section for

[[Page 1996]]

its pre-existing QOF subs. All elective relief provided in this 
paragraph (f)(2) is effective on day one.
    (ii) Treatment as a QOF partnership--(A) Election. A consolidated 
group may elect to treat certain pre-existing QOF subs as QOF 
partnerships (electing QOF partnership). To be eligible for the 
election in this paragraph (f)(2)(ii)(A), a pre-existing QOF sub must 
have converted to an entity treated as a partnership for Federal income 
tax purposes as of the election date.
    (B) Effect of the QOF partnership election. As a result of making 
the election under this paragraph (f)(2)(ii), the pre-existing QOF sub 
is treated as a QOF partnership from day one. Consequently, the 
consolidated group must file amended or superseding returns, as 
applicable, to account for the electing QOF partnership's income, gain, 
deduction, and loss; the electing QOF partnership also must file its 
own partnership returns for taxable periods beginning on day one, as 
applicable. The electing QOF partnership must include its self-
certification under Sec.  1.1400Z2(d)-1(a) with its own returns, and 
the self-certification will be treated as timely so long as the 
consolidated group filed a timely self-certification under Sec.  
1.1400Z2(d)-1(a) for the pre-existing QOF sub. In addition, appropriate 
adjustments must be made to account for the change in status of the 
electing QOF partnership from day one, including modifications to 
investment adjustments to the basis in members' stock made under Sec.  
1.1502-32 and adjustments to members' earnings and profits made under 
Sec.  1.1502-33.
    (C) Pre-existing QOF sub with single owner. If a pre-existing QOF 
sub is wholly owned by one member of a consolidated group, then for 
purposes of making the election under this paragraph (f)(2)(ii), the 
electing QOF partnership is deemed to have had a nominal partner from 
day one until the date the electing QOF partnership is treated as a 
partnership for Federal income tax purposes without regard to this 
paragraph (f)(2)(ii).
    (D) Example. The following example illustrates the election under 
this paragraph (f)(2)(ii).

    (1) Facts. P, the common parent of a consolidated group (P 
group), wholly owns M1 and M2. On July 1, 2018, M1 and M2 each sell 
an asset to an unrelated party and realize $70x and $30x of eligible 
gain, respectively. On August 13, 2018, M1 and M2 form Q12 (a QOF C 
corporation that was formed as a corporation under state law). Also 
on August 13, 2018, M1 and M2 contribute $70x and $30x, 
respectively, to Q12 in exchange for stock of Q12 and properly elect 
to defer their respective eligible gains under section 1400Z-2(a) 
and Sec.  1.1400Z2(a)-1. The P group also makes a timely self-
certification under Sec.  1.1400Z2(d)-(1)(a) for Q12. Following 
March 13, 2020, the P group intends to timely elect under this 
paragraph (f)(2)(ii) to treat Q12 as a QOF partnership.
    (2) Analysis--(i) Eligibility to elect. For the P group to elect 
to treat Q12 as a QOF partnership under this paragraph (f)(2)(ii), 
by the date of the election, Q12 must either convert to a state law 
partnership or another entity treated as a partnership for Federal 
income tax purposes.
    (ii) Consequences of the election. As a result of making the 
election under this paragraph (f)(2)(ii), Q12 is treated as a QOF 
partnership from August 13, 2018 (day one). The P group must file 
amended or superseding returns, as applicable and as necessary, to 
account for Q12's income, gain, deduction, and loss. In addition, 
Q12 must file its own returns for the taxable period beginning on 
August 13, 2018, as applicable. The returns must be filed within the 
time frame provided in paragraph (h)(3)(iii) of this section. 
Finally, because the P group filed a timely self-certification under 
Sec.  1.1400Z2(d)-(1)(a) for Q12 as a QOF C corporation, Q12's self-
certification as a QOF partnership would be is considered timely 
filed.
    (3) Deemed nominal partner--(i) Facts. The facts are the same as 
paragraph (f)(2)(iii)(D)(1) of this section, except that on July 1, 
2018, only M1 sells an asset to an unrelated party and realizes $70x 
of eligible gain. On August 13, 2018, M1 contributes cash of $70x to 
Q12 in exchange for stock of Q12 and properly elects to defer the 
eligible gain under section 1400Z-2(a) and Sec.  1.1400Z2(a)-1. As 
of the date the election is made to treat Q12 as a partnership from 
day one, a second party invests in Q12, and Q12 is an entity treated 
as a partnership for Federal income tax purposes.
    (ii) Analysis. The analysis is generally the same as in 
paragraph (f)(2)(iii)(D)(2) of this section. In addition, because 
Q12 is wholly owned by M1, solely for purposes of treating Q12 as a 
QOF partnership from August 13, 2018, Q12 is deemed to have a 
nominal partner from August 13, 2018 until the election date or the 
date Q12 qualifies as a partnership, if earlier.

    (iii) Treatment as a non-member QOF C corporation--(A) Election. A 
consolidated group may elect to treat the pre-existing QOF sub as a QOF 
C corporation that is not a member of the consolidated group.
    (B) Effect of the non-member QOF C corporation election. As a 
result of making the election under this paragraph (f)(2)(iii), the 
pre-existing QOF sub is treated as not being a member of the 
consolidated group from day one. Consequently, the consolidated group 
must file amended or superseding returns, as applicable, to exclude all 
of the pre-existing QOF sub's income, gain, deduction, and loss from 
the consolidated returns; the pre-existing QOF sub also must file its 
own returns for taxable periods beginning on day one, as applicable. In 
addition, all adjustments resulting from the pre-existing QOF sub's 
operations must be eliminated from the consolidated group, including 
investment adjustments made under Sec.  1.1502-32 to basis in members' 
stock (as well as stock in the pre-existing QOF sub) and adjustments 
made under Sec.  1.1502-33 to members' earnings and profits.
    (iv) Treatment as a non-QOF C corporation--(A) Election. A 
consolidated group may elect to treat a pre-existing QOF sub as if it 
never self-certified to be a QOF pursuant to Sec.  1.1400Z2(d)-1.
    (B) Effect of the non-QOF C corporation election. As a result of 
making the election under this paragraph (f)(2)(iv), the pre-existing 
QOF sub is treated from day one as a member of the consolidated group 
and not as a QOF. Therefore, section 1400Z-2 is not applicable, and 
amended returns or superseding returns must be filed, as applicable, to 
account for the eligible gain that was invested in the pre-existing QOF 
sub. In addition, appropriate adjustments must be made to account for 
the non-applicability of section 1400Z-2, including adjustments to 
members' stock basis and earnings and profits under Sec. Sec.  1.1502-
32 and 1.1502-33, respectively.
    (3) Election to continue treating pre-existing QOF sub as a member 
of the consolidated group--(i) Election. A consolidated group may elect 
to have a pre-existing QOF sub retain its QOF status and remain a 
member of the consolidated group.
    (ii) Effects of electing to remain a QOF and a member of the 
consolidated group. As a result of making the election under this 
paragraph (f)(3), the conditions and effects provided in Sec.  1.1504-
3(b)(2) and paragraph (b)(1) of this section will apply to the pre-
existing QOF sub and the consolidated group as of the effective date of 
this election. See paragraph (h)(1) of this section for the effective 
date of this election, and see paragraph (h)(3)(iii) of this section 
regarding the timing for meeting the requirements in Sec.  1.1504-
3(b)(2)(ii).
    (g) Deconsolidation rules--(1) In general. This paragraph (g) 
provides rules applicable on any deconsolidation of a QOF C corporation 
(deconsolidating QOF).
    (2) Deconsolidation and inclusion event. A deconsolidation event is 
not an inclusion event unless the deconsolidation is the result of an 
actual transfer of the QOF member stock or a worthlessness event within 
the meaning of Sec.  1.1502-80(c). For example, when a consolidated 
group fails to meet the

[[Page 1997]]

conditions in Sec.  1.1504-3(b)(2) of this section and causes a QOF 
member to deconsolidate, the deconsolidation event is not an inclusion 
event solely as a result of the consolidated group's failure to meet 
the requirements in Sec.  1.1504-3(b)(2) of this section.
    (3) Basis in the deconsolidating QOF at time of deconsolidation--
(i) ELA in a deconsolidating QOF. Any ELA in stock of the 
deconsolidating QOF at the time of the deconsolidation is taken into 
account under the rules of Sec.  1.1502-19. See paragraph (b)(1)(iii) 
of this section for rules coordinating the application of section 
1400Z-2(c) with Sec.  1.1502-19.
    (ii) Positive basis in the deconsolidating QOF resulting from Sec.  
1.1502-32. Consolidated group members retain any positive basis in the 
deconsolidating QOF resulting from investment adjustments under Sec.  
1.1502-32 following its deconsolidation. However, following the 
deconsolidation, for purposes of determining the amount includible 
under Sec.  1.1400Z2(b)-1(e), the amount of basis referred to in 
section 1400Z-2(b)(2)(A)(ii) is computed by applying only those rules 
applicable to corporations that do not file a consolidated return (that 
is, the basis rules under subchapter C and section 1400Z-2). Therefore, 
any positive basis resulting from Sec.  1.1502-32 adjustments is not 
taken into account in computing the includible amount under Sec.  
1.1400Z2(b)-1(e).
    (4) Deconsolidating QOF's earnings and profits--(i) Deconsolidation 
on or before December 31, 2026. Notwithstanding Sec.  1.1502-33(e)(1), 
if a deconsolidating QOF deconsolidates before December 31, 2026, the 
deconsolidating QOF retains its earnings and profits under this 
paragraph (g)(4)(i). Any earnings and profits of the deconsolidating 
QOF that were taken into account by any other members under Sec.  
1.1502-33 are eliminated from those members as of the end of the day on 
which the deconsolidating QOF deconsolidates.
    (ii) Deconsolidation after December 31, 2026. If the 
deconsolidating QOF deconsolidates after December 31, 2026, the rules 
under Sec.  1.1502-33(e) apply.
    (5) Consequences under Sec.  1.1502-36. See Sec.  1.1502-
36(f)(10)(i)(B) for the treatment of a deconsolidation as a transfer of 
all of the stock in the deconsolidating member held by other members of 
the consolidated group.
    (h) Form and manner of making an election under this section--(1) 
In general. The elections provided in this section are irrevocable. The 
information required for each election is provided in this paragraph 
(h). A reclassification election under paragraph (f)(2) of this section 
is effective as of day one. All other elections are effective on the 
election date.
    (2) Election under paragraph (c)(2) of this section to treat 
investment by M2 as qualifying investment by M1--(i) Form of election. 
The election under paragraph (c)(2) of this section must be made in the 
form of a statement titled ``THIS IS AN ELECTION UNDER Sec.  1.1502-
14Z(c)(2) TO TREAT AN INVESTMENT BY [insert name and employer 
identification number (E.I.N.) of M2] AS A QUALIFYING INVESTMENT BY 
[insert name and E.I.N. of M1].'' The statement must be included with 
the consolidated group's timely filed return (original, superseding, or 
amended return, as applicable, including extensions). In addition, the 
statement must include the information required under paragraph 
(h)(2)(ii) of this section.
    (ii) Required information. (A) The amount of M1's eligible gain;
    (B) The amount of the investment M2 has made in a QOF, including 
identification of the amount of the investment that is eligible for 
treatment as a qualifying investment under paragraph (c)(2) of this 
section and the amount (if any) that is not eligible for such 
treatment; and
    (C) The date on which M1 recognized its eligible gain, and the date 
on which M2 made the investment in the QOF.
    (3) Elections under paragraph (f) of this section for transition 
relief--(i) Form of election. The elections under paragraph (f) of this 
section must be made in the form of a statement titled ``THIS IS AN 
ELECTION UNDER Sec.  1.1502-14Z(f) FOR [insert name and E.I.N. of pre-
existing QOF sub].'' All actions necessary to make these elections, 
including the filing of an amended return (or superseding return, as 
applicable), or filing an original return, as applicable, must be 
completed within the time designated in paragraph (h)(3)(iii) of this 
section. The statement must be included on or with any amended prior-
year consolidated return (or superseding or original return, as 
applicable) and on or with the consolidated group's timely filed return 
(original or amended if filed by the due date for the return, including 
extensions) for the election year. In addition, the statement must 
include the information required in paragraph (h)(3)(ii) of this 
section.
    (ii) Required information--(A) Reclassification election under 
paragraph (f)(2)(ii) of this section. (1) A statement that the pre-
existing QOF sub is electing to be a QOF partnership;
    (2) The election date;
    (3) The effective date of the election;
    (4) Specification of the appropriate adjustments required under 
paragraph (f)(2)(ii) of this section made by the pre-existing QOF sub 
and the consolidated group; and
    (5) Certification that the appropriate change under state law or 
the entity classification election under Sec.  301.7701-3 of this 
chapter (as applicable) has been made, and the date of the change or 
entity classification election.
    (B) Reclassification election under paragraph (f)(2)(iii) or (iv) 
of this section. (1) A statement that the pre-existing QOF sub is 
changing its status;
    (2) The pre-existing QOF sub's new status (either a non-member QOF 
C corporation, under paragraph (f)(2)(iii) of this section, or a non-
QOF C corporation, under paragraph (f)(2)(iv) of this section);
    (3) The election date;
    (4) The effective date of the election; and
    (5) Specification of the appropriate adjustments made the by pre-
existing QOF sub and the consolidated group pursuant to paragraph 
(f)(2)(iii) or (iv) of this section, as applicable.
    (C) Election to continue treating the pre-existing QOF sub as a 
subsidiary member of the consolidated group under paragraph (f)(3) of 
this section. (1) A statement that the pre-existing QOF sub is electing 
to retain its status as a QOF C corporation and remain a member of the 
consolidated group;
    (2) The election date; and
    (3) Certification that the pre-existing QOF sub and the 
consolidated group are in compliance with the conditions under Sec.  
1.1504-3(b)(2)(ii) as of the date that the pre-existing QOF sub and the 
consolidated group are in compliance with the conditions under Sec.  
1.1504-3(b)(2)(ii).
    (iii) Time for completing the elections under paragraph (f) of this 
section. (A) If the pre-existing QOF sub is making an election under 
paragraph (f)(2)(ii) or (f)(3) of this section, all actions necessary 
to make such election must be completed by April 13, 2020. 
Specifically, if the pre-existing QOF sub is making the election under 
paragraph (f)(3) of this section, the conditions in Sec.  1.1504-
3(b)(2)(ii) must be met by April 13, 2020. In addition, the 
consolidated group's amended return (or superseding return, as 
applicable), taking into account the relevant changes, if applicable, 
must be filed by May 12, 2020. Moreover, if the electing QOF 
partnership had been a QOF partnership on day one and the electing QOF 
partnership's return would have been

[[Page 1998]]

due, then such return also must be filed by May 12, 2020].
    (B) If the pre-existing QOF sub is making a reclassification 
election under paragraph (f)(2)(iii) or (iv) of this section, all 
actions necessary to make such election, including the filing of the 
pre-existing QOF sub's own return (if the return would have been due 
had the pre-existing QOF sub not been included in the consolidated 
group on day one), and the consolidated group's amended return (or 
superseding return, as applicable), if applicable, must be completed by 
April 13, 2020.
    (iv) Extension of statute of limitations. If, as a result of making 
a reclassification election in paragraph (f)(2) of this section, the 
consolidated group is required to file an amended return, and the 
electing QOF partnership is required to file a return by May 12, 2020 
or the pre-existing QOF sub is required to file a return by April 13, 
2020 (collectively, the related returns), then the consolidated group 
(and the pre-existing QOF sub, if an election under paragraph 
(f)(2)(iii) of this section is made) also must consent to extend the 
period of limitations on assessment with respect to any issues arising 
under section 1400Z-2 in the related returns of the consolidated group 
(and the pre-existing QOF sub, if applicable). This consent must be 
effected at such time and in such form and manner as may be prescribed 
by the Commissioner of Internal Revenue in Internal Revenue Service 
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).
    (i) [Reserved]
    (j) Examples. The following examples illustrate the rules of this 
section. For purposes of these examples, and unless otherwise stated: P 
is the common parent of the P consolidated group (P group); S, B, and M 
are members of the P group; Q is a QOF C corporation that is not a 
member of the P group; and X is an unrelated party.

    (1) Example 1: Distribution by a QOF member and inclusion 
events--(i) Facts. P wholly owns S. In 2018, S sells an asset to an 
unrelated party and realizes $500x of eligible gain. S forms a new 
QOF C corporation Q2, contributes $500x to Q2 in exchange for stock 
of Q2, and properly elects to defer the eligible gain under section 
1400Z-2(a) and Sec.  1.1400Z2(a)-1. The P group elects under Sec.  
1.1504-3(b)(2) to consolidate Q2. In 2024, Q2 distributes $20x to S 
when S's basis in Q2 is $50x, the value of Q2 exceeds $500x, and Q2 
has no earnings and profits. There are no other events in 2024 that 
results in investment adjustments to Q2 stock.
    (ii) Analysis. Under Sec. Sec.  1.1502-13(f)(2) and 1.1502-32, 
the intercompany distribution from Q2 to S of $20x reduces S's basis 
in Q2 to $30x ($50x-$20x). Under paragraph (b)(1)(i) of this 
section, because the distribution does not create or increase an ELA 
in Q2 stock, the distribution is not an inclusion event.
    (iii) Distribution that creates an ELA. The facts are the same 
as in paragraph (j)(1)(i) of this section except that in 2024 Q2 
distributes $70x to S. Under Sec. Sec.  1.1502-13(f)(2) and 1.1502-
32, the intercompany distribution from Q2 to S of $70x reduces S's 
basis in Q2 to $0 and creates an ELA of $20x ($50x-$70x). Under 
paragraph (b)(1)(i) of this section, because an ELA is created in 
Q2's stock, the distribution is an inclusion event to the extent of 
the increase in the ELA. S therefore includes $20x of its deferred 
gain into income in 2024. See Sec.  1.1400Z2(b)-1(e)(2). In 
addition, under Sec.  1.1400Z2(b)-1(g)(1)(ii), the adjustment to S's 
basis in Q2 under section 1400Z-2(b)(2)(B)(ii) is applied before 
determining the other Federal income tax consequences of the 
distribution. Therefore, as a result of the inclusion event, S's 
basis in Q2 is first increased to $70x ($50x + $20x), and then S's 
basis in Q2 is reduced by $70x (the amount of the distribution) to 
$0 under Sec.  1.1502-32.
    (2) Example 2: Basis adjustment when member owns qualifying QOF 
stock--(i) Facts. P wholly owns S. In 2018, S sells an asset to an 
unrelated party and realizes $500x of eligible gain. S contributes 
$500x to Q in exchange for stock of Q and properly elects to defer 
the eligible gain under section 1400Z-2(a) and Sec.  1.1400Z2(a)-1. 
S does not otherwise own stock in Q. In 2026, the fair market value 
of S's qualifying investment in Q exceeds $500x. In 2029, when S 
still owns its qualifying investment in Q, P sells all of the stock 
of S to X. S retains its stock in Q.
    (ii) Analysis--(A) Five-year and seven-year basis increase and 
Sec.  1.1502-32 tier-up. In 2023, when S has held the stock of Q for 
five years, under section 1400Z-2(b)(2)(B)(iii), S increases its 
basis in its Q stock by $50x (10 percent of $500x, the amount of 
gain deferred by reason of section 1400Z-2(a)(1)(A)). The 10-percent 
basis increase qualifies as tax-exempt income to S under paragraph 
(d) of this section. Thus, P (an upper-tier member) increases its 
basis in S's stock by $50x under Sec.  1.1502-32(b)(2)(ii). 
Similarly, in 2025, when S has held the stock of Q for seven years, 
under section 1400Z-2(b)(2)(B)(iv), S increases its basis in its Q 
stock by an additional $25x (5 percent of $500x). The 5-percent 
basis increase also qualifies as tax-exempt income to S under 
paragraph (d) of this section, and P increases its basis in S's 
stock by an additional $25x under Sec.  1.1502-32(b)(2)(ii).
    (B) S's recognition of deferred capital gain in 2026. S did not 
dispose of its Q stock prior to December 31, 2026. Therefore, under 
section 1400Z-2(b)(1)(B) and Sec.  1.1400Z2(b)-1(b)(2), S's 
remaining deferred gain is included in S's income on December 31, 
2026. The amount of gain included under section 1400Z-2(b)(2)(A) and 
Sec.  1.1400Z2(b)-1(e)(3) is $425x ($500x of remaining deferred gain 
less S's $75x basis in Q). S's basis in Q is increased by $425x to 
$500x, and P's basis in S also is increased by $425x under Sec.  
1.1502-32(b)(2)(i).
    (C) P's disposition of S. P's sale of S stock in 2029 results in 
the deconsolidation of S. S retains its Q stock, and S is not 
treated as selling or exchanging its Q stock for purposes of section 
1400Z-2(c). Therefore, no basis adjustments under section 1400Z-2 
are made as a result of P's sale of S stock.
    (iii) S sells the stock of Q after 10 years. The facts are the 
same as in paragraph (j)(2)(i) of this section, except that in 2029, 
instead of P selling all of the stock of S, S sells all of the stock 
of Q to X for its fair market value of $800x. At the time of the 
sale, S has owned the Q stock for over 10 years, and S elects under 
section 1400Z-2(c) to adjust its stock basis in Q from $500x (see 
the analysis in paragraph (j)(2)(ii)(B) of this section) to $800x, 
the fair market value of Q on the date of the sale. As a result of 
the election, S has no gain on the sale of Q stock. Additionally, 
the $300x basis increase in Q is treated as tax-exempt income to S 
pursuant to paragraph (d) of this section. Thus, P increases its 
basis in P's S stock by $300x under Sec.  1.1502-32(b)(2)(ii).
    (3) Example 3: Intercompany sale of qualifying investment--(i) 
Facts. In 2018, S sells an asset to an unrelated party and realizes 
$100x of eligible gain. Also in 2018, S contributes $100x to Q in 
exchange for Q stock and properly elects to defer the eligible gain 
under section 1400Z-2(a) and Sec.  1.1400Z2(a)-1. S does not 
otherwise own stock in Q. In 2021, S sells all of its Q stock to B 
for $250x in a fully taxable transaction. In 2026, the fair market 
value of Q is $300x. In 2030, B sells the Q stock to X for $800x.
    (ii) Analysis--(A) Intercompany sale treated as an inclusion 
event. In 2021, S's sale of its Q stock to B is an inclusion event 
under section 1400Z-2(b)(1) and Sec.  1.1400Z2(b)-1(c). The amount 
includible pursuant to Sec.  1.1400Z2(b)-1(e)(1) is $100x (the 
lesser of the remaining deferred gain of $100x and the fair market 
value of the qualifying investment of $250x, over S's basis in Q, 
$0). As a result of the inclusion, S's basis in Q increases from $0 
to $100x and S also realizes a capital gain of $150x ($250x of 
amount realized less its $100x basis in the Q stock) from the 
intercompany sale of Q to B. Because S's sale of its Q stock to B is 
a fully taxable transaction, paragraph (c)(3)(ii) of this section 
applies to treat the sale as an intercompany transaction and S's 
intercompany gains are taken into under Sec.  1.1502-13(c)(2)(ii). 
Thus, S defers the inclusion of its $100x of remaining deferred gain 
and its $150x of capital gain in 2021. B has a $250x basis in its Q 
stock.
    (B) Five-year basis increase in 2023. Pursuant to paragraph 
(c)(3)(ii) of this section, S and B are treated as divisions of a 
single entity for purposes of applying section 1400Z-2. In 2023, the 
single entity would have held the QOF investment for five years and 
its basis in Q would be increased to $10x ($100x x 10%) under 
section 1400Z-2(b)(2)(B)(iii). To achieve this single entity result, 
$10x of S's $100x of remaining deferred gain is redetermined to be 
tax-exempt income. See Sec.  1.1502-13(c)(1); see also paragraph 
(c)(3)(ii)(B) of this section making Sec.  1.1502-13(c)(6)(ii) 
inapplicable in

[[Page 1999]]

determining the excludability of S's intercompany gain. Therefore, 
in 2023, S is treated as having $10x of tax-exempt income, S's 
remaining deferred gain is $90x ($100x-$10x), while B's basis in Q 
remains $250x.
    (C) Seven-year basis increase in 2025. The same analysis in 
paragraph (j)(3)(ii)(B) of this section applies for the year 2025. 
Therefore, in 2025, S is treated as having $5x ($100x x 5%) of tax-
exempt income, S's remaining deferred gain is $85x ($90x-$5x), and 
B's basis in Q remains $250x.
    (D) Inclusion of S's remaining deferred gain in 2026. B 
continues to own the Q stock through 2026, and, treating S and B as 
divisions of a single entity for purposes of section 1400Z-2, the 
single entity would include its remaining deferred gain in income on 
December 31, 2026. See section 1400Z-2(b)(1), Sec.  1.1400Z2(b)-
1(b). On a single-entity basis, the amount includible pursuant to 
Sec.  1.1400Z2(b)-1(e) is $85x (the lesser of the remaining deferred 
gain of $100x and the fair market value of the qualifying investment 
of $300x, over the single entity's basis in Q, $15x). B does not 
otherwise have an income event with respect to its Q stock in 2026. 
Therefore, under Sec.  1.1502-13(c), all $85x of S's remaining 
deferred gain is taken into account in 2026. In addition, S's $150x 
of capital gain on its Q stock sale continues to be deferred, and 
B's basis in Q remains $250x.
    (E) B sells the Q stock in 2030. In 2030, B sells all its Q 
stock to X for $800x. Under paragraph (c)(3)(ii)(D) of this section, 
B is entitled to make the election under section 1400Z-2(c) if, 
treating S and B as a single entity, the single entity would be 
eligible to make the election. Taking into account S's holding 
period, B has held Q for over 10 years, and B is eligible for the 
election when it sells Q to X in 2030. B makes the section 1400Z-
2(c) election at the time of sale. Following the election, if S and 
B were divisions of a single entity, the single entity's basis in Q 
would increase from $100x to its fair market value of $800x, causing 
to be excluded the $700x of gain on the sale of Q stock. To achieve 
this single entity result, Sec.  1.1502-13(c)(1) redetermines B's 
$550x ($800x-$250x) of gain and S's deferred $150x of capital gain 
to be tax-exempt income. See paragraph (c)(3)(ii)(B) of this section 
making Sec.  1.1502-13(c)(6)(ii) inapplicable in determining the 
excludability of S's intercompany gain. Therefore, as a result of 
the sale of the Q stock and B making the section 1400Z-2(c) 
election, S has $150x of tax-exempt income, and B has $550x of tax-
exempt income.
    (4) Example 4: Intercompany sale of qualifying investment 
followed by sale of QOF at a loss outside of the consolidated 
group--(i) Facts. The facts are the same as in paragraph (j)(3)(i) 
of this section, except that in 2030, B sells the stock of Q for 
$225x to X.
    (ii) Analysis. The analysis for tax years prior to 2030 is the 
same as in paragraphs (j)(3)(ii)(A) through (D) of this section. In 
addition, applying the analysis in paragraph (j)(3)(ii)(E) of this 
section, B is entitled to make the election under section 1400Z-2(c) 
and B makes the election. Following the election, if S and B were 
divisions of a single entity, the single entity's basis in Q would 
increase from $100x to $225x, causing to be excluded the $125x of 
gain on the sale of Q stock. To achieve this single entity result, 
Sec.  1.1502-13(c)(1) redetermines B's $25x ($225x-$250x) of loss to 
be a noncapital, nondeductible expense and S's deferred $150x of 
capital gain to be tax-exempt income. Therefore, as a result of the 
sale of Q stock and B making the section 1400Z-2 election, S has 
$150x of tax-exempt income, and B has $25x of noncapital, 
nondeductible expense.
    (5) Example 5: Intercompany section 351 transfer of qualifying 
investment--(i) Facts. In 2018, M sells an asset to an unrelated 
party and realizes $100x of eligible gain. Also in 2018, M 
contributes $100x to Q in exchange for Q stock and properly elects 
to defer the eligible gain under section 1400Z-2(a) and Sec.  
1.1400Z2(a)-1. M does not otherwise own stock in Q. In 2021, when 
the value of Q is $200x, M contributes all of its Q stock to S in 
exchange for S stock in a transaction that qualifies under section 
351.
    (ii) Analysis. In 2021, M's contribution of its Q stock to S is 
an inclusion event under section 1400Z-2(b)(1) and Sec.  
1.1400Z2(b)-1(c). The amount includible pursuant to Sec.  
1.1400Z2(b)-1(e) is $100x (the lesser of the remaining deferred gain 
of $100x and the fair market value of the qualifying investment of 
$200x, over S's basis in Q, $0). Because M's contribution of its Q 
stock to S is not a fully taxable transaction, the general rule in 
paragraph (c)(3)(i) of this section applies to treat the 
contribution as not an intercompany transaction for purposes of 
applying section 1400Z-2, and Sec.  1.1502-13 does not apply to 
treat M and S as a single entity for purposes of section 1400Z-2. 
Thus, as a result of the transfer, M takes its $100x of remaining 
deferred gain into account, M's basis in S is $100x, and S's basis 
in Q is $100x.
    (6) Example 6: Intercompany sale of qualifying investment 
followed by a tax-free transfer of the qualifying investment--(i) 
Section 351 transfer to another member of the consolidated group--
(A) Facts. In 2018, S sells an asset to an unrelated party and 
realizes $100x of eligible gain. Also in 2018, S contributes $100x 
to Q in exchange for Q stock and properly elects to defer the 
eligible gain under section 1400Z-2(a) and Sec.  1.1400Z2(a)-1. S 
does not otherwise own stock in Q. In 2021, when the fair market 
value of the Q stock is $250, S sells all of its Q stock to B for 
$250x in a fully taxable transaction. In 2024, B transfers all its Q 
stock to another member of the P group, B2, in a section 351 
transaction. At such time, the fair market value of the Q stock is 
$300x.
    (B) Analysis--(1) Intercompany sale in 2021. In 2021, S's sale 
of its Q stock to B is an inclusion event under section 1400Z-
2(b)(1) and Sec.  1.1400Z2(b)-1(c). The amount includible pursuant 
to Sec.  1.1400Z2(b)-1(e) is $100x (the lesser of the remaining 
deferred gain of $100x and the fair market value of the qualifying 
investment of $250x, over S's basis in Q, $0). As a result of the 
inclusion, S's basis in its Q stock increases from $0 to $100x and S 
also realizes a capital gain of $150x ($250x of amount realized less 
its $100x basis in the Q stock) from the intercompany sale of the Q 
stock to B. Because S's sale of its Q stock to B is a fully taxable 
transaction, paragraph (c)(3)(ii) of this section applies to treat 
the sale as an intercompany transaction. Therefore, S's intercompany 
gains are taken into account under Sec.  1.1502-13(c) and (d). Thus, 
S defers the inclusion of its $100x of remaining deferred gain and 
its $150x of capital gain in 2021. B has a $250x basis in its Q 
stock.
    (2) Five-year basis increase in 2023. Pursuant to paragraph 
(c)(3)(ii) of this section, S and B are treated as divisions of a 
single entity for purposes of applying section 1400Z-2. In 2023, the 
single entity has held the QOF investment for five years and its 
basis in the Q stock would be increased to $10x ($100x x 10%) under 
section 1400Z-2(b)(2)(B)(iii). To achieve this single entity result, 
$10x of S's $100x of remaining deferred gain is redetermined to be 
tax-exempt income. See Sec.  1.1502-13(c)(1); see also paragraph 
(c)(3)(ii)(B) of this section making Sec.  1.1502-13(c)(6)(ii) 
inapplicable in determining the excludability of S's intercompany 
gain. Therefore, in 2023, S is treated as having $10x of tax-exempt 
income, S's remaining deferred gain is $90x ($100x-$10x), and B's 
basis in the Q stock remains $250x.
    (3) Intercompany transfer in a section 351 transaction. In 2024, 
B's contribution of its Q stock to B2, a member of the P group, is 
an inclusion event under section 1400Z-2(b)(1) and Sec.  
1.1400Z2(b)-1(c). The amount includible pursuant to Sec.  
1.1400Z2(b)-1(e) is $90x (the remaining deferred gain as determined 
in paragraph (j)(6)(i)(B) of this section). Because B's contribution 
of its Q stock to B2 is not a fully taxable transaction, the general 
rule in paragraph (c)(3)(i) of this section applies to prevent the 
contribution from being treated as an intercompany transaction for 
purposes of section 1400Z-2. As a result, for purposes of section 
1400Z-2, Sec.  1.1502-13 does not apply to treat B and B2 as a 
single entity, and the application of Sec.  1.1502-13(j) is adjusted 
accordingly. As a result of the section 351 transfer, S takes its 
$90x of remaining deferred gain into account. B's basis in its B2 
stock is $250x, and B's basis in its Q stock is $250x. However, 
because S's $150x of capital gain from the intercompany sale of its 
Q stock to B in 2021 is not an item related to section 1400Z-2, it 
continues to be deferred under Sec.  1.1502-13 because B2 is a 
member of the P group. See Sec.  1.1502-13(j)(4) regarding 
successive intercompany transactions.
    (ii) Section 351 transfer to a non-member--(A) Facts. The facts 
are the same as in paragraph (j)(6)(i)(A) of this section, except 
that B2 is not a member of the P group, and B contributes all its Q 
stock to B2 in a transaction that qualifies under section 351.
    (B) Analysis--(1) Intercompany sale in 2021 and five-year basis 
increase in 2023. The analysis for the 2021 and 2023 tax years are 
the same as in paragraphs (j)(6)(i)(B)(1) and (2) of this section.
    (2) Transfer of Q to a non-member in a section 351 transaction. 
In 2024, B's contribution of its Q stock to B2, a non-member of the 
P group, is an inclusion event under section 1400Z-2(b)(1) and Sec.  
1.1400Z2(b)-1(c). The amount includible

[[Page 2000]]

pursuant to Sec.  1.1400Z2(b)-1(e) is $90x (the remaining deferred 
gain as determined in paragraph (j)(6)(ii)(B)(1) of this section). 
S's deferred capital gain of $150x is taken into account in 2024 
under the acceleration rule of Sec.  1.1502-13(d) because the Q 
stock has left the P group. B2's holding period for the qualifying 
investment does not include the time during which B and S held the 
qualifying investment.
    (iii) Section 721(a) transfer to a partnership--(A) Facts. The 
facts are the same as in paragraph (j)(6)(i)(A) of this section, 
except that B2 is a partnership, and an unrelated party is the other 
partner in B2. B's transfer of all of its Q stock to B2 qualifies 
for non-recognition treatment under section 721(a). In 2026, the 
fair market value of Q is $330x.
    (B) Analysis--(1) Intercompany sale in 2021 and five-year basis 
increase in 2023. The analysis for the 2021 and 2023 tax years are 
the same as in paragraphs (j)(6)(i)(B)(1) and (2) of this section.
    (2) Transfer of Q stock to a partnership in a section 721(a) 
transaction. In 2024, B transfers its Q stock to B2, a partnership, 
in a section 721(a) transaction. Although a section 721(a) 
transaction is not an inclusion event under Sec.  1.1400Z2(b)-
1(c)(7), under the acceleration rule of Sec.  1.1502-13(d), S must 
take into account its $90x of remaining deferred gain because B2 has 
benefited from an increased basis in the Q stock as a result of the 
intercompany sale between S and B such that this is the appropriate 
time to take the remaining deferred gain into account. S's deferred 
capital gain of $150x is taken into account in 2024 for the same 
reason.
    (7) Example 7: Computation and application of the attribute 
reduction amount under Sec.  1.1502-36(d) when S owns a QOF--(i) 
Facts. In 2018, S sells an asset to an unrelated party and realizes 
$5,000x of eligible gain. S contributes $5,000x to Q in exchange for 
stock of Q and properly elects to defer the eligible gain under 
section 1400Z-2(a) and Sec.  1.1400Z2(a)-1. In 2024, M sells all of 
its S stock to X for its fair market value of $100x, and M's basis 
in the stock of S is $300x. At the time of sale, S owns the Q stock 
with a basis of $500x (S's basis in its Q stock was increased under 
section 1400Z-2(b)(2)(B)(iii) to $500x in 2023), and S has a net 
operating loss carryover of $50x. M's transfer of the S shares is a 
transfer of loss shares under Sec.  1.1502-36. Assume that no basis 
redetermination is required under Sec.  1.1502-36(b) and no basis 
reduction is required under Sec.  1.1502-36(c).
    (ii) Attribute reduction under Sec.  1.1502-36(d). Under Sec.  
1.1502-36(d), S'