True to their name, recently created qualified opportunity zones (QOZs) may raise attractive opportunities for contractors. But, before taking advantage, familiarize yourself with the requirements of these projects and be on guard against their potential risks.
How QOZs Work
QOZs were established under the Tax Cuts and Jobs Act. They’re designed to attract investment in economically distressed areas by offering tax benefits to those who invest in them through qualified opportunity funds (QOFs). These funds allow investors who have realized capital gains on other assets to reinvest the proceeds in a QOF and defer tax on those gains until the end of 2026 or the date they sell their QOF investments, whichever comes first.
In addition to deferring their gains, investors enjoy a 10% reduction in gain for QOF investments held at least five years, or a 15% reduction for investments held at least seven years. They also avoid taxation altogether on any post-acquisition gains earned by QOF investments held at least 10 years. However, to receive the maximum 15% gain reduction, one must have invested in a QOF by the end of 2019 in order to meet the seven-year holding period by the end of 2026.
A QOF is a fund that’s established for the purpose of investing in QOZs and meets certain requirements, including holding at least 90% of its assets in “QOZ Property.” Such property includes:
- Direct acquisitions of “QOZ Business Property” — that is, real estate or other tangible property used in a trade or business within a QOZ, and
- Certain equity interests in “QOZ Businesses” that invest primarily in QOZ Business Property and meet certain other requirements.
For a building to qualify as QOZ Business Property, it must, among other things, be purchased by a QOF or QOZ Business after 2017 and meet either an “original use” or “substantial improvement” requirement.
To meet the original use requirement, the building must have been new or under construction when bought. Under IRS guidance, used property may meet the original use requirement if it had been vacant for an uninterrupted period of five years or more when purchased.
A building that fails the original use test can still qualify as QOZ property if it’s substantially improved. Under IRS guidance, that means that the QOF or QOZ Business must more than double the adjusted basis of the building (excluding the land) within 30 months after acquiring it.
QOZ projects should create new demand for construction services, but these jobs may be risky. This is particularly true for substantial improvement projects, given the time pressure of the 30-month deadline. Building owners anxious to qualify for QOZ tax incentives may attempt to impose tight timelines in their contracts to help ensure that they meet the deadline.
Before signing a contract, assess whether the job’s timelines are realistic and inspect the building carefully to identify potential issues that may delay the project or increase costs. Also, be sure the contract includes provisions that protect you in the event of delays that are out of your control.
Do your Homework
If you get the chance to bid on a QOZ project, research the job carefully. You may also want to have an attorney review the contract to ensure its language is fair and reasonable. As always, reach out to your IMC professional for additional guidance.