Opportunity Zone Magazine Opportunity Zone Magazine Volume 1, Issue 1

QUALIFIED OPPORTUNITY FUNDS: COMPARE & CONTRAST DIRECT & INDIRECT INVESTMENTS What is the difference between a direct and indirect investment? How much of the funds’ assets are required to be QOZBP? Direct investment into QOZBP occurs when the fund directly owns the tangible property. An indirect investment layers in another tier, a qualified opportunity zone business (QOZB). When investing in this way, the fund infuses equity into a separately regarded operating entity (via stock or partnership interest) that holds the tangible property and business operations. While there is an expectation that there is business activity in either structure, the current guidance provides different definitions and tests for direct versus indirect investments. The indirect form of investment received desirable leniencies in the first round of proposed regulations, but it also comes with additional statutory restrictions. As discussed above, 90 percent of a QOF’s assets must be qualified opportunity zone property. Failure to maintain this 90 percent threshold results in penalties assessed at the QOF level. In a direct investment into a QOZBP, 90 percent of the QOF’s assets would need to meet this tangible property definition. If a fund uses the indirect structure, while 90 percent of the QOF’s assets must be invested in the next tier, the QOZB is granted a “substantially all” threshold for QOZBP it must own. The first set of proposed regulations define “substantially all” for these purposes to be 70 percent. Accordingly, use of an indirect investment structure allows for more liberty in the composition of the business assets. What is qualified opportunity zone business property? Take caution: While missing the 90 percent test results in a penalty computed in relation to the shortfall, missing the 70 percent test might mean that 100 percent of the QOF’s assets are not qualified. 1 Regardless of the chosen structure, every QOF has an underlying investment in a QOZBP. A QOZBP is defined as tangible property used in a trade or business that the QOF acquired by purchase after Dec. 31, 2017 from an unrelated party. Either the original use of the property must commence in the Qualified Opportunity Zone (QOZ) with the QOF or the property must be substantially improved by the QOF. Additionally, substantially all of the use of such property by the QOF must be in an opportunity zone during substantially all of its holding period. 2 How much time is allowed to hold cash used to construct or improve qualified property? The 90 percent test applied at the QOF level is measured every six months with a caveat on these dates in a QOF’s initial year. Accordingly, any cash that a direct investment holds on a test date is not eligible as a 90 percent qualified asset. On the contrary, the first round of proposed guidance introduced OPPORTUNITYZONEMAGAZINE.COM 47

Opportunity Zone Magazine Opportunity Zone Magazine Volume 1, Issue 1 | Page 49