REAL OPPORTUNITIES OUTSIDE REAL ESTATE : USING THE OPPORTUNITY ZONES INCENTIVE FOR OPERATING BUSINESSES
To take advantage of the opportunity zone benefits , opportunity zone fund investments are generally structured as an investment in a QOZ fund , which in turn invests in one or more QOZ businesses .
FINAL REGULATION MADE CLEAR THAT MANY OPERATING BUSINESSES CAN MEET THE QOZ BUSINESS REQUIREMENTS
There are three main hurdles to qualification as a QOZ business . The first requires that 70 % of the tangible property of the business be in an opportunity zone . The second is that 40 % of the intangible property of the business be used in the active conduct of a business within an opportunity zone . The last requirement is that the company must derive 50 % of its gross income from the active conduct of a business in an opportunity zone . Each is described in more detail below :
• The Tangible Assets Must Be Opportunity Zone Property Located in Opportunity Zones . 5 The applicable statute provides that “ substantially all ” of the tangible property of a QOZ business must be tangible personal property used in the business of the QOZ business ( Qualified Property ). Regulations have clarified that , in the context of determining whether tangible property meets the opportunity zone requirements , “ substantially all ” means 70 %. 6 Additionally , Qualified Property must have been : ( 1 ) acquired in 2018 or later ; ( 2 ) first used in an opportunity zone by the QOZ business ( or substantially improved by the same ); and ( 3 ) “ substantially all ” of the use of the property is in an opportunity zone . 7
• A Substantial Portion of Intangible Property Is Used In An Opportunity Zone . 8 A substantial portion of any intangible property must be used in the active conduct of the QOZ business trade or business in an opportunity zone . 9 Regulations clarify that a substantial portion means 40 %. 10 Intangible property is treated as used in the QOZ business trade or business if the use of the intangible property is normal or customary and used in the opportunity zone to contribute to the generation of income . 11
• Most Income Must Be Earned in An Opportunity Zone . 12 At least 50 % of the company ’ s gross income of the QOZ business must be derived from the active conduct of its business in an opportunity zone . 12 Given the difficulty of determining where income is generated , the Treasury regulations provide three safe harbors that , if met , a QOZ business will be deemed to earn 50 % of its income in an opportunity zone . 14 These safe harbors are : ( 1 ) more than 50 % of the service hours of the QOZ business trade or business are performed in an opportunity zone ; ( 2 ) more than 50 % of the pay for services performed in the QOZ business trade or business is for services performed in an opportunity zone ; or ( 3 ) the tangible property of the QOZ business trade or business located in an opportunity zone and the management and operational functions performed in an opportunity zone are necessary to generate at least 50 % of the QOZ business ' s gross income . 15 Even if none of the safe harbors is met , facts and circumstances may still be used to show that more than 50 % of the income was earned in an opportunity zone .
Perhaps one reason for investors ’ reluctance to use the QOZ program for an operating business is that when it was first enacted there was still significant ambiguity regarding the requirements discussed above . Many businesses today are geographically fluid . Specifically , businesses rely on use of the internet , mobile human capital , and technology . In short , and particularly exacerbated during the pandemic , business is generally not conducted entirely in one place . Thus , without additional guidance , it was difficult to determine where “ substantially all ” of a business ' s assets were located , what constituted a “ substantial portion ” and what amount equated to “ most income ”. That ambiguity likely resulted in investors looking elsewhere .
By focusing solely on real estate investments , potential investors have missed a different investment ( with albeit higher risk ) that can generate potentially higher returns : investing in an operating business as a Qualified Opportunity Zone Business .
Luckily , the Treasury regulations clarified many of these requirements . Using the 70 % standard for property , a QOZ business can provide some services using its business property outside opportunity zones . Similarly , the clarification of the substantial portion of intangible property as 40 % permits a QOZ business to allow some work involving intangible property to occur outsize an opportunity zone , such as accessing code or programs from a laptop . Perhaps , the most helpful is the safe harbor regarding the generation of income . These regulations provide concrete guidelines that businesses can follow to facilitate compliance with the statute . As a whole , the regulations opened the door for modern operating businesses that , while maintaining a substantial presence in the opportunity zone , are not constrained by impractical restrictions ( the building in which they operate ).
An impressive variety of operating businesses potentially qualify as QOZ businesses under the final regulations . In addition to location-bound businesses like brick-and-mortar stores or even manufacturers that ship products worldwide , many SaaS and other software businesses with high growth potential may qualify as QOZ businesses . A software company would meet several of the key QOZ business requirements by focusing on locating much of its property ( both tangible and intangible ) and workforce in an opportunity zone . If a majority of a software business ’ s work , both by hours and by compensation , is performed in an office located in an opportunity zone , the business should meet the QOZ business income requirement through both the first and second safe harbors . Furthermore , the software business could ensure that most of its tangible property , including equipment , is located in an opportunity zone , thereby meeting the QOZ
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