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SSTI submits OZ comments to IRS

January 03, 2019

This fall, the IRS released proposed Opportunity Zone rules, which did not address several key questions for business investment. SSTI submitted comments for official consideration last week, requesting that rules clarify initial investment periods, interim returns and qualifying business activity locations. Several organizations echoed similar concerns, including the U.S. Conference of Mayors and U.S. Chamber of Commerce. Other comments posted to the site include calls for requirements that would facilitate greater impact, including screening potential bad actors, encouraging investments in ESOPs, and measuring economic impacts for current zone residents. Read SSTI’s full letter below.


Dear Office of the Associate Chief Counsel:

On behalf of numerous state, local, university and nonprofit organizations around the country, SSTI welcomes the opportunity to provide comments on the Internal Revenue Service’s notice of proposed rulemaking for “Investing in Qualified Opportunity Funds.”

SSTI, a nonprofit organization founded in 1996, strengthens initiatives to create a better future through science, technology, innovation and entrepreneurship. The members that comprise our network seek to work with Opportunity Zones, Opportunity Funds and Opportunity Zone Businesses in order to generate greater economic outcomes in these under-invested regions. SSTI members would serve many roles to further the success of the initiative, including marketing deals, managing funds, convening investors, providing services to businesses, and offering complementary incentives.

While the IRS’s most recent proposed rulemaking would clarify some questions about the use of Qualified Opportunity Zones to facilitate tangible property investment, the rules would not provide needed clarity to encourage investment in entrepreneurs and small businesses. This omission is glaring because the legislation’s primary purpose was to facilitate the investment of patient capital into small businesses located in distressed communities. Statements by the bill’s authors clarify this intent. Upon introducing the original bill, Rep. Pat Tiberi (R-OH) said that the first benefit of the legislation was that, “it removes barriers for investors to fund enterprises,” and second, it would help, “investors to fund and support entrepreneurs and small businesses” (emphasis added).[1] When Sen. Tim Scott (R-SC) talks about the types of projects that could use the incentive, he discusses small businesses.[2] The IRS should provide rules that enable the law to execute its core purpose: facilitating patient investment to businesses located in distressed areas.

Specifically, organizations ready to facilitate investments into Qualified Opportunity Zone Businesses need to see three changes between the proposed and final rules: (a) a safe harbor for initial investments by Qualified Opportunity Funds, (b) rules for reinvestment by Qualified Opportunity Funds, and (c) revisions to the 50 percent gross income test.

1. Safe Harbor for Initial Investments by Qualified Opportunity Funds

The proposed rules do not address a key timing concern and could therefore inhibit the incentive’s ability to facilitate investments in Qualified Opportunity Zone Businesses (QOZBs). Just as the proposed 31-month safe harbor for business investments in tangible property will facilitate good decision-making, Qualified Opportunity Funds (QOFs) should have a safe harbor to invest a new capital gain-deferral election into a QOZB. Such a provision would help ensure that both funds and businesses are able to conduct proper due diligence on a potential investment without pressures to accept terms speedily to meet an OZ deadline.

Under the proposed rules, an investor has 180 days to make an election to invest in a QOF. The timing for the QOF to invest in a QOZB depends on the date of this election relative to the next biannual certification of assets. In practice, this means that the fund could have as much as six months or as little as one day from the time that it receives a commitment from an investor until the money must be committed to a business. The process of identifying, reviewing and contracting an investment can take months, and so the alignment of these windows will cause substantial concern and pressure on both QOFs and QOZBs.

Some QOFs will have pre-existing relationships with potential investors that will allow planning of a capital gains-triggering event and election, enabling the fund to begin its investigation of potential investments in advance. This will not be the case for all funds, however, and not all capital gains events can be planned. Further, many investors will expect additional due diligence into QOZBs, which are, by definition, located in areas with more than an average rate of failed businesses and poor economic indicators. On balance, the rules should lean toward protecting entrepreneurs, funds and investors.

In order to provide for maximum Opportunity Zone (OZ) investment under the best possible conditions, the final rules should allow ample time for new qualifying investments.

2. Provision for Reinvestment by Qualified Opportunity Funds

The intention of the OZ incentive is to keep investment dollars at work in the communities for as long as possible. Unfortunately, the absence of a rule clarifying the opportunity for reinvestment is a barrier to investment in QOZBs.

Congress specifically requested such a rule with the Tax Cuts and Jobs Act’s critical (e)(4)(B) clause, stating that the Secretary will create:

(B) rules to ensure a qualified opportunity fund has a reasonable period of time to reinvest the return of capital from investments in qualified opportunity zone stock and qualified opportunity zone partnership interests, and to reinvest proceeds received from the sale or disposition of qualified opportunity zone property.

In some cases, the entrepreneur and business will be best served by making a decision that threatens the qualifying nature of the QOZB. Not every business will be able to survive the 10 years; and sustain 10 years’ worth of growth without developing assets or business activity outside of an OZ; and grow without needing or wanting to restructure an early-stage investment; and decline all acquisition offers from larger companies. If a reinvestment rule is not in place, then the OZ incentive creates a situation where the best interest of the company’s investors may be at odds with the best interests of the company. Such a possibility should be avoided.

We believe that the interests of the QOZBs, and, ultimately, the citizens within the zone, will be best served if QOFs are able to reinvest funds back into the zone without triggering a tax event for investors. Such a provision will help keep investments in the OZ for as long as possible, which will provide the greatest long-term benefits to the community.

The final rules should include clear directions for what returns may be reinvested by a QOF and how long the QOF has to make a new investment without terminating the tax benefits for the investors.

3. 50 Percent Gross Income Test

The proposed rule requiring a QOZB to derive 50 percent of its gross income from the active conduct of a trade or business “in the Qualified Opportunity Zone” will forestall qualifying investments in businesses. We agree with the IRS’s concern that tax benefits accrue to investments that are predominately and directly benefiting the OZ. However, in this case, the proposed rule would undermine the intended safeguard by generating uncertainty.

Modern high-growth businesses and many retail establishments have customers located throughout the country and around the world. If the Opportunity Zone initiative is to truly succeed at providing economic opportunity to distressed communities, then the rules should facilitate investments in high-growth and technology-oriented companies. To this end, the rule should clarify that the location of sales is not the point of concern, but the location of employees and assets.

A similar challenge for mail-order businesses was addressed in the rules around Empowerment/Enterprise Zones. A question in the U.S. Department of Housing and Urban Development’s 2003 guidance[3] read:

How does a business apply the active conduct of business within an EZ, EC, or RC test if raw materials and customers come from outside the EZ, EC, or RC?

The tax regulations relating to Enterprise Zone Facility Bonds describe a mail-order clothing business that is located in an EZ. The business purchases the supplies for its clothing business from suppliers located both within and outside the EZ and expects that orders will be received both from customers who will reside or work within the EZ and from others outside the EZ. All orders are received, filled at, and shipped from the clothing business located in the EZ. The income generated from the sales would be treated as gross income derived from the active conduct of business within an EZ.

This guidance clarified that a business operating within the zone remains eligible when customers and materials are located outside the zone. At the same time, the economic benefit to the zone is preserved, because the business is compelled to ensure that its employees are operating in the zone.

The IRS should continue this example and modify the proposed rule to clarify that businesses executing sales online (and otherwise remotely) remain eligible so long as those sales are related to services or products developed, produced, or fulfilled within the zone.

The final test should not only be clear, but also simple. The proposed, unclear rule could result in businesses being pressured by investors or auditors to adopt novel reporting or accounting standards in an effort to meet the undefined test. Such additional administrative processes would put many small businesses in the position of having to devote substantial funds from their qualifying investments toward program requirements rather than growth. This would clearly cut against the purpose of the initiative. A clear, but complicated, final rule would have a similar impact.

We appreciate the work that the IRS has completed to date to translate a new incentive model into actionable guidance. There is less precedent in past code for business investment incentive programs than for tangible property-focused programs, which has doubtless made the process difficult. In order for the Opportunity Zone incentive to realize its initial intent and full potential, however, the issues addressed here must be clarified with new guidance.

We are confident that legislation and precedent provide opportunities for solutions, and SSTI would be happy to work with the IRS and other stakeholders to help identify the best path forward so that qualifying communities throughout the country can experience tremendous investment, employment opportunities and economic growth.

[1] Tiberi, P. (2016, Apr. 27). “The Investing in Opportunity Act of 2016.” Medium. Retrieved from: https://medium.com/the-investing-in-opportunity-act/the-investing-in-opportunity-act-of-2016-2ac7352c3c90.

[2] E.g., White, B. (2018, Nov. 20). “The $100 billion question.” Politico. Retrieved from: https://www.politico.com/agenda/story/2018/11/20/tim-scott-opportunity-zones-000793.

[3] U.S. Department of Housing and Urban Development. (n.d.). Tax Incentive Guide for Businesses in the Renewal Communities, Empowerment Zones, and Enterprise Communities: FY 2003. Retrieved from: https://www.hud.gov/sites/documents/19132_TAXGUIDE2003.PDF.


federal agency, opportunity zones