Private Equity and Venture Capital Investment in Opportunity Zones
The tax regime for investment in private businesses located in qualified opportunity zones (“QOZs”) has recently become more apparent, with two sets of proposed regulations[1] governing investments in QOZs having been issued by the Treasury. Such QOZ business investments present the opportunity to combine the high capital returns associated with private equity investments with a preferential tax regime that, when certain conditions are met, excludes a substantial amount of return from taxation. As a result, the interest in QOZs among privately held business continues to grow. Below, we summarize some of the key requirements for establishing a business or subsidiary in a QOZ that is eligible for the preferential tax benefits afforded to qualifying investments in a QOZ. In addition, we present an operating checklist for private companies designed to streamline compliance with the QOZ requirements.
Investors in QOZ businesses may potentially avail themselves of three key benefits under the Internal Revenue Code of 1986 (as amended, the “Code”): (i) the deferral of capital gains recognized by such investors from other investments and re-invested in a QOZ until December 31, 2026, (ii) a step-up in basis of 10% or even 15% for investments held for 5 or 7 years, respectively, and (iii) a permanent exclusion from taxation of gains attributable to the private equity investment if such investment is held for 10 years or more.
Many privately held QOZ businesses (“QOZ Business”) employ a dual entity structure whereby a qualified opportunity fund (“QOF”) invests in an underlying QOZ Business. The first entity in the structure, the QOF, which is typically an entity treated as a partnership for federal income tax purposes, acts as the investor-facing entity and receives the investment from, and manages the relationship with, the underlying investors that are seeking the beneficial tax treatment associated with investments in a QOZ. The second entity in the structure is the QOZ Business, which may be a corporation, a limited partnership, or a limited liability company treated as a partnership for tax purposes. The QOZ Business may acquire assets a number of ways, including through purchase or lease, subject to applicable rules.
In order to qualify as a QOZ Business, the relevant entity must meet a number of requirements, which may be broken into three categories: (1) requirements governing the relationship between the QOF and the QOZ Business; (2) requirements regarding the QOZ Business’s property; and (3) requirements governing the operations of the QOZ Business. An outline of these requirements is included in a summary checklist attached hereto. Please see the attachment for an outline of the specific requirements applicable to a QOZ Business. For further information on QOZs and QOZ Businesses, or to discuss the practical application of the attached summary checklist, please contact us at the information listed below.
DOWNLOAD THE SUMMARY CHECKLIST HERE [1]Although the regulations governing investments in QOZs are still in proposed form, a taxpayer generally is permitted to rely on their rules so long as the taxpayer applies those rules in their entirety and in a consistent manner.
