Is there any way I can apply for an exception to the penalties if I have 85%?
You could make a reasonable cause argument to imposition of penalties after they are applied to get them lifted. You should set up a lower development entity under the QOF so that a 70% rule applies. If your development has already started this may be harder but I know of a work around.
The Qualified Opportunity Fund shall pay a penalty for each month it fails to meet the requirement in an amount equal to the product of in the excess of: the amount equal to 90 percent of its aggregate assets, over the aggregate amount of Qualified Opportunity Zone property held by the fund, multiplied by the underpayment rate established under section 6621(a)(2) for such month. Third, there is the reasonable cause exception. No penalty shall be imposed under this subsection with respect to any failure if it is shown that such failure is due to reasonable cause.
The final regulations may provide some relief from penalties, but in your example, the penalty base will only be 5% of your QOF balance. For example, if you have a $1-million Qualified Opportunity Fund and you miss the 90% target by 5% for the period, the penalty base would be $50,000 ($1,000,000 x 5%) and the penalty for the six-month measurement period would be $50,000 x 6.5% (annual penalty) x 6 months / 12 months = $4,167. There will be "reasonable cause" exceptions and the calculation is done on a monthly average of qualifying and non-qualifying assets on IRS Form 8996.
If structured properly through a tiered structure, you can go as low as 63%.
The penalty is interest on the tax deferred by investing in the QOF. The 90% amount is set by statute, so I highly doubt an exception is possible.
You don't get an exception, but you get taxed based on the 5% delta. The IRS underpayment rate gets applied to the value of the delta (differential), so if you're only at 85%, you pay less in penalties than you would if you had 25%.
You can't really apply for an exception. However, there are two techniques that can reduce or eliminate the penalty. One is the 31 months can be extended by any delays due to government approval time. The second is the value of improvements are not just the cost of improvements, but the value of the improvements. If you are close, get a new appraisal on the value of tangible assets. The new appraisal may show that the value of tangible assets has doubled and the original assets plus improvements are now all Qualified Opportunity Zone assets. The related land also is now considered a Qualified Opportunity Zone asset. The penalty is calculated as follows for a 90% test penalty example. Total assets $50,000,000. 90% of Assets are $45,000,000. Total qualified assets $40,000,000. There is a $5,000,000 shortfall. The monthly penalty is $20,833.33, $5,000,000 X (5% /12). If there is a penalty, the shortfall will be recalculated each month. Note, the rate is 3% plus fed short-term rate. At time of writing, the rate is 5%.
The Opportunity Zones program provide a reward in the form of preferential tax treatment of deferred gains, but also a penalty if the QOF does not maintain compliance with the 90% asset test. The statute requires a QOF that fails this 90% test to pay a penalty for each month it fails to satisfy this requirement. The penalty is computed on IRS Form 8996, Part IV. It takes the amount by which QOZP for each month falls short of the 95% requirement, multiples by the applicable federal rate of interest set forth by the Treasury/IRS, and divides by 12. You don't go about "applying" for an exception to the penalties, but there are certain rules allowing you time to invest proceeds from capital raising and property sales.
Here is the formula: (total assets x 90%) - total qualified assets = X. If greater than zero, then multiply "X" by the federal underpayment rate designated for the month of noncompliance. If equal to or less than 0, there is no penalty. This penalty is calculated monthly for each month of noncompliance. If you have reasonable cause for failure to meet the 90% test, you can avoid penalties. There is currently no bright-line test for reasonable cause. Therefore it's based on the fund's facts and circumstances. An example, though, could be someone committing fraud, an act of God destroying records, a clerical error that caused noncompliance and has since been rectified. I expect though some future guidance will be provided to ask for penalty abatement under reasonable cause.
The penalties are computed using Form 8996 on a monthly basis. There is no relief for complying with any lower percentages. The second set of regulations provided certain relief for contributions received during the six months prior to the test date and one year for proceeds from distributions if kept in cash, cash equivalents and debt instruments with life of less than 18 months.
The penalty as currently provided for in the statute will be based on the amount by which you miss the investment standard. The 10% allowance is all that is permitted at this time.
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