You have to look at the statutes and guidance and work with a good attorney to ensure compliance. Unfortunately, there is no registry or Good Housekeeping-type seal of approval.
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How can a QOF investing in operating businesses know for sure that the business is a qualified OZ operation?
I want to invest in a fund that is focusing on businesses in Opportunity Zones. How do businesses prove their status and what kind of obligation do they have to stay qualified so I don’t lose out on my tax benefits?
Answers
There are many ways to confirm. You have to structure your agreement to address this.
Ultimately, qualification of a business is based on geography (in a zone), new investments (satisfying the 70% test) and not being one of the so-called sin businesses. A fund investing in such a business should be able to have sufficient objective information, absent fraud, to confirm that the benefit is available.
As an potential investor in a fund, your ability to vet the operations of individual businesses will be constrained by the fund structure. You should expect to rely primarily on the fund manager to monitor and ensure legal compliance for individual investments. In turn, the documentation for the funds should explain exactly how the fund manager intends to do so. You need to be confident that the answer is sufficient (or negotiate for stricter controls if you are not satisfied).
This is a very good question and an important due-diligence requirement. I would ask the business for a lot of disclosure around how they intend to comply because it certainly is harder to be sure of an investment when you are not dealing simply with real estate. Evaluate their team of advisors and look for disclosure on how they intend to monitor themselves and to cure issues. You might want to consider investing in a fund that invests in a single business, although there can be benefits on having a fund invest in multiple QOZBs, as I'm sure you know.
The requirement to confirm that any Qualified Opportunity Zone business you invest in meets the requirements of the law is the responsibility of the investor. If the investor is invested in a fund, the fund manager/asset manager is responsible for making that ongoing determination. Generally speaking, the QOZB should represent to the investor that the operation will, on an ongoing basis, meet the requirements of a QOZB.
They self-certify. You need a good investment document and you need to know you are dealing with reputable and experienced operators.
The filings required of QOZBs have not yet been released. The IRS is working on those. There are several compliance tests in the statute and regulations that a QOZB must follow, or a QOF must follow if it operates an enterprise directly. This doesn't mean that operating businesses are entirely free from ambiguity, but in my estimation, there's enough clarity to move forward with most ideas for operating businesses.
It is very important that all the requirements are understood by all parties involved. The regulations provide the requirements. It is the responsibility of the business and the QOF to establish the necessary controls and processes to ensure compliance.
I have seen some of these business plans. Due to the complexities of the related party rules as well as the requirement that the assets are "first used" in an OZ, this can cause some hurdles in qualifying a business that is already in an OZ. It can be done, but requires asset-by-asset substantial improvements to qualify. Which is impractical/ impossible? Treasury received many complaints about the asset-by-asset test vs. an aggregate approach. It is possible to lease the assets of the existing business, but if the old owners own more than 20% of the QOF, then the related party rules under the lease provisions kick in and the QOF needs to purchase additional assets (equal or exceeding the value of the leased assets) to be used in the OZ. As far as qualifying the business, the regulations provide fairly clear guidelines, and generally if more than 50% of the income and 70% of the assets held by a Qualified Opportunity Zone Business are used in the OZ, you will meet the semi-annual tests. I prefer to see newly purchased businesses relocate into an OZ or for investors to start a new business.
The fund manager should be doing extensive compliance monitoring at a minimum to make sure that the businesses each meet the various requirements. Best case would be legal opinions, but I'm not seeing such opinions being required in many transactions as opinions result in significant additional expense. The bottom line is that you need to be very comfortable with your fund manager and the level of due diligence and their risk tolerance before investing.
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