This is not an ideal situation for a developer in a QOZ to be in. Basically, the developer is limited by the related party rules, which dictate that the "seller" of the land hold less than 20% of all capital and profits interests.
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What happens if a developer purchases land before establishing a QOF or QOZB?
What options does the developer have to take advantage of the Opportunity Zone program?
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You can elect for the purchasing entity (if any) to be a QOF. You can enter a master lease with a QOZB, even a related one. You can even contribute the land to a new QOF, provided that you can meet the other testing requirements once construction is finished.
A developer may have several options. If he purchased the land in a single purpose entity treated as a partnership or corporation, then that entity could be the QOZB. In this case, he would just form another entity to be the QOF, which would receive investments of deferred gains from the developer or investors, or both, and invest the proceeds to the QOZB. If he purchased the land in an entity that cannot qualify as a QOZB, or is disregarded from an entity that cannot qualify as a QOZB, then he would need to sell the property to an entity that can qualify as a QOZB. The issue here is whether the seller entity will be treated as related to the new QOZB, which can be addressed at least three ways. First, if the developer can keep his interest in the QOZB below the relatedness threshold, then the land can be a good asset. Second, if he anticipates having sufficient "good" assets in the QOZB, so that the land accounts for less than 30% of the QOZB's tangible assets, he can move forward with a related party sale. Third, he might also be able to lease the property to the QOZB under a ground lease.
In general, the land may be considered a bad asset and hurt the QOZBP tests at the business level. There are alternatives that may help, but careful study and planning must be performed.
An investor with raw unimproved land located in an opportunity zone seeking the opportunity zone tax incentives must follow strict rules and procedural requirements. First, the previously acquired land will never meet the Qualified Opportunity Zone Business Property (QOZBP) requirements because QOZBP requires property acquired by purchase from an unrelated party. However, vertical improvements made upon the land may able to meet the QOZBP requirements so long as: (i) it is intended to be used in a trade or business in an opportunity zone; (ii) the materials used to construct the new building were QOZBP; and (iii) it is treated as acquired after 2017. Second, because any buildings constructed on the land will be considered original use QOZBP, you must create a QOF and a QOZB, and have the QOZB utilize a working capital safeharbor to complete construction. You can not build original use property at the QOF level without failing the 90% Qualified Opportunity Zone Property Requirement. Because the QOZB must have substantially all (at least 70%) of the tangible property owned or leased by the QOZB be considered QOZBP, the cost of buildings constructed upon the land must exceed at least 233.33% of the value of the land. When determining compliance with this 70% tangible property test, the land will not be considered QOZBP, but the buildings will. Thus, the QOZB will be able to meet the 70% tangible property test so long as the cost of the building is at least 2.33X more valuable than the land (2.33/3.33=70%). Third, you must not contribute the land to a QOF because a QOF cannot contribute the land to the QOZB since stock or partnerships interest in the QOZB must be acquired by the QOF solely in exchange for cash. Thus, you can only contribute the land to the QOZB. Fourth, according to the OZ rules, land contributed to the QOZB will be valued at FMV each year because it is not purchased. Thus, you construct buildings at a cost that vastly exceeds the 2.33X threshold. The way for an investor with land located in an opportunity zone to structure this transaction is to create a QOF, invest eligible gains into the QOF, and then create a QOZB. When creating the QOZB, the QOF will contribute cash in exchange for stock or partnership interests in the QOZB, and the investor contributes the land. The QOZB will then utilize a working capital safe harbor to build structures upon the contributed land at a cost equaling at least 2.33X of the land value. Upon the expiration of the working capital safe harbor period, the QOZB will need to operate a trade or business in an opportunity zone that meets the five QOZB requirements. However, the QOZB will satisfy the 70% tangible property test so long as the cost of the building is at least 2.33X greater than the value of the contributed land (remember that you must revalue contributed land each year).
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