The second round of proposed regulations specifically addressed this. You can't pre-pay the rent and must acquire new property with a value at least equal to the value of the leased property.
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What happens if a lease is between related parties in an OZ transaction?
What additional requirements do they need to follow in this lease situation?
Answers
You need to make sure the lease is at fair-market value. I have been advising clients to retain an MAI-certified real estate appraiser to determine FMV in these situations.
The lease should meet arm's length standards under Section 482 transfer pricing principles.
Leases between related parties are permitted by the proposed regulations. For purposes of the QOF's 90% test and the QOZB's 70% test, the QOF or the QOZB may use the value for the lease reported on a GAAP financial statement if GAAP assigns a value thereto or the present value of the lease payments using the AFR as the discount rate. You should discuss the leasing rules with your accountants or legal advisors. As you know, the QOZ provisions of the Internal Revenue Code are very complicated and complying with these highly technical rules are key to obtaining the benefits.
A related party lease cannot have prepayments of more than one year. If the original use of leased tangible personal property in a Qualified Opportunity Zone does not commence with the lessee, the property is not Qualified Opportunity Zone business property, but certain exceptions may apply.
A related party lease (a lease between owners owning more than 20% of a QOF) will require the lessor/fund to lease or buy an equal dollar value of other equipment from a third party. For example, if a lessor leases $100,000 of tangible assets to a QOF or QOZB that owns more 20% of the fund, then the fund will need to purchase or lease another $100,000 of assets in order for the related-party leased assets to qualify as QOZ property. The lease must be "arms-length" in terms of the economics and any buy-out options and the lessee cannot prepay more than 12 months of lease payments.
If the lease is otherwise structured at arms-length/market rate - the related party lease also requires no prepayments from QOF/QOZB to the lessor. If QOF or QOZB is leasing any personal property, the QOF or QOZB must purchase additional personal property of an equal value during the lease term. There must not have been a plan, intent or expectation for the real property to be purchased by the QOF for an amount other than FMV.
That’s OK. The lease has to be at FMV rent and other similar requirements.
If the lease is among related parties, the same must be at arms' length value and the lessee must take title of the property within 30 months. In addition, prepayment is limited to 12 months of rent.
Lease is exempt from the related party rules. The lease must be at fair market value and cannot have prepayments beyond a year.
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