What are the pros and cons of both these methods and why should I chose one over the other?
Whether the financial statement or alternative valuation method will give you a better result depends on various factors. You will have a bit more discretion on the alternative valuation method, since the NPV will vary by interest rate and other factors. Smaller funds will not want the cost of a full audit, which can easily exceed $20,000 per period.
You might not even have a choice if you don't file an "applicable financial statement." If you file an AFS, though, you'll be able to review this really thoroughly with your accounting and legal team to weigh which one is most advantageous. It will depend on facts and circumstances. There's no blanket answer.
The proposed regulations require that a QOF or Qualified Opportunity Zone Business may select the applicable financial statement valuation only if the applicable financial statement is prepared according to U.S. generally accepted accounting principles (GAAP) and requires recognition of the lease of the tangible property. Under the alternative valuation method, the value of tangible property that is leased by a QOF or Qualified Opportunity Zone Business is determined based on a calculation of the “present value” of the leased tangible property at the time the lease for such property is entered into. Once calculated, the proposed regulations require that such calculated value be used as the value for such asset for all testing dates for purposes of the “substantially all of the use” requirement and the 90-percent asset test. What method is better will depend on your particular facts and circumstances.
The applicable financial statement method is the value reported on a GAAP balance sheet, provided that a value for the lease is required to be reported on the GAAP balance sheet. The alternative method is the net present value of the lease payments determined using the applicable federal rate as the discount rate. The applicable federal rate for short-term, mid-term and long-term debt is published monthly by the IRS and the rate used is the one that would be applied to debt instruments of the same term as the lease. Renewal options of the lease are included in the lease term if the rent is predetermined. Once the net present value is determined at the beginning of the lease, that is the value used for the remainder of the lease under the alternative method. If the QOF or QOZB does not have GAAP financial statements, the alternative method should be used. You should discuss which method you would want to use with your accountants or legal advisors. As you know, the QOZ provisions of the Internal Revenue Code are very complicated and the complying with highly technical rules are key to obtaining the benefits.
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