Working capital safe harbor only applies to QOZB and QOZB has a 70% qualified asset requirement; QOF has a 90% requirement.
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Why is it more beneficial for an operating business to be owned by a QOZB rather than a QOF?
Does the newly introduced 62-month start-up business Working Capital Safe Harbor impact this?
Answers
The QOZB has easier compliance in general. QOFs owning assets directly do not get to enjoy the same allowances under the statute and regulations as QOZBs. For instance, as you noted, a QOZB enjoys a working capital safe harbor, whereas a QOF does not.
Generally, the QOZB offers a lower threshold for meeting the minimum investment standards. For purposes of applying the 90% test, the QOZB must qualify by sourcing 70% of its assets as qualified property and a 50% income test of which has 3 different ways to qualify.
Ninety percent of a QOF’s assets must be qualified opportunity zone business property QOZBP and/or equity in a QOZB. Cash and accounts receivable are not good assets for this 90% test. In contrast, to be a QOZB, 70% of the entity’s assets must be QOZBP compared to the requirement that 90% of all of a QOF’s property be QOZBP and/or interests in a QOZB; at least 50% of the entity’s gross income must be from the active conduct of a trade or business in a QOZ; the entity cannot operate a sin business or lease 5% or more of its assets to a sin business; 40% of its intangible property must be used in its active business in a QOZ; no more than 5% of its assets can be composed of nonqualified financial property. But, a QOZB can hold reasonable working capital. So yes, the 31-month working capital safe harbor that under certain circumstances could be extended to 62 months, is part of the reason for the two-tier structure used to own an operating business.
As you have noted, the safe harbor is only available for a QOZ business and is not available for a business that is operated directly by the QOF. Additionally, the QOZ business has a substantially all requirement for QOZ business project whereas the QOF has a 90% requirement. There are a few benefits for operating a business within a QOF, but the flexibilities offered in the QOZ business structure often outweigh those at the QOF level.
62 months is not impacted.
To start, the Qualify Opportunity Zone property for the QOF is 90% while for the QOZB is 70%.
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