Because it violates the proposed regulations and that would be a non-qualified asset held by the QOZB or QOF. A 15-month maturity is fine. If the loan is a trade or business loan versus an investment, a longer period may be allowed.
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Why shouldn’t my QOZB make a loan to another with a term of more than 18 months?
Would it be safe if we set the limit to 15 months instead?
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There are a variety of situations in which a QOF or QOZB gets a pass from certain hyper-technical rules if its non-operating assets are held in "cash, cash equivalents, or debt instruments with a term of 18 months or less. The rules are terribly convoluted, so you really have to know the exact facts of your situation to know just which rule you are trying to get around and exactly how to accomplish that. Accordingly, I can't give a one-size-fits-all answer. However, I will note that a 15-month note isn't really better than an 18-month note. For purposes of this code section, they are equivalent. They both have a term of 18 months or less. Having said that, I could imagine someone using a note with a term that is shorter than 18 months, so that if something goes wrong, and the term of the note winds up getting extended, your extended note still has a term of less than 18 months. But that's a practical analysis, and not a legal one.
No more than 5% of the assets of the QOZB can be in so-called "non-qualified financial property." Debt instruments, regardless of term, are non-qualified financial property. There is an exception, however, for working capital. One of the requirements for a debt instrument to be working capital is that it have a term of no more than 18 months. There are other requirements for working capital.
Careful not to violate working capital rules.
The QOZB must be vigilant of several requirements. In specific terms, the 70% requirement has to be property held by the business and the limitation of 5% on non-qualified financial assets.
A QOZB cannot have more than 5% of the unadjusted tax basis of its assets in non-qualified financial property (NQFP). NQFP include notes, stock, bonds, interests in partnerships or LLCs, etc. But a QOZB is permitted to have reasonable working capital. There is a safe harbor for working capital that is to be used for constructing, improving or acquisition of tangible property or developing a business (must be a written plan as to how the working capital will be spent, the working capital must be spent substantially consistent with the written plan, and each infusion of working capital meeting the prior two tests must be spent within 31 months of receipt by the QOZB). Reasonable working capital may be held in cash, cash equivalents, or notes with a term of 18 months or less. A QOZB also can have working capital that does not meet the safe harbor if it can justify that it is reasonably needed working capital for its business. If a loan does not meet the reasonable working capital tests, it is a bad asset and if it exceeds 5% of the unadjusted basis of the entity’s assets, the entity won’t qualify as a QOZB and that failure could cause QOFs that invested in it to fail their 90% test. The QOZ rules are very technical and complicated. You should consult with your own tax advisors.
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