Submitted by Colleen Campbell, ERCGP Intern

Part 3

To attain status as a Qualified Opportunity Zone (QOZ), tangible property must satisfy either the original use or substantial improvement requirement. As legislators released the proposed legislation for Opportunity Zones in May 2019, commenters were quick to question the meaning and boundaries of original use and substantial improvement.

To satisfy the original use requirement, a business property’s original use must commence with the Qualified Opportunity Fund (QOF). This occurs when structures on the property are first placed in service for purposes of depreciation, and that the continued depreciation of previously existing and depreciating structures will not satisfy the requirement. In other words, if a “taxpayer other than the QOF” has made prior use of the property which has resulted in depreciation or amortization, the property must be substantially improved to attain the benefits of a QOZ.

The final regulations clarify a number of issues surrounding the definition of original use:

• Certificates of occupancy may not be used to satisfy the original use requirement for existing structures.
• Properties that have been used previously for non-business activities do not satisfy the original use requirement.
• There is no “safe harbor” for taxpayers who purchase property, believing that it has not already been used.
• Newly constructed buildings that are purchased by a QOF satisfy the original use requirement.
• A special 1-year vacancy period allows a QOF to satisfy the original use requirement if a “property that was vacant prior to and on the date of publication of the QOZ designation notice that listed the designation of the QOZ in which the property is located, and through the date on which the property was purchased by an eligible entity.”
  • Property that was not vacant at the time of the QOZ designation must be vacant for a period of three years to satisfy the original use requirement.
• All real property, land, and structures which compose a brownfield site satisfy the original use requirement. The eligible QOF must however make investments in the land which benefit human health and safety.

If a property does not satisfy the original use requirement, the property must be substantially improved. A property has only been substantially improved only if, “during any 30-month period beginning after the date of acquisition of the property, the QOF or QOZB spends as much to improve the property (measured by additions to basis) as the QOF or QOZB’s original basis in the property at the beginning of the 30-month period.” Furthermore, at least 50 percent of the income of the business must be earned from activity within the QOZ, a substantial portion of the property in the QOZ must be actively used by the entity for business, and  “less than five percent of the average of the aggregate unadjusted bases of the property of such entity must be attributable to nonqualified financial property.”

Any cost added to the value of a property will be used in calculating whether a QOF has made a substantial improvement on property. This may include equipment installation, building demolition, permit fees, and remediation among many other possible expenses. However, commenters questioned the methodology for calculating whether a substantial improvement had been made. The final regulations provide the following clarifications:

• “A QOF or QOZ business may treat all buildings that compose an eligible building group and that are located entirely within the geographic borders of a parcel of land described in a single deed as a single property.”
• “A QOF or QOZ business may treat all buildings composing an eligible building group that are located entirely within the geographic borders of contiguous parcels of land described in separate deeds as a single property to the extent each building is operated as part of one or more trades or businesses that meet the following three requirements:
  • (1) the buildings must be operated exclusively by the QOF or by the qualified opportunity zone business;
  • (2) the buildings must share facilities or share significant centralized business elements, such as personnel, accounting, legal, manufacturing, purchasing, human resources, or information technology resources; and
  • (3) the buildings must be operated in coordination with, or reliance upon, one or more of the trades or businesses (for example, supply chain interdependencies or mixed-use facilities).”