Submitted by Colleen Campbell, ERCGP Intern
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:
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: