Opportunity-zone business may count land-sale income toward its active-business test

Plain-English summary

A qualified opportunity zone business was developing a retail and multifamily real estate project on two parcels. During its start-up period, an unrelated buyer unsolicitedly offered to purchase one parcel, requiring the business to redesign the project for the remaining parcel. The business planned to reinvest the net sale proceeds in the revised project and said the COVID-19 pandemic had significantly delayed construction. The IRS ruled that gross income from the land sale could count as income from the active conduct of a trade or business for the 50 percent opportunity-zone test. This treatment depended on adopting a new or revised working-capital plan within 120 days after the qualified-disaster incident period ended and spending the net proceeds within the applicable original 31-month period plus the available 24-month disaster extension. The IRS did not decide whether the funds, partnerships, business, merger, or working-capital plans otherwise satisfied the opportunity-zone rules.

Ruling snapshot

• Question: Could income from a start-up opportunity-zone business's sale of one development parcel count toward the 50 percent active-business gross-income test?
• Outcome: approved, subject to a timely revised working-capital plan and the applicable spending periods
• Key authorities: IRC §§ 1397C(b), 1400Z-2(d), and 708(b)(2)(A); Treas. Reg. § 1.1400Z2(d)-1

Full text (IRS public release)

 Internal Revenue Service                                       Department of the Treasury
                                                                Washington, DC 20224

 Number: 202249005                                              Third Party Communication: None
 Release Date: 12/9/2022                                        Date of Communication: Not Applicable
 Index Number: 1400Z.02-00
                                                                Person To Contact:
 -----------------------------------                            ------------------------, ID No. ------------------
 -------------------------------                                ----------------------------------------------------
 --------------------------                                     Telephone Number:
 -----------------------------                                  -------------------
                                                                Refer Reply To:
     -------------------------------------------------------    CC:ITA:B05
                                                                PLR-105848-22
                                                                Date:
                                                                October 17, 2022



                 TY: -------

Legend

 Taxpayer               =    -----------------------------------
 Date 1                 =    ---------------------
 Project                =    -------------------------------------------------------------
 City                   =    ------------
 Initial QOZB A         =    ---------------------------------
 Initial QOZB B         =    ----------------------------------
 Date 2                 =    -------------------
 Date 3                 =    -------------------
 Date 4                 =    -------------------
 Date 5                 =    --------------------------
 Date 6                 =    ----------------
 Date 7                 =    --------------------------
 Date 8                 =    --------------
 Date 9                 =    --------------------------
 $y                     =    -----------------
 Date 10                =    --------------------------
 Date 11                =    --------------------------
 Participating          =    --------------------------------------------------------------------------------------
 QOFs                        --------------------------------------------------------------------------------------
                             --------------------------------------------------------------------------------------
                             --------------------------------------------------------------------------------------
                             ---------------------------------------

Dear ---------------:

This letter supersedes our letter, dated September 12, 2022, for correction of obvious
error.
PLR-105848-22                                2


This ruling responds to Taxpayer’s request for a letter ruling, dated Date 1, on the
application of the 50% gross income requirement under § 1400Z-2(d)(3)(A)(ii) of the
Internal Revenue Code (Code). Specifically, Taxpayer is requesting a ruling that the
gross income derived by Taxpayer from the sale of land may be treated as gross
income derived from the active conduct of a trade or business in a qualified opportunity
zone (QOZ) for purposes of satisfying § 1400Z-2(d)(3)(A)(ii) of the Internal Revenue
Code (Code), provided that Taxpayer adopts a new or revised working capital plan
within 120 days of the end of the qualified disaster incident period satisfying the
requirements of § 1.1400Z2(d)-1(d)(3)(v)(A) through (E) of the Income Tax Regulations
(Regulations) and that plan utilizes the proceeds of such sale (net of any tax
distributions) in a manner such that the completion of spending takes into account the
originally allowed up-to-31 month period and up-to-24 additional months where
applicable provided by § 1.1400Z2(d)-1(d)(3)(v)(B) of the Regulations and
§ 1.1400Z2(d)-1(d)(3)(v)(D) of the Proposed Income Tax Regulations (Proposed
Regulations).

                                         FACTS

Taxpayer represents the facts are as follows:

The Project is a real estate project being developed in a QOZ located in City. The
Project consists of the development and construction of new retail and multifamily
housing. As part of the financing of the Project, multiple separate qualified opportunity
funds (QOF) were created and formed for the sole purpose of investing in the Project
(together, “Participating QOFs”). Taxpayer represents that each Participating QOF has
timely self-certified and continues to satisfy the requirements under §§ 1400Z-2(d) of
the Code and the regulations thereunder.

Two separate qualified opportunity zone businesses (QOZB), Initial QOZB A and Initial
QOZB B (together, “Initial QOZBs”), were also created for the sole purpose of
developing, constructing and operating the Project and were treated as partnerships for
Federal tax purposes. Initial QOZB A and Initial QOZB B created and formed wholly
owned, disregarded subsidiaries for the sole purpose of acquiring certain parcels of land
for the development and construction of buildings.

On Date 2, Date 3, and Date 4, the Participating QOFs funded both Initial QOZB A and
Initial QOZB B. Initial QOZB A used the funds plus a promissory note to purchase
Parcel B. Initial QOZB B used the funds plus a promissory note to purchase Parcel C.
Both purchases were from an unrelated third party. On Date 3, upon receipt of the first
tranche of capital, each QOZB adopted an initial working capital plan and written
schedule.

On Date 5, the QOFs funded both Initial QOZBs. Expenditures by Initial QOZBs were
expended in a manner substantially consistent with the working capital plan and the
PLR-105848-22                               3

written schedules originally adopted by the QOZBs upon receipt of the first and second
tranches of funding. On Date 5, upon the receipt of the second tranche of capital, the
working capital plan and written schedule were supplemented by additional written
plans reflecting the additional capital.

Throughout this period beginning with Date 2 and through the merger transaction on
Date 6, Initial QOZBs continued to maintain working capital plans and updated written
schedules intended to satisfy § 1.1400Z2(d)-1(d)(3)(v) of the Regulations, including on
each date of the QOZB testing dates determined to apply between the initial funding
date through the merger transaction. In addition, each QOZB properly designated the
cash amounts as working capital assets pursuant to its written schedules such that the
unexpended balances held on each of the applicable QOZB testing dates as reasonable
in amount for purposes of applying the nonqualified financial property limitation.

On Date 6, Initial QOZB A merged into Initial QOZB B under state law and formed
Taxpayer. Taxpayer is organized as a partnership and uses the accrual method.
Between Date 6 and Date 7, Taxpayer incurred additional predevelopment costs. The
amount was expended in a manner substantially consistent with the working capital plan
and the written schedules originally adopted and subsequently supplemented.

On Date 8, an unrelated third party, unsolicited, approached Taxpayer to purchase
Parcel B. On Date 8, Taxpayer entered into a purchase and sale agreement to sell
Parcel B to the unrelated third party for $y. Taxpayer represents that because of the
sale of Parcel B, Taxpayer will need to revise the scope of the Project to fit entirely
within Parcel C. Taxpayer also represents that any gain on the sale of Parcel B is
expected to be allocated to its partners and subject to income tax. Additionally,
Taxpayer represents that Taxpayer will reinvest the additional proceeds received from
the sale of Parcel B (net of tax distributions) in the Project and the project scope
reduced. Further, Taxpayer also represents that the Covid-19 pandemic has
significantly impacted and delayed the Project.

Taxpayer also intends to adopt a new or revised working capital safe harbor plan to
reflect the revised scope. The revised plan will decrease the number of residential units
and retail square footage and extend the completion date by a few years.

Taxpayer further represents that throughout the post-merger period beginning Date 6
through the date of filing this ruling request, Taxpayer has continued to maintain
working capital plans and written schedules intended to satisfy the requirements of
§ 1.1400Z2(d)-1(d)(3)(v) of the regulations including on each of the QOZB testing dates
determined to apply between the merger date and the filing of this ruling request.

                                RULING REQUESTED

Taxpayer requests a ruling that the gross income derived by Taxpayer from its sale of
Parcel B, which occurs during Taxpayer’s start-up period, may be treated as gross
PLR-105848-22                                4

income derived from the active conduct of a trade or business in a QOZ for purposes of
satisfying § 1400Z-2(d)(3)(A)(ii) and § 1397C(b)(2) of the Code, provided that Taxpayer
adopts a new or revised working capital plan within 120 days of the end of the qualified
disaster incident period satisfying the requirements of § 1.1400Z2(d)-1(d)(3)(v)(A)
through (E) of the Regulations and that such plan utilizes the proceeds from the sale of
Parcel B (net of any tax distributions) in a manner such that the completion of spending
takes into account the originally allowed up to 31-month period and up-to-24 additional
month period, as provided by § 1.1400Z2(d)-1(d)(3)(v)(B) Regulations and
§ 1.1400Z2(d)-1(d)(3)(v)(D) of the Proposed Regulations.

                                   LAW & ANALYSIS

Section 1400Z-2(d)(3) of the Code provides the term qualified opportunity zone
business means a trade or business in which substantially all of the tangible property
owned or leased by the taxpayer is qualified opportunity zone business property, which
satisfies the requirements of § 1397C(b)(2), (4) and (8) and which is not described in
§ 144(c)(6)(B).

Section 1397C(b) sets forth 8 requirements that a corporation or partnership must
satisfy to qualify as a ‘qualified business entity’ and therefore an ‘enterprise zone
business’. Section 1400Z-2(d)(3) incorporates three of these eight requirements.
Sections 1397C(b)(2) and (8) are relevant to this ruling. Section 1397C(b)(2) requires
that “at least 50% of the total gross income of such entity is derived from the active
conduct of such business.” Thus, a QOZB must derive at least 50% of its total gross
income from the active conduct of a trade or business within a QOZ. Section
1397C(b)(8) requires that a QOZB hold less than 5% of its aggregate unadjusted bases
of the property of such entity is attributable to nonqualified financial property. Section
1397C(e)(1) defines the term nonqualified financial property to mean debt, stock,
partnership interests, options, futures contracts, forward contracts, notional principal
contracts, annuities and other similar property, however it does not include reasonable
amounts of working capital held in cash, cash equivalents, or debt instruments with a
term of 18 months or less.

To determine if substantially all of the tangible property owned or leased by the QOZB is
qualified opportunity zone business property, § 1.1400Z2(d)-1(d)(2)(i) of the Regulations
provides that ‘substantially all’ means that at least 70% of the QOZB’s tangible property
owned or leased is qualified opportunity zone business property.

Section 1400Z-2(d)(2)(D) of the Code provides that qualified opportunity zone business
property is tangible property used in a trade or business of the QOZB if such property
was acquired by the QOZB by purchase (as defined in § 179(d)(2)), after December 31,
2017, and the original use of the property commenced with the QOZB or the QOZB
substantially improved the property. Finally, during substantially all of the QOZB’s
holding period of the property, substantially all of the use of such property was in a
QOZ.
PLR-105848-22                                5


Section 1.1400Z2(d)-1(d)(3)(v) of the Regulations provides that solely for purposes of
applying § 1397C(e)(1) to the definition of a QOZB, working capital assets are treated
as reasonable in amount if the following requirements are satisfied:

              A) The amounts are designated in writing for the development of a trade
or business in a QOZ, including when appropriate the acquisition, construction and/or
substantial improvement of tangible property;
              B) There is a written schedule consistent with the ordinary start-up of a
trade or business for the expenditure of working capital assets and such assets must be
spent within 31 months of the receipt of the assets;
              C) The working capital assets are actually used in a manner substantially
consistent with the writing and written schedules above;
              D) If the QOZB is located in a QOZ within a federally declared disaster,
the QOZB may receive not more than an additional 24 months to consume its working
capital assets; and
              E) A business may benefit from multiple overlapping or sequential
applications of the working capital safe harbor, provided that each application
independently satisfies all of these requirements.

Section 1.1400Z2(d)-1(d)(3)(v)(D) of the Proposed Regulations modified the existing
§ 1.1400Z2(d)-1(d)(3)(v)(D) of the Regulations to reflect the need for additional
clarification due to the ongoing Covid-19 pandemic. The modification provided flexibility
for QOZBs to revise or replace their original written designation and written plan if the
QOZB is located in a QOZ within a federally declared disaster, provided that the
remaining working capital assets are expended within the original regulatorily required
31-month period, increased by the additional 24 months.

Section 1.1400Z2(d)-1(d)(3)(vi)(A) of the Regulations provides that property described
in paragraphs (d)(3)(vi)(B), (C) and (D) of this section may benefit from one or more
31-month periods, for a total of 62 months, in the form of multiple overlapping or a
sequential application of the working capital safe harbor period if:

       1) Each application independently satisfies all of the requirements in
§ 1.1400Z2(d)-1(d)(3)(v)(A) through (C) of the Regulations;
       2) The working capital assets from an expiring 31-month period were expended
in accordance with the requirements of § 1.1400Z2(d)-1(d)(3)(v)(A) through (C) of the
Regulations;
       3) The subsequent infusions of working capital assets form an integral part of the
plan covered by the initial working capital safe harbor period; and
       4) Each overlapping or sequential application of the working capital safe harbor
includes a substantial amount of working capital assets.

This provision only applies to start-up businesses.
PLR-105848-22                                 6

Section 1.1400Z2(d)-1(d)(3)(vi)(B) of the Regulations provides that solely for purposes
of applying the 50% test in § 1397C(b)(2) of the Code to the definition of a QOZB in
§ 1400Z-2(d)(3), if any gross income is derived from property that is treated as a
reasonable amount of working capital, then that gross income is counted towards the
satisfaction of the 50% test.

Section 1.1400Z2(d)-1(d)(3)(vi)(D)(1) of the Regulations provides for start-up
businesses utilizing the working capital safe harbor, if paragraph (d)(3)(v) of this section
treats property of an entity that would otherwise be nonqualified financial property as
being a reasonable amount of working capital because of compliance with the three
requirements of paragraphs (d)(3)(v)(A) through (C) of this section, the entity satisfies
the requirements of § 1400Z-2(d)(3)(A)(i) of the Code only during the working capital
safe harbor period(s) for which the requirements of paragraphs (d)(3)(v)(A) through (C)
of this section are satisfied; however such property is not qualified opportunity zone
business property for any purpose.

Section 1.1400Z2(d)-1(d)(3)(vi)(D)(2) of the Regulations provides that tangible property
referred to § 1.1400Z2(d)-1(d)(3)(v)(A) is expected to satisfy the requirements of section
1400Z-2(d)(2)(D)(i) of the Code as a result of the planned expenditure of working capital
described in § 1.1400Z2(d)-1(d)(3)(v)(A), and is purchased, leased, or improved by the
trade or business, pursuant to the written plan for the expenditure of the working capital,
then the tangible property is treated as qualified opportunity zone business property
satisfying the requirements of § 1400Z-2(d)(2)(D)(i), during that and subsequent
working capital periods the property is subject to, for purposes of the 70-percent
tangible property standard in § 1400Z-2(d)(3).

Section 1400Z-2(d)(2)(C) of the Code provides that a qualified zone partnership interest
means any capital or profits interest in a domestic partnership if, where such interest is
acquired by a QOF after December 31, 2017, from a partnership solely in exchange for
cash, and as of the time the interest was acquired, such partnership was a QOZB, or in
the case of a new partnership, was organized for purposes of being a QOZB, and
during substantially all of the QOF’s holding period for the interest, such partnership
qualified as a QOZB.

Section 1.1400Z2(d)-1(c)(3)(ii)(A) of the Regulations provides that a partnership interest
that meets all the requirements to be treated as a qualified opportunity zone partnership
interest except for the requirement that the partnership interest is acquired by the QOF
after December 31, 2017, from the partnership solely in exchange for cash, is a
qualified opportunity zone partnership interest if it is received solely in exchange for a
qualified opportunity zone partnership interest in a merger or a consolidation transaction
described in § 708(b)(2)(A) of the Code. The other requirements of § 1400Z-2(d)(2)(C)
must be met with respect to both the partnership interest held before the transaction
and the partnership interest for which it is exchanged in the transaction.
PLR-105848-22                                7

Section 708(b)(2)(A) of the Code provides that in the case of a merger or consolidation
of two or more partnerships, the resulting partnership shall be considered the
continuation of any merging or consolidating partnership whose members own an
interest of more than 50% in the capital or profits of the resulting partnership.

Section 1.1400Z2(d)-1(c)(3)(ii)(B) of the Regulations provides that the requirements of
§ 1400Z-2(d) of the Code apply to the property of a QOZB acquired from a QOZB in a
transaction described in § 708(b)(2)(A) as if the resulting partnership has held the
property during the period in which the merging or consolidating partnership held the
property. For example, an item of property must be substantially improved by the same
date by which the merging or consolidating partnership was required to satisfy the
substantial improvement test for such property.

Taxpayer represents that Initial QOZB A and Initial QOZB B qualify as QOZBs.
Taxpayer represents that throughout the period beginning with Date 2 and through the
merger transaction on Date 6, Initial QOZBs continued to maintain working capital plans
and updated written schedules intended to satisfy § 1.1400Z2(d)-1(d)(3)(v) of the
Regulations, including on each date of the QOZB testing dates determined to apply
between the initial funding date through the merger transaction. Taxpayer further
represents that that throughout the post-merger period beginning Date 6 through the
date of filing this ruling request, Taxpayer has continued to maintain working capital
plans and written schedules intended to satisfy the requirements of
§ 1.1400Z2(d)-1(d)(3)(v) of the Regulations including on each of the QOZB testing
dates determined to apply between the merger date and the filing of this ruling request.

Initial QOZBs were formed with the sole purpose of acquiring Parcel B and Parcel C
located in a QOZ, and to develop, construct and operate the newly constructed
buildings located on Parcels B and C. They received capital from certain entities
certified as QOFs and in exchange, gave the entities a capital partnership interest.

With the capital provided from the first tranche, the Initial QOZBs purchased Parcel B
and Parcel C. Parcel B and Parcel C are land parcels located in a QOZ and were
purchased from an unrelated third party after December 31, 2017.

Initial QOZB A was merged into Initial QOZB B under state law in a merger transaction
described in § 708(b)(2)(A) of the Code on Date 6, with Initial QOZB B surviving, and
Initial QOZB B changed its name to Taxpayer. Because of the application of § 708 of
the Code, Taxpayer is treated under § 1.1400Z2(d)-1(c)(3)(ii) as retaining its QOZB
status for federal income tax purposes, provided it continues to meet the requirements
of § 1400Z-2(d)(3) after the merger. Further, because Parcel B and Parcel C were
purchased by Initial QOZBs prior to the merger and continued to be owned by the
successor partnership, the parcels retain their characterization as qualified opportunity
zone business property.
PLR-105848-22                                8

The working capital and written schedules adopted by Taxpayer on Date 10 and Date
11 aggregated and merged the earlier, separate working capital plans adopted by Initial
QOZBs with the third working capital plan and written schedules executed by Taxpayer,
such that for state law purposes a new aggregate written working capital plan was
comprised of three separate, sequential or overlapping plans effective for the post-
merger period.

Upon the sale of Parcel B to the unrelated third party, Taxpayer will revise the scope of
the Project so that it can be completed within the geographic limitations of Parcel C.
These changes will be reflected in a revised working capital plan and written schedules
that will be adopted upon the receipt of the sale proceeds or not later than 120 days
after the close of the incident period, as defined in 44 C.F.R. 206.32(f), with respect to
that disaster. Taxpayer will revise its working capital plans to designate unexpended
working capital assets from its three prior plans and aggregate these working capital
assets with the net proceeds from the sale of Parcel B into new written plans and
expenditure schedules identifying when and how subsequent expenditures would be
taken into account while satisfying the requirements of § 1.1400Z2(d)-1(d)(3)(v)(A)
through (E) of the Regulations. Each tranche of funding received between Date 2 and
Date 8 remains required to be expended within 55 months from the date of receipt and
in no case longer than 86 months from the date the first tranche of working capital
assets was received.

Parcel B was purchased with capital treated as working capital by Initial QOZB A and
was purchased pursuant to the working capital plan and written schedules. Section
1.1400Z2(d)-1(d)(3)(vi)(B) of the Regulations requires that such working capital assets
be the origin of the gross income derived for such amount to be counted toward the
satisfaction of the active trade or business requirement. Because Parcel B was
purchased with working capital assets, the proceeds of the sale of Parcel B may also be
treated as working capital assets solely for purposes of satisfying the 50% test in
§ 1397C(b)(2) of the Code in application to the definition of a QOZB. Further, Taxpayer
intends to reinvest these proceeds (net of any tax distributions) and will incorporate the
amounts into its revised working capital plans and written schedules, becoming
functionally indistinguishable from other working capital assets.

                                     CONCLUSION

Based on the information submitted and the representations given, the following ruling
is hereby granted:

The gross income derived by Taxpayer from its sale of Parcel B, which occurs during
Taxpayer’s start-up period, may be treated as gross income derived from the active
conduct of a trade or business in a QOZ for purposes of satisfying § 1400Z-2(d)(3)(A)(ii)
and § 1397C(b)(2) of the Code, provided that Taxpayer adopts a new or revised
working capital plan within 120 days of the end of the qualified disaster incident period
satisfying the requirements of § 1.1400Z2(d)-1(d)(3)(v)(A) through (E) of the
PLR-105848-22                                  9

Regulations and that such plan utilizes the proceeds from the sale of Parcel B (net of
any tax distributions) in a manner such that the completion of spending takes into
account the originally allowed up to 31-month period and up-to-24 additional month
period, as provided by § 1.1400Z2(d)-1(d)(3)(v)(B) of the Regulations and
§ 1.1400Z2(d)-1(d)(3)(v)(D) of the Proposed Regulations.

Except as expressly provided herein, no opinion is expressed or implied concerning the
tax consequences of any aspect of any transaction or item discussed or referenced in
this letter. Specifically, we express no opinion, either express or implied, concerning
whether any investments made into the Participating QOFs are qualifying investments
as defined in § 1.1400Z2(a)-1(b)(34) of the Regulations or whether the Participating
QOFs meet the requirements under § 1400Z-2 of the Code and the Regulations
thereunder to be a QOF. Also, we express no opinion on whether any partnership
interest held by the Participating QOFs in the Initial QOZBs or Taxpayer qualifies as
qualified opportunity zone property, as defined in § 1400Z-2(d)(2). Additionally, we
express no opinion on whether Initial QOZB A, Initial QOZB B, or Taxpayer meets the
requirements under § 1400Z-2(d)(3) to be QOZBs, or whether their working capital
plans meets the safe harbor requirements of § 1.1400Z2(d)-1(d)(3)(v) of the
Regulations. Moreover, we express no opinion, either express or implied, concerning
any aspect of the merger of Initial QOZB A into QOZB B. Further, we express no
opinion regarding the tax treatment of the instant transaction under the provisions of any
other sections of the Code or regulations that may be applicable, or regarding the tax
treatment of any conditions existing at the time of, or effects resulting from, the instant
transaction.

This ruling is directed only to the taxpayer requesting it. Section 6110(k)(3) of the Code
provides that it may not be used or cited as precedent.

In accordance with the Power of Attorney on file with this office, a copy of this letter is
being sent to your authorized representative.

A copy of this letter must be attached to any income tax return to which it is relevant.
Alternatively, taxpayers filing their returns electronically may satisfy this requirement by
attaching a statement to their return that provides the date and control number of the
letter ruling.
PLR-105848-22                               10

The rulings contained in this letter are based upon information and representations
submitted by the taxpayer and accompanied by a penalty of perjury statement executed
by an appropriate party. While this office has not verified any of the material submitted
in support of the request for rulings, it is subject to verification on examination.

                                     Sincerely,



                                     Christina M. Glendening
                                     Senior Counsel, Branch 5
                                     Office of Associate Chief Counsel
                                     (Income Tax & Accounting)


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