Opportunity Zone LIHTC Structure Fund or Business? "Active" Trade or Business Test

1. Opportunity Zone LIHTC StructureFund or Business?"Active" Trade or Business Test By: Frank A. Hoffman

2. Where Invested? Opportunity Zone designated by the Governor What is Invested? Capital Gain timely (within 180 days) re-invested into Type of Structure? Qualified Opportunity Fund which invests in either • Investment in what? • Qualified Opportunity Zone Property • Qualified Opportunity Zone Business Property • THE DIRECT METHOD • or • 2. Qualified Opportunity Zone Business • THE INDIRECT METHOD

3. QOF 90% Qualifying Asset Test • A QOF must hold 90% of its assets in “qualified opportunity zone property,” which can be a combination of following three items: • "QOZ Business Property" – Direct Method • Newly issued "QOZ Stock" – Indirect Method • Newly issued "QOZ Partnership Interest" – Indirect Method • In the case #1 – the Direct Method, QOZ Business Property is tanigble property used in a any "trade or business" conducted directly by the QOF. • In cases #2 and #3 – the Indirect Method, for stock or a partnership interest to constitute QOZP, the such QOZ corporation or QOZ partnership must conduct a "QOZ Business” that owns QOZ Business Property.

4. Models for Real Estate OwnershipDirect vs Indirect Investors Property QOF QOZ Business Investors QOF Property

5. Investment In what? • Qualified Opportunity Zone Property • Qualified Opportunity Zone Business Property • THE DIRECT METHOD

6. QOZ Business Property – Direct Method • If QOF has no "QOZ Stock" and no "QOZ Partnership" Interest QOF must hold at least 90% of its assets in "QOZ Business Property". • No Other Tests: • No "Active" "Trade or Business" test • No 5% Nonqualified Financial Property Test • No Operating "Sin Business" Limitations • Up to 10% of the assets may be held in cash (assuming other 90% qualify as QOZ Business Property)

7. QOZ Business Property – Direct MethodRev. Rul. 2018-29 • Applies to the QOF direct redevelopment of an industrial site for "residential rental property". • Provides clear guidance that a QOF mutli-family real estate project (regardless of management structure) will qualify as a "trade or business." • Provides clear guidance that QOF land located in an OZ and acquired directly by QOF after December 31, 2018 does not have to be "substantially improved" by the QOF to qualify as QOZ Business Property. • Provides clear guidance the "substantial improvement test" only applies to the cost basis of an existing building and does apply or other wise include the cost basis attributable to the land upon which the building is located.

8. Investment in what? • Qualified Opportunity Zone Property • 2. Qualified Opportunity Zone Business • THE INDIRECT METHOD QOZ Business Property – INDirect Method

9. QOZ Stock or QOZ Partnership Interest • QOF can opt for an indirect invest by investing in QOZ Stock or a QOZ Partnership Interest • Can be any stock in a domestic corporation or any capital or profits interest in a domestic partnership • Must be acquired by a QOF at its original issue • Solely in exchange for cash • The Corporation or Partnership must be qualified as a "QOZ Business" at the time of investment (or was being organized for the purpose of being a Qualified Opportunity Zone) • Must continue to be a QOZ Business during "substantially all" of the QOF’s holding period

10. What is a QOZ Businesses (QOZB)? A QOZ Business is subject to the following requirements: • Entity Test • "Substantially All" of the Tangible Property owned or leased by the Entity must be QOZ Business Property. • 5% limit on "Nonqualified Financial Property" (cash and other financial assets) • Trade or Business Test • 50% “Active” Trade or Business Gross Income Test • Use of a "substantial portion" of the intangible assets in the “Active” Portion of the Trade or Business. • No “sin” business investments

11. What is a QOZ Businesses (QOZB)? There is no definition of what constitutes a "Trade or Business" under Section 1400Z-2 or the Proposed Regulations. Recent Proposed Regulations for Section 199A the IRS and Treasury generally define "trade or business" for section 199A purposes consistent with the meaning of that phrase under Section 162(a). Under prior "trade or business" IRS guidance and case law it is likely that real estate rental activity (including triple net lease structures) would constitute a "trade or business" under Section 1400Z.

12. What is a QOZ Businesses (QOZB)? There is no guidance of what constitutes an "Active” Trade or Business for purposes of applying the 50% Active Gross Income Test in Section 1400Z-2 or 1400Z-2 Proposed Regulations. Recent IRS guidance for what constitutes an "Active" Trade or Business for purposes of Section 355 would limit "Active" Trade or Business for rental real estate to scenarios where the management of the real estate is performed by employees of the entity or employees of controlled affiliates of the entity. Entities with unaffiliated management would not be classified as "active." Recent 199A Proposed Regulations permit a passively held triple net leased property to be considered as an active business activity to the extent that the property is leased to another active trade or business that taxpayer has direct or indirect ownership, if the taxpayer and/or parties related by family attribution or common ownership of the business tenant own more than 50 percent of the business tenant. If the income comes from multiple tenants, one being a related party and the other an unrelated party, then only the portion attributable to the related party will automatically be considered an active trade or business, and the landlord will have to do more than just collect rent from the unrelated party in order for that portion to be considered an active trade or business.

13. What is a QOZ Businesses (QOZB)? IRS Notice 2006-77 states that solely for purposes of Section 1400N(d)(2)(A)(ii) (Go Zone Property Bonus Depreciation), the determination of whether a trade or business is actively conducted by the taxpayer is to be made based on all the facts and circumstances, IRS Notice 2006-77 further states that for purposes of § 1400N(d)(2)(A)(ii) (Go Zone Property Bonus Depreciation), a partner, member, or shareholder of a partnership, limited liability company, or S corporation, respectively, is considered to actively conduct a trade or business of the partnership, limited liability company, or S corporation if the partnership, limited liability company, or S corporation meaningfully participates (through the activities performed by itself, or by others on behalf of the partnership, limited liability company, or S corporation, respectively) in the management or operations of the trade or business.

14. What is a QOZ Businesses (QOZB)? IRS Notice 2006-77 also provides: Example 1. During 2006, MNO, a limited liability company, constructs and places in service a new apartment building in the GO Zone. MNO is treated as a partnership for federal tax purposes.B, a member in MNO, manages and operates this apartment building for MNO. Because B manages and operates the apartment building forMNO, MNO meaningfully participates in the management and operations of the apartment building. Consequently, all of the use of the apartment building is in the GO Zone and in the active conduct of a trade or business by MNO in the GO Zone. Accordingly, the unadjusted depreciable basis (as defined in § 1.168(b)- 1T(a)(3)) of the apartment building qualifies for the GO Zone additional first year depreciation deduction (assuming all other requirements are met). However, limitation provisions of the Code (for example, § 469) apply and may limit the amount of the GO Zone additional first year depreciation deduction that may be claimed by the members of MNO.

15. What is a QOZ Businesses (QOZB)? Without further guidance it would be difficult to conclude with confidence that a typical Section 42 Operating Partnership Structure would be classified as an "Active" Trade or Businesswhere: • The entity Is a limited partnership • one or more general partners that own 1% or less of the limited partnership • There are no employees • There is a management company is typically an affiliate of one of the general partners and not an affiliate of the limited partners. • There is an Investor entity that does not participate in management and owns 99% or more of the limited partnership • There is a limited partnership agreement that expressly limits the Investor's ability to participate in day to day management of the operating partnership • The Investor is a bank and all bank regulations treat the 42 operating partnership as an investment entity; not as an operating subsidiary of the bank • All related banking regulations expressly limiting the ability of a bank to take any ownership interest in an active operating subsidiary without prior regulatory approval