Where are the Regs?

Where are the Regs?

April 12, 2019

The OZ industry is experiencing some degree of frustration due to the delay in the updated proposed regulations being issued by the Treasury Department.  It is believed that the new draft proposed regulations have already been prepared and sent to OMB for comment and approval before being released.  We understand that OMB takes up to thirty (30) days to complete that process and may have already provided further comments to the Treasury Department in which case the process will continue until the proposed regulations are finalized.  Some professionals have indicated that the regulations should be released by the end of April.

As a result of this delay, and as reported in various major publications, many potential participants in the industry, especially including wealth managers and investors, are on the sidelines seeking more certainty as to many of the open issues that were made before regulations were issued in October of 2018.

Given the strict timeframe as to decisions to make investments and actually funding money, the delay is somewhat troublesome.  For instance, for those taxpayers that seek to take advantage of the OZ program for 2018 capital gains, the outside date (assuming the 180-day period commences at the end of the 2018 calendar year) would be June 28, 2019.  Furthermore, for those seeking to take advantage of 2019 capital gains deferrals, the outside date would be December 31, 2019.

Therefore, the industry has a significant amount of pent-up demands for product yet the delays are complicating the process due to structuring issues including the following:

  1. The ability to sell an asset prior to the expiration of the ten-year holding period and have those funds reinvested in another OZ project.
  2. The ability to sell an interest in an OZ fund and reinvest the money into another OZ fund.
  3. Issues related to funding of OZ businesses since the existing regulations primarily address the real estate industry and not operating businesses.  For instance, the regulations provide that 50 percent of the revenue from the OZ business must be generated within an OZ zone.  Legislatures have significant concern about that particular legal requirement and are proposing new legislation to change the 50 percent test to "substantial revenue."
  4. There are issues related to meeting the substantial improvable requirements and clarity as to whether multiple assets can be utilized to make substantial improvements to assets rather than improvements to the asset acquired with the preexisting use.

Based upon the above, transactions are still being structured within a more limited framework, with the only exit strategy for an OZ investment being the sale of one’s interest in the OZ fund itself after a ten-year holding period.  That creates requirements that offering documents are structured to enable a so-called “drag-along” right to require the mandatory exit from the fund.  Offerings are being structured with the concept that there is a feeder entity that funds money into several OZ funds with each fund undertaking the development of a single asset.  In other words, the industry is recognizing that at this time it is not feasible to have one fund own multiple assets from an exit standpoint.

Another major takeaway from the OZ program is the fact that there really is not any social responsibility required in connection with compliance with the OZ program.  However, local and state governments are exploring incentive programs for developers who comply with standards that will create benefits for the local communities.  Hopefully, these added incentives will result in a win-win situation for all parties affected by the OZ program.
 

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