COVID EMERGENCY Ends and Puts Written Plan Revisions “On the Clock”
By Joseph B. Darby III
The COVID Emergency actually ended about a zillion years ago, but finally, on May 11, 2023, even the federal government recognized this fact by declaring the emergency officially over.
Beyond stating the obvious, this announcement has important ramifications for qualified opportunity funds (QOFs) and qualified opportunity zone businesses (QOZBs), because proposed OZ regulations issued in 2021 clearly allow QOFs and QOZBs to amend the required Written Plan under the working capital safe harbor (WCSH) rules for a period of up to 120 days following the official end of the COVID Emergency.
This 120-day “free pass” ends on September 8, 2023, so anyone with an old, outdated, or no longer accurate Written Plan (meaning almost everyone) should take advantage of this opportunity to update the Written Plan to reflect up-to-the-minute changes.
Under Code Section 1400Z-2, a QOZB must hold less than 5% of its assets as "nonqualified financial property," which includes various financial assets but does not include (i) reasonable amounts of working capital held in cash, (ii) cash equivalents, or (iii) short-term debt. Prior to April 12, 2021, the applicable Treasury Regulations under Code Section 1400Z-2 (Regulations) provided a "working capital safe harbor" that treated working capital as reasonable if three requirements were met:
1) The amounts are designated in writing for the development of a trade or business in a qualified OZ including when appropriate the acquisition, construction, and/or substantial improvement of tangible property in such a zone.
2) There is a written schedule consistent with the ordinary start-up of a trade or business for the expenditure of the working capital assets. Under the schedule, the working capital assets must be spent within 31 months of the receipt by the business of the assets.
3) The working capital assets are actually used in a manner that is substantially consistent with the writing and written schedule described above.
The Regulations provided that multiple overlapping Written Plans could be utilized to extend the safe harbor period to a total of 62 months, and also provided that if a QOZB was located in a federally declared disaster zone, it could receive up to 24 additional months to spend the working capital. However, the Regulations did not address a situation that became common during the COVID Emergency, which was that the original Written Plan became difficult or impossible to implement because of the crisis.
Proposed Regulations issued on April 12, 2021, REG-121096-19 (4/12/2021) (the “April 12 Proposed Regulations”) were designed to address this situation. Under these April 12 Proposed Regulations, a QOZB can revise the Written Plan and its spending targets so long as the new plan is adopted within 120 days of the end of a federally declared disaster. The QOZB remains, however, subject to the original 31- month period, plus an additional period of up to 24 months tacked on due to the federally declared
disaster. Notably, these April 12 Proposed Regulations can be relied upon for tax years beginning with 2020 even though they have never been finalized.
Specific Language Added.
The April 12 Proposed Regulations added three sentences to regulation 1.1400Z2(d)-1(d)(3)(v)(D), which as modified reads as follows (with the added language in italics):
(D) Federally declared disasters. If the qualified opportunity zone business is located in a qualified opportunity zone impacted by a federally declared disaster (as defined in section 165(i)(5)(A)), the qualified opportunity zone business may receive not more than an additional 24 months to expend its working capital assets, as long as it otherwise meets the requirements of paragraph (d)(3)(v) of this section. For purposes of the preceding sentence, meeting the requirements of paragraph (d)(3)(v) of this section may be determined by reference either to the original amount of working capital assets designated in writing under paragraph (d)(3)(v)(A) of this section and reasonable written schedule under paragraph (d)(3)(v)(B) of this section or to a new or revised written designation and written schedule that satisfy the requirements of paragraph (d)(3)(v)(A) and (B) of this section, respectively. A new or revised written designation of the amount of working capital assets and reasonable written schedule for expending that amount may be used only if adopted not later than 120 days after the close of the incident period, as defined in 44 CFR 206.32(f), with respect to that disaster. In determining whether a new or revised schedule satisfies the requirements of paragraph (d)(3)(v)(B) of this section, the planned completion of spending must take into account the up-to-31 month period originally allowed under paragraph (d)(3)(v)(B) of this section, plus the up- to-24 additional months provided in this paragraph (d)(3)(v)(D).
Concerns About Implications after COVID Emergency Ends.
Although this broad relief for Written Plans that were rendered moot or irrelevant by COVID was very welcome, the specific language was also weirdly alarming because it seemed to suggest that, after the 120-day post-COVID period ended, a “new or revised” Written Plan would no longer be accepted. A Written Plan is first put in place at the time when working capital is contributed to a QOZB, and while the QOZB is then required to spend the working capital in a manner “substantially consistent” with this plan, no one with the slightest experience in building real estate or starting businesses thought that a Written Plan covering a 31-month period was going to remain static and never change. Rather, it was always assumed – at least prior to the issuance of the April 12 Proposed Regulations -- that the Written Plan could be altered and updated as the actual project moved forward, so long as it stayed “substantially consistent” with parameters of the original plan, and thus a taxpayer could make practical allowances for the types of changes that happen, inevitably, during the implementation of every real estate development project or business startup.
Novogradac OZ Working Group wrote a letter in response to the April 12 Proposed Regulations commenting on this exact point and recommending that the new language should not be read to
construe narrowly otherwise normal amendments to a Written Plan. The specific comment was as follows:
The Proposed Regulations do not address relief for modifications to working capital written plans for changes in circumstances that are outside of the context of a federally declared disaster. This omission implies that a QOZB cannot modify its plan in any way except for a federally declared disaster. Practitioners have interpreted the “substantially consistent standard” in the final regulations to allow for QOZBs to make reasonable modifications to a written plan to address commonly occurring changes in developing a trade or business or changes in business circumstances that do not rise to the level of a disaster declaration. We believe this should be the case.
Unfortunately, the IRS has never issued final regulations nor responded formally to these very pertinent comments, and so the only thing we know for sure is that changes up through September 8, 2023, will be considered appropriate and acceptable retroactive to the start of the Written Plan. After that... well, after that there are a lot of things to discuss and possibly argue about.
Recommendation: Act NOW.
The point is that any taxpayer relying on a Written Plan dating back to the COVID era should definitely act now to revise the Written Plan and bring it fully up to date. We recommend that you find a way to “date stamp” for revised Written Plan, e.g., by emailing it to your accountant on or before September 8, 2023, or at the very least by saving the file on your computer system before that date to show that it was in existence prior to the magical cut-off date.
Note: We have no idea how the IRS is ultimately going to audit the Written Plan requirements, and whether they will bring a light touch, a heavy touch, or an audit's outright sledgehammer to the review process. Therefore, being able to prove that your “new” Written Plan was locked in place by September 8, 2023, can only be helpful, and may prove crucial on audit many years in the future.