rr-18-29.pdf

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Section 1400Z-2.--Special Rules for Capital Gains Invested in Opportunity Zones

Rev. Rul. 2018-29

ISSUES
(1) If a qualified opportunity fund (QOF), as defined in § 1400Z-2(d)(1) of the
Internal Revenue Code (Code), purchases an existing building located on land that is
wholly within a qualified opportunity zone (QOZ), as defined in § 1400Z-1, can the
original use of the building or the land in the QOZ be considered to have commenced
with the QOF?
(2) If a QOF purchases an existing building in a QOZ and the land upon which
the building is located in a QOZ, is a substantial improvement to the building measured
by additions to the adjusted basis in the building or is it measured by additions to the
adjusted basis in the building and the land?

(3) If a substantial improvement to the building is measured by additions to the
QOF’s adjusted basis in the building, does § 1400Z-2(d) require the QOF to separately
substantially improve the land?

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FACTS
In September 2018, QOF A purchases for $800x Property X, which is located
wholly within the boundaries of a QOZ. Property X consists of a building previously
used as a factory erected prior to 2018 and land on which the factory building is located.
QOF A intends to convert the factory building to residential rental property. Sixty
percent ($480x) of the $800x purchase price for Property X is attributable to the value of
the land and forty percent ($320x) is attributable to the value of the building. Within 24
months after the date of QOF A’s acquisition of Property X, QOF A invests an additional
$400x in converting the building to residential rental property.
LAW AND ANALYSIS
Pursuant to § 1400Z-1(b)(1)(A) of the Code, the Chief Executive Officer of each
State nominated a limited number of population census tracts to be designated as
QOZs for purposes of §§ 1400Z-1 and 1400Z-2.
Under § 1400Z-2(d)(1), the term “qualified opportunity fund” (QOF) means any
investment vehicle organized as a corporation or a partnership for the purpose of
investing in qualified opportunity zone property (Zone Property) (other than another
QOF) that holds at least 90 percent of its assets in Zone Property.
Under § 1400Z-2(d)(2)(A), Zone Property means property that is either qualified
opportunity zone stock (Zone Stock), qualified opportunity zone partnership interest
(Zone Partnership Interest), or qualified opportunity zone business property (Zone
Business Property).
Zone Business Property is defined in § 1400Z-2(d)(2)(D). Section 1400Z-
2(d)(2)(D)(i) provides that Zone Business Property is tangible property used in a trade

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or business of the QOF if (a) such tangible property is purchased by the QOF after
December 31, 2017, (b) the original use of such tangible property commences with the
QOF or the QOF substantially improves the tangible property, and (c) during
substantially all of the QOF’s holding period for such tangible property, substantially all
of the use of such tangible property is in a QOZ.
Under § 1400Z-2(d)(2)(D)(ii), tangible property used in a QOF’s trade or business
is treated as substantially improved by the QOF only if, during any 30-month period
beginning after the date of acquisition of such tangible property, additions to basis with
respect to such tangible property in the hands of the QOF exceed an amount equal to
the adjusted basis of such tangible property at the beginning of such 30-month period in
the hands of the QOF.
Questions have arisen as to whether for purposes of § 1400Z-2(d)(2)(D)(i) the
original use of land in the QOZ can ever be considered to have commenced with a QOF
and, therefore, constitute Zone Business Property. In addition, if the original use of land
in the QOZ cannot commence with a QOF and if land is treated as property separate
from a building for purposes of § 1400Z-2(d), must land be substantially improved in
order to qualify as Zone Business Property?
Given the permanence of land, land can never have its original use in a QOZ
commencing with a QOF. Section 1400Z-2 seeks to encourage economic growth and
investment in the designated QOZs by providing Federal income tax benefits to
taxpayers who newly invest in businesses located within these economically distressed
communities. Consistent with this intent, a building located on land within a QOZ is
treated as substantially improved within the meaning of § 1400Z-2(d)(2)(D)(ii) if, during

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any 30-month period beginning after the date of acquisition of the building, additions to
the taxpayer’s basis in the building exceed an amount equal to the taxpayer’s adjusted
basis of the building at the beginning of such 30-month period. Further, the fact that the
cost of the land within the QOZ upon which the building is located is not included in the
taxpayer’s adjusted basis in the building does not mean that the taxpayer is required to
separately substantially improve such land for it to qualify as Zone Business Property.
Under the facts of this revenue ruling, QOF A purchased Property X, a factory
building and the land on which was located (both wholly within a QOZ), for $800x with
the intent to convert the building into residential rental property. Sixty percent ($480x)
of the purchase price for Property X was attributable to the value of the land and forty
percent ($320x) was attributable to the value of the building. Section 1400Z-
2(d)(2)(D)(ii) does not apply to the land on which the factory building is located, but
does apply to the building. Because the factory building existed on land within the QOZ
prior to QOF A’s purchase of Property X, the building’s original use within the QOZ did
not commence with QOF A. However, under § 1400Z-2(d)(2)(D)(ii) QOF A substantially
improved Property X because during the 30-month period beginning after the date of
QOF A’s acquisition of Property X QOF A’s additions to the basis of the factory building
($400x) exceed an amount equal to QOF A’s adjusted basis of the building at the
beginning of the 30-month period ($320x). The fact that the cost of the land on which
the building is located is not included in QOF A’s adjusted basis of the building does not
mean that QOF A is required to separately substantially improve the land.

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HOLDING
(1) If a QOF purchases an existing building located on land that is wholly within a
QOZ, the original use of the building in the QOZ is not considered to have commenced
with the QOF for purposes of § 1400Z-2(d)(2)(D)(i), and the requirement under
§ 1400Z-2(d)(2)(D)(i) that the original use of tangible property in the QOZ commence
with a QOF is not applicable to the land on which the building is located.
(2) If a QOF purchases a building wholly within a QOZ, under § 1400Z-
2(d)(2)(D)(ii) a substantial improvement to the building is measured by the QOF’s
additions to the adjusted basis of the building.
(3) Under § 1400Z-2(d), measuring a substantial improvement to the building by
additions to the QOF’s adjusted basis of the building does not require the QOF to
separately substantially improve the land upon which the building is located.
DRAFTING INFORMATION
The principal author of this revenue ruling is Erika C. Reigle of the Office of
Associate Chief Counsel Income Tax & Accounting. For further information regarding
this revenue ruling, contact Erika C. Reigle at (202) 317-7006 (not a toll-free call).