The Tangible Property Test

Since coming into impact in January 2018, Subchapter Z of the US Tax Code—often known as the chance zone provisions—has enabled buyers to pour billions of {dollars} right into a broad array of companies, from actual property improvement corporations to tech startups. Investments in certified alternative funds (QOFs) supply various distinct tax advantages, not the least of which is lowered capital positive aspects tax legal responsibility. However the guidelines governing these investments are quirky, perplexing and—in some instances—severely restrictive.

For an entity to be thought-about a professional alternative zone enterprise (QOZB), a minimum of 70% of its tangible property have to be certified alternative zone (QOZ) property. On this sixth in our sequence of articles on certified alternative funds (QOFs), we focus on the tangible property take a look at intimately.

As talked about in a earlier article, amongst different necessities for an entity to be thought-about a professional alternative zone enterprise (QOZB), it should meet the tangible property take a look at.

A QOZB partnership or QOZB company satisfies the tangible property take a look at if considerably the entire tangible property of the entity is QOZB property. For these functions, “substantially all” means 70% (Prop. Reg. §1.1400Z(d)-1(d)(3)(i)).

Tangible property is QOZB property whether it is (1) used within the energetic conduct of a commerce or enterprise bodily situated in a professional alternative zone (QOZ); (2) acquired by a QOZB after December 31, 2017, from an unrelated social gathering; and (3) both (a) the unique use of such property within the QOZ started with the QOZB (the authentic use take a look at) or (b) the QOZB considerably improves such property (the substantial enchancment take a look at) (Part 1400Z-2(d)(2)(D)(i)).

The tangible property take a look at limits its scope to the proportion of tangible property that’s QOZB property. In different phrases, the numerator is the worth of tangible property that qualifies as QOZB property and the denominator is solely all of an entity’s tangible property (not all of its belongings).

Measurement of Worth

Typically, for functions of figuring out whether or not an entity satisfies the tangible property take a look at to qualify as a QOZB, the entity might measure its tangible belongings utilizing considered one of two strategies (Treas. Reg. § 1.1400Z2(d)-1(b)(1)): the relevant monetary assertion valuation methodology (Treas. Reg. § 1.1400Z2(d)-1(b)(3)) or the various methodology (Treas. Reg. § 1.1400Z2(d)-1(b)(4)). Whichever methodology of measurement the QOZB chooses for a given tax yr, that methodology have to be utilized constantly to the entire QOZB’s tangible property (Treas. Reg. § 1.1400Z2(d)-1(b)(2)(ii)(A)).

The relevant monetary assertion valuation methodology permits the entity to make use of the e book worth of the asset as proven on an relevant monetary assertion (throughout the that means of Treas. Reg. § 1.475(a)-4(h)) for the related interval. With respect to leased property, this methodology is barely out there if the relevant monetary assertion follows usually accepted accounting rules (GAAP) and requires an task of worth to the leased property. (On this context, leased property means property with respect to which the QOZB or QOF is lessee. This doesn’t embody property for which the QOZB or QOF is lessor.)

If a QOZB has no relevant monetary assertion or chooses to not use the relevant monetary assertion valuation methodology, it should use the choice methodology. Below the choice methodology, the worth of property owned by the entity is measured by its unadjusted price foundation if bought or constructed for truthful market worth or, if acquired for lower than truthful market worth, the asset’s truthful market worth, decided on the final day of the primary six-month interval of the taxable yr and on the final day of the taxable yr (Treas. Reg. § 1.1400Z2(d)-1(b)(4)(ii)). If property is leased, then the property is valued at this time worth of the discounted future funds below the lease (Treas. Reg. § 1.1400Z2(d)-1(b)(4)(iii)).

Thus, for functions of the tangible property take a look at, property usually shall be measured both by its e book worth, price foundation, truthful market worth, or the worth of discounted money outlays with respect to leases. The values usually shall be mounted at some stage in the holding interval of the asset, save presumably for a revaluation if the relevant monetary assertion valuation methodology is used.

Instance Computation

Tangible Property

 

Unadjusted Foundation

 

Guide Worth (per AFS)

A

 

  $25

 

  $90

B

 

  $15

 

  $20

C

 

  $10

 

  $20

Whole

 

  $50

 

  $130

For example, assume {that a} QOZB has the steadiness sheet described above. Utilizing the choice valuation methodology, its complete tangible property would have a worth of $50. This might be the denominator within the ratio for the tangible property take a look at. If asset A had been QOZB property (for instance, as a result of authentic use of asset A within the QOZ started with the QOZB), however not belongings B or C, then the ratio can be $25/$50, or 50%, and the QOZB wouldn’t fulfill the tangible property take a look at. If as an alternative, asset B was additionally QOZB property (for instance, as a result of the QOZB had considerably improved asset B), then the ratio can be $35/$50, or 70%, and the QOZB would fulfill the tangible property take a look at.

Contemplating the identical steadiness sheet and utilizing the relevant monetary assertion valuation methodology this time, the QOZB’s complete tangible property would have a worth of $120. If asset A was QOZB property, however not belongings B or C, then the ratio can be $90/$120, or 75%, and the QOZB would fulfill the tangible property take a look at.

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