To operate a business in a Qualified Opportunity Zone (QOZ), certain criteria must be met to be designated as a Qualified Opportunity Zone Business (QOZB). Opportunity Zones were established under the Tax Cuts and Jobs Act (TCJA) of 2017.
The legislative intent behind this enacted tax code was to stimulate economic growth by incentivizing new, old, small, or even large organizations to establish their businesses within a designated zone. What is the incentive? In exchange for investing in these locations, taxpayers are offered deferred tax benefits based on the duration of time the business is owned or leased within the designated QOZ.
There are currently 8,764 designated opportunity zones. The governors of each state and territory nominated opportunity zone locations that have been approved by the US Treasury as qualified opportunity zones. Section 13823 of the TCJA includes section 1400Z-1, which identifies these specific census tracts as eligible qualified opportunity zones.
Qualified Trade or Business (QTB) Requirement
One of the essential requirements of operating a QOZB is that the business must be recognized as a Qualified Trade or Business (QTB) organized under the law of the United States, District of Columbia and U.S Territories. The TCJA states the QOZB must be “engaged in the active conduct of a trade or business.”
When the law was first enacted, the definition of a QTB was ill-defined. In the Supreme Court case vs Groetzinger in 1987, the term had been previously defined ‘‘to be engaged in a trade or business, the taxpayer must be involved in the activity with continuity and regularity and that the taxpayer’s primary purpose for engaging in the activity must be for income or profit.’’ Entities that operate or lease property in a QOZ are considered “engaged in the active conduct of a trade or business,” and therefore, qualify as a QOZB. However, triple-leasing of properties does not qualify.
Exclusion of ‘Sin Businesses’
Similar to Qualified Small Businesses (QSB) TCJA defines qualified trades for QOZBs in the negative, listing excluded trades rather than included trades. Language throughout the amendments of the regulation state that QOZBs should not be recognized as ‘sin business’ industries. A Sin Business is one to sell alcohol, gambling, sell tobacco, etc. In short, Sin Businesses are excluded from qualifying as a QOZB because the entire motive behind Opportunity Zones is to build the community through businesses rather than create an environment that would create economic harm.
Per Section 1.1400Z2(d)-1(d)(4)(i)(A), QOZBs cannot be:
- Golf course
- Country Club
- Massage Parlor
- Hot tub Facility
- Suntan Facility
- Racetrack or other Gambling Facility
- A store whose principal business is the sale of alcoholic beverages for consumption off premises
- Transparent entities (including a qualified subchapter S subsidiary (as defined in section 1361(b)(3)(B)), a grantor trust, or an entity disregarded as separate from the QOF under §301.7701-3)
Any other business falling outside this list and also meeting the above QOZB criteria is eligible to operate as a Qualified Opportunity Zone Business. This allows a wide range of businesses to be eligible within an Opportunity Zone, incentivizing investment and cash flow through the community.
Other Business Operating Requirements
In addition to the qualified trade requirements, other operating requirements must also be met. According to the IRS,
“Each taxable year, a QOZ business must earn at least 50% of its gross income from business activities within a QOZ. The regulations provide three safe harbors that a business may use to meet this test. These safe harbors take into account any of the following:
- Whether at least half of the aggregate hours of services received by the business were performed in a QOZ;
- Whether at least half of the aggregate amounts that the business paid for services were for services performed in a QOZ; or
- Whether necessary tangible property and necessary business functions to earn the income were located in a QOZ.”
If the three safe harbor tests become confusing or misleading, an individual can just look at whether 50% of the business’s gross income comes directly from the business’s activities or trade.
CapGains is Here to Help
If you are interested in learning more about the benefits of founding or investing in a Qualified Opportunity Zone Business, contact us today.