Pub. 9 2019-2020 Issue 2

O V E R A C E N T U R Y : B U I L D I N G B E T T E R B A N K S - H E L P I N G C O L O R A D A N S R E A L I Z E D R E A M S September • October 2019 11 Kristin Godfrey is a banking and business transaction attorney at Jones & Keller in Denver, Colorado. She knows firsthand how to reach business objectives and close challenging transactions. Ms. Godfrey can be reached at kgodfrey@joneskeller.com. guidance (PDF), providing much-needed clarity on how to form, operate and exit QOZ projects with greater confidence. These proposed regulations also provide details on who qualifies and how to take advantage of—and remain eligible for—the related tax credits. Although questions remain, the stage is set for QOZ funds and entities operating in these economically distressed communities to grab a foothold. Banks already present in those markets and lending into these same low-income census tracts may have the opportunity to expand their Community Reinvestment Act (CRA) activities to include QOZ projects. While bank regulators have not yet ruled on the specific application of QOZ lending for CRA purposes, the similarities in the two incentive programs—primarily, promoting investment and lending activities in lower-income areas—are compelling. This suggests that new CRA opportunities may lie at the intersection of these two programs. QOZ Requirements There are four primary requirements for receiving the generous tax breaks and incentives associated with an investment in a QOZ. The property must be: • Located in a federally designated Opportunity Zone; • Tangible property used in a trade or business; • Acquired by purchase for cash after December 31, 2017; and • Either (a) new construction that is not put into use until after the purchase of the property; or (b) “substantially improved” after purchase of the property, which requires that the costs of constructing, renovating or expanding the property during any 30-month period beginning after the date of the acquisition of the property must exceed 100% of the adjusted basis of the property at the start of the 30-month period. When all four conditions are met, as well as the technical rules and calculations outlined in the April guidance, the investor should benefit froma five to seven-year deferral on the capital gains otherwise due on the amount originally invested. Additionally, if the QOZ investor (typically a development fund) holds the property for more than 10 years, the QOZ fund and, indirectly, each investor thereof, shouldbenefit fromno taxes due on the profits, or capital gains, upon the sale of the property. While the Treasury regulations restrict how an investor may participate in a QOZ fund, the rules do not prohibit a QOZ fund from obtaining a senior mortgage loan secured by the property to be purchased or improved or limit any other debt financing for the property. Where CRA and QOZ meet Financial institutions are often looking for ways to improve their CRA scores. According to the Economic Innovation Group, the census tracts designated as a QOZ have no less than twice the average of poverty and unemployment rates, and thus, clearly overlap with communities serving low and moderate-income individuals and neighborhoods. One assessment tool for determining CRA compliance is whether the financial institution’s lending activities “revitalize or stabilize a low or moderate-income geography.” (See InteragencyCRAQuestions andAnswersRegardingCommunity Reinvestment, 81 Fed. Reg. 142, July 25, 2016, p 48527). Generally, in order to have a stabilizing effect on the community, a loan needs to provide a direct, long-term benefit to the community’s residents or those nearby. For example, in a low-income area, a loan for a pharmacy that employs and serves residents of the area likely promotes community development for the area. Similarly, acquisition or renovation of commercial property to create opportunities for small businesses to serve the immediate needs of the community may also promote community revitalization. Such businesses might include services-based business that provide low-cost legal or other professional services, job-training, or continuing education to the immediate community. Bank examiners presume an activity revitalizes or stabilizes a low or moderate-income geography if the activity has been approved by the governing board of an Enterprise Community or Empowerment Zone (designated by 26 U.S.C. Section 1391) or if the activity has received a similar official designation as consistent with a Federal, state, local or tribal government plan for the revitalization or stabilization of the low to moderate- income geography. The Opportunity Zones established by the TCJA seem to be a natural fit. The long-term (e.g. 10 year) requirement to hold the QOZ investment in order to capture the step-up in basis upon the eventual sale of the property also promotes a long-term benefit to the local neighborhood where the QOZ project is located. Takeaway While seemingly attractive to boost CRA ratings, QOZ lendingmust always be consistent with safe and sound banking practices. Make no mistake, an otherwise appealing inner-city or in-fill project still must make good business sense. With, however, over 9,000 census tracts designated as QOZ, and many of them within distressed or underserved non-metropolitan areas, seemingly limitless opportunities abound to find creative and innovative solutions to revitalize and stabilize low- tomoderate-income geographic areas. Ideally, bank regulators will soon clarify CRA regulations to incorporate specific reference to the TCJA and QOZ projects. n