One of the hottest real estate topics right now is the Federal Qualified Opportunity Zone program. This program has aroused the interest of real estate investors because of the potential tax advantages offered to those who invest in certain economically underdeveloped areas. To participate in this program, investors must timely invest the proceeds of capital gains, such as those from the sale of a property, in a Qualified Opportunity Fund (“QO Fund”). The program provides for 3 major tax breaks: (i) a tax deferral of up to 7 years on the product invested; (ii) up to 15% reduction in tax payable on invested products; and (iii) a permanent exclusion from the accrued gain from the sale of the QO Fund’s investment if held for 10 years.

Trade or active business test

Almost anyone can form a QO fund, but the fund itself must meet certain requirements. One of the main requirements is that the QO fund must hold at least 90% of its assets in qualifying opportunity assets, which can be in the form of stocks, partnership (or LLC) interests and / or other tangible goods used in a trade or business. If the QO fund holds shares or interests in partnerships, then the underlying business must derive at least 50% of its gross income from “actively conducting a business or business”. This requirement is particularly troublesome for rental property investors because a company that only receives rental income (no more) can be considered passive.

It doesn’t help that the tax code has not defined this term and that the IRS guidance provided to date has not interpreted it either. Additional guidance was expected earlier this year, which could have offered some help, but due to the recent government shutdown, the IRS is behind schedule. In the meantime, tax advisers facing this problem seek guidance in other parts of the tax code.

In search of the old direction

One place to look is the interpretive guide that was released for the Gulf Opportunity Zone Tax Credits, IRS Notice 2006-77. The Notice provided that the determination of the existence of an active commercial or commercial activity be based on all the facts and circumstances. An intermediary entity such as a partnership is generally considered to be actively carrying on a business or commercial activity if the partnership “participates significantly” in the management or operations of the business or commercial activity. If the partnership participates in a meaningful way, then this active treatment is passed on so that each financial partner is also treated as actively carrying on the business or business activity. This principle is very useful because it applies not only to partnerships but also to LLC members or shareholders of S companies. To determine whether a partnership is meaningfully involved in the management and operations, not only its own activities are taken into account, but also activities performed by others “on behalf” of the partnership.

Notice 2006-77 also provided two examples where the participation of a partnership in the management and operation of an immovable was deemed “significant”:

  • Apartment building. An LLC is building and commissioning a new apartment building. A member of the LLC “manages and operates” the building for the LLC.
  • Office buildings. A partnership constructs and puts into service two new commercial buildings and leases these buildings to an independent tenant who uses the other two buildings as office space. The lease contract is not a triple net lease. One of the partners in the partnership manages and operates the two office buildings of the partnership.

In contrast, a partnership that owned a single building rented triple-net to a tenant did not meet the “significant ownership” requirement and, therefore, was not considered to be actively carrying on a commercial or commercial activity. The tenant was responsible under the rental agreement for all costs associated with the building (eg, paying all taxes, insurance and maintenance expenses).

In search of new directions

More recently, the IRS proposed a safe haven for rental real estate businesses and the “trade or business” issue for the new 20% deduction provision for flow-through entities. See IRS Notice 2019-07. Although the advisory clearly states that the Safe Harbor alone apply for the purposes of the 20% deduction provision, the notice offers clues as to how the IRS may interpret the phrase “actively conducting a transaction or business” for QO funds in a real estate context.

In order to accommodate this Safe Harbor, 250 hours or more of “rental services” must be performed per year for the rental business by the owner or by employees, agents and / or independent contractors of the owner. . This Safe Harbor cannot be used for triple net leased property.

The term “rental services” includes (i) advertising to rent or lease real estate, (ii) negotiating and enforcing leases, (iii) verifying information contained in applications from potential tenants, (iv) rent collection, (v) day-to-day operation, maintenance and repair of the property, (vi) property management, (vii) purchase of materials, and (viii) supervision employees and independent contractors. The term, however, does not include financial or investment management activities, acquisition of assets, study and review of financial statements or reports on operations, planning, management or construction of capital improvements to long term, or the hours spent traveling to and from real estate.


At one end of the spectrum, it is clear that mere ownership of vacant land or triple net leased property is not “active conduct of a business or business” for the purposes of the QO Fund. At the other end of the spectrum, if a partnership or one of its partners provides substantial “rental services” for real estate, it is clear that the partnership and each of its partners must be considered as engaged in the “active conduct of a trade or business” for the purposes of the QO Fund.

For situations that fall in the middle of the spectrum, until additional guidance from the QO Fund IRS is issued, taxpayers will need to call their tax advisors to analyze their specific set of facts.


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