Opportunity Zone Property

Understanding Original Use vs. Substantial Improvement in regards to Opportunity Zone Property.

1. Do you have an Original Use or Substantial Improvement Project? Opportunity Funds may invest only in projects that satisfy the Original Use Test or the Substantial Improvement Test in regards to Opportunity Zone Property.

Opportunity Zone Property Original Use Test

To satisfy the Original Use Test, the original use of the Opportunity Zone Property must commence with the Opportunity Fund.

For example, the Opportunity Fund purchases raw land and constructs a hotel. There was no economic use of the land or the building materials until the Opportunity Fund built the hotel, and so the hotel satisfies the Original Use Test for that opportunity zone property.

Opportunity Zone Property Substantial Improvement Test

To satisfy the Substantial Improvement Test, the Opportunity Fund must invest (within 30 months after acquisition) an amount equal to the Opportunity Fund’s basis in the opportunity zone property on the date of acquisition.

For example, the Opportunity Fund acquires an old hotel building for $3.0m, and invests an additional $3.1 m (bringing total invested amount to $6.1m) to renovate the building and re-open it as a hotel. The Opportunity Fund’s basis on acquisition was $3.0m, and it invested an additional sum in excess of it’s acquisition basis, and so the renovated hotel satisfies Substantial Improvement Test for that opportunity zone property..

A common error is the belief that an existing operating business located in an Opportunity Zone will make a good Opportunity Fund investment.

For example, I received a call from the owner of an excellent light manufacturing business in an Opportunity Zone, who was wondering if a sale to an Opportunity Fund might be a viable exit to allow his retirement. I explained to the caller that his business probably would not satisfy the Original Use Test or the Substantial Improvement test, and so it was unlikely an Opportunity Fund would be interested in it. The drafters of the Opportunity Fund/Zone law had their heads screwed on right. The law allows for tax advantages only if the money invested in the Opportunity Zone creates positive change – either by creating a new business, or by substantially improving an existing one. Just investing money in an existing business in the Opportunity Zone doesn’t cut it.