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The Second Set of Proposed Opportunity Zone Regulations

Introduction

On April 17, 2019, the Internal Revenue Service (the “IRS”) and the U.S. Department of the Treasury (the “Treasury”) issued a second set of proposed regulations (the “Proposed Regulations”) under section 1400Z-2 of the Internal Revenue Code (the “Code”) regarding the qualified opportunity zone program, which was enacted as part of the law commonly referred to as the “Tax Cuts and Jobs Act” (“TCJA”).[1]

The Proposed Regulations are very taxpayer friendly, and address some, but not all, of the questions that were left unanswered by the first set of proposed regulations issued in October 2018 (the “Initial Proposed Regulations”). The Initial Proposed Regulations were discussed here.

The Proposed Regulations generally are proposed to be effective on or after the date of the publication of final regulations. Nevertheless, taxpayers and qualified opportunity funds (“QOFs”) may generally rely on the Proposed Regulations, so long as the taxpayer and/or the QOF applies the Proposed Regulations consistently and in their entirety. However, taxpayers may not rely on the rules that permit a QOF partnership, S corporation, or REIT whose owners have held their QOF interests for at least 10 years to sell assets without its owners recognizing capital gains on the sale, until the Proposed Regulations are finalized.

Some states conform to federal tax law with respect to QOFs (and grant equivalent tax benefits); others do not and tax gains that would otherwise be deferred, reduced or eliminated under the opportunity zone program.

This blog summarizes some of the important aspects of the Proposed Regulations. It assumes familiarity with the opportunity zone program. For background, see our prior blog post.

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Players, Staff and Draft Picks May be Traded Tax-Free Under New Safe Harbor

On April 11, 2019, the Internal Revenue Service (the “IRS”) issued Revenue Procedure 2019-18, creating a safe harbor that allows professional sports teams to treat trades of personnel contracts (including contracts for players, coaches and managers) and draft picks as having a zero value for determining gain or loss recognized for federal income tax purposes if certain requirements are met.[1]  While the safe harbor applies to trades entered into after April 10, 2019, teams can choose to apply it to any open taxable year.

Like-Kind Exchange Treatment Prior to the 2017 Tax Reform

By way of background, prior to P.L. 115-97, commonly referred to as the Tax Cuts and Jobs Act, (the “2017 Tax Reform”), trades were treated as exchanges of like-kind property used in a trade or business under Section 1031.[2]  Accordingly, teams were generally able to avoid current recognition of income on a trade to the extent no cash (or other property) was received.

Aftermath of the Legislation Prior to IRS Relief

The 2017 Tax Reform limited like-kind exchange treatment under Section 1031 to real property (i.e., land and buildings).  As a result, absent the safe harbor, teams generally would have to recognize gain or loss based on the difference between the fair market value of the personnel contract or draft pick received and the tax basis of the personnel contract or draft pick given up.  A team’s basis in a personnel contract or draft pick is generally equal to the team’s cost to acquire it, including certain payments for future services (such as a signing bonus), less depreciation.  However, the value of a personnel contract or draft pick at any given time is difficult to measure.

IRS Grants Relief in Revenue Procedure 2019-18

Applying a “real world view,” the IRS recognized in Revenue Procedure 2019-18 that assigning an objective monetary value to a personnel contract or draft pick would result in “highly subjective, complex, lengthy, and expensive disputes between professional sports teams and the IRS.”  By assigning zero value to these assets, teams are allowed to conduct trades similarly to the way in which they did prior to the 2017 Tax Reform.  Other rules regarding the tax treatment of sales and exchanges continue to apply, including Section 1231 (rules for determining whether gain or loss is capital or ordinary) and Section 1245(a)(1) (depreciation recapture rule).

Requirements to the Safe Harbor’s Application

Under the safe harbor, professional sports teams may treat the value of personnel contracts and draft picks as zero in a trade if certain conditions are satisfied:

  • First, all parties to the trade that are subject to U.S. federal income tax must use the safe harbor.
  • Second, each party to the trade must transfer and receive a personnel contract or draft pick.  In addition, no team may transfer any other property (other than cash) as part of the trade.
  • Third, no personnel contract or draft pick on any side of the trade may be an amortizable Section 197 intangible.  Given the number of teams that have been sold in recent years, this limitation could be problematic and seems to raise all of the issues the IRS sought to avoid by issuing the revenue procedure.
  • Fourth, the financial statements of all teams that are party to the trade may not reflect assets or liabilities resulting from the trade other than cash.

Tax Consequences of the Safe Harbor’s Application

The tax consequences under the safe harbor to the teams that are a party to a trade are as follows:

  • Because the value of each personnel contract or draft pick is zero, no gain or loss will be recognized by a team if it does not receive cash and does not have a tax basis in the personnel contract or draft pick given up.
  • Any cash received by a team as a part of a trade will be included in the team’s amount realized and will be recognized as gain to the extent it exceeds any unrecovered tax basis in the personnel contract or draft pick transferred in the trade.
  • A team will generally recognize a loss if it has unrecovered tax basis in the personnel contract or draft pick it transferred (e.g., if the traded player was paid a signing bonus that the team had not yet fully depreciated) that exceeds the amount of any cash the team received in the trade.
  • A team that provides cash as part of a trade will acquire a tax basis in the personnel contract or draft pick it receives equal to the amount of such cash.  This tax basis may be depreciated over the life of the asset acquired.  If more than one personnel contract or draft pick is received, the basis must be allocated to each personnel contract or draft pick equally, regardless of the subjective value the team may place on each.
  • A team that does not provide cash as part of a trade will have a tax basis of zero in all personnel contracts or draft picks received.

The safe harbor only applies to trades of personnel contracts or draft picks among teams in professional sports leagues.  It does not apply to any other transaction, including to trades of a team for another team or a sale of a team.  We expect that a standard set of representations and warranties and covenants will develop in response to the revenue procedure.

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Taxpayers should consider the effects of the safe harbor and plan accordingly.  Please contact your usual Proskauer lawyer, or any member of Proskauer’s Tax Department, to discuss the impact of this revenue procedure further.

 

[1] For purposes of this discussion, any references to “team” or “teams” are references to teams in a professional sports league, and any references to “trade” or “trades” are references to trades of personnel contracts and rights to draft picks by teams in a professional sports league.

[2] All references to “Section” are references to the Internal Revenue Code of 1986, as amended.

Proposed FDII Regulations under Section 250

I.                   Introduction.

On March 4, 2019, the Internal Revenue Service (the “IRS”) and the Department of the Treasury (the “Treasury”) released proposed regulations (the “Proposed Regulations”) regarding the deduction for “foreign-derived intangible income” (“FDII”) under section 250 of the Internal Revenue Code.[1] Section 250 was enacted in 2017 as part of the tax reform act.[2] Very generally, section 250 provides domestic corporations with a reduced effective 13.125% tax rate on FDII, which is a formulary proxy for a domestic corporation’s intangible income attributable to foreign sales and services.[3] The reduced tax rate for FDII is intended to encourage U.S. multinationals to retain intellectual property in the United States rather than transfer it to a foreign subsidiary where it could generate global intangible low-taxed income (“GILTI”), which is taxable at a 10.5% rate. The Proposed Regulations also would permit individuals who make a section 962 election with respect to their controlled foreign corporation (“CFCs”) to benefit from the reduced 13.125% rate on the GILTI earned by those CFCs.

The Proposed Regulations are generally effective for taxable years ending on or after March 4, 2019.

This post provides both background to and a summary of some of the most important aspects of the Proposed Regulations. For more information, please contact any of the Proskauer tax lawyers listed on this post or your regular Proskauer contact. Continue Reading

“Passthrough Deduction” Regulations Finalized

On January 18, 2019, the U.S. Department of Treasury (“Treasury”) and the Internal Revenue Service (the “IRS”) released final regulations (the “Final Regulations”) regarding the “passthrough deduction” for qualified trade or business income under section 199A of the Internal Revenue Code.[1] The Final Regulations modify proposed regulations (the “Proposed Regulations”) that were released in August 2018. The Final Regulations apply to tax years ending after February 8, 2019, but taxpayers may rely on the Proposed Regulations for taxable years ending in calendar year 2018.

Section 199A was enacted in 2017 as part of the tax reform act.[2] Generally, section 199A provides a deduction (the “passthrough deduction”) of up to 20% for individuals and certain trusts and estates of certain of the income from certain trades or businesses that are operated as a sole proprietorship, or through certain passthrough entities. The passthrough deduction provides a maximum effective rate of 29.6%.

This post provides background and summarizes some of the most important changes from the Proposed Regulations to the Final Regulations. For more information, please contact any of the Proskauer tax lawyers listed on this post or your regular Proskauer contact.

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Extension of FBAR Filing Deadline for Certain Filers

On December 4, 2018, FinCEN issued Notice 2018-1, extending the filing deadline for the Report of Foreign Bank and Financial Accounts, FinCEN Form 114 (FBAR), for certain individuals with signature or other authority over (but no financial interest in) employer-owned foreign financial accounts to April 15, 2020. FinCEN has provided similar extensions over the previous six years.[1] This new extension applies to reporters with signatory authority during the 2018 calendar year and to those individuals whose reporting deadline was extended under prior notices (such as certain employees or officers of investment advisers registered with the U.S. Securities and Exchange Commission (SEC) who have signature authority over, but no financial interest in, certain foreign financial accounts).[2] All other filers must still file by April 15, 2019, although FinCEN will grant an automatic extension until October 15, 2019.

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Proposed Rental Business Safe Harbor under Section 199A

On January 18, the Internal Revenue Service (“IRS”) and the U.S. Department of the Treasury issued final regulations (the “Final Regulations”) on the “pass through” deduction under section 199A[1] of the Internal Revenue Code (the “Code”). Very generally, section 199A provides individuals with a deduction of up to 20% of income from a domestic “trade or business” operated as a sole proprietorship or through a partnership, S corporation, trust, or estate. The Final Regulations define trade or business as “a trade or business under section 162, other than the trade or business of performing services as an employee.”[2]

Prior to the issuance of the Final Regulations, taxpayer commenters expressed uncertainty as to whether a rental business qualified as a trade or business under section 199A—based on a long-standing uncertainty as to whether, and to what extent, a rental real estate business was a trade or business for purposes of section 162.

To provide some certainty for taxpayers potentially entitled to the pass-through deduction, the IRS released Notice 2019-07 (the “Notice”) in conjunction with the Final Regulations. The Notice proposes a safe harbor under which taxpayers (including partnerships and S corporations owned by at least one individual, estate, or trust) may treat a “rental real estate enterprise” as a trade or business solely for the purposes of the section 199A deduction. Because the Notice would provide a safe harbor—and not a substantive rule—failure to meet the tests set forth in the Notice does not necessarily mean a rental real estate business is ineligible for the section 199A deduction. If the Notice standards are not met, then the general test under section 162 would need to be met for such a business.[3] However, in certain other contexts, tax professionals and the IRS have viewed safe harbors as establishing the bounds of the substantive law; it remains to be seen whether taxpayers will claim the pass-through deduction for real estate leasing activities that fail to satisfy the safe harbor.

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