Many discussions pertaining to the “substantial improvement” requirement of Qualified Opportunity Zones (QOZs) focus on real estate. For instance, capital investment and renovation of an older office building. Or ground-up construction of a multi-family property.
Regardless of the example, the rule of thumb is that as long as the adjusted basis of the property exceeds an amount equal to the adjusted basis at the start of a 30-month period following the property’s acquisition, the IRS considers it “substantially improved.” This means it’s eligible for potential tax deferral on the part of Qualified Opportunity Fund (QOF) investors.
Interestingly enough, substantial improvement in connection with QOZ personal property isn’t discussed quite as much. The guidelines discuss substantial improvement of property, but don’t designate between “real” or “personal.” As such, all QOZ property, whether real estate or personal, can be used as part of the “substantial improvement” requirement under the Opportunity Zone program.
The “Business” Side of “Personal” Property
One reason tying “personal property” with “substantial improvement” can be confusing is because the former gives the impression that the asset in question is for personal use. We consider appliances, clothing, jewelry, or household goods as personal property. This type of property wouldn’t qualify for anything remotely related to the Opportunity Zone program.
But in a business sense, and from the point of view of a Qualified Opportunity Zone Business (QOZB), “personal property” is defined as assets other than real estate. The difference between real and personal property is the latter isn’t permanently connected to a particular location. It can be moved when a business moves. And, while personal property can be used to secure loans (similar to real property), it is taxed differently from its real estate cousin.
To a QOZB, furniture, equipment, electronics, and supplies are personal property. Even inventory, including raw materials, can qualify as QOZ business property. And as tangible property, inventory fits under the definition of “original use,” defining it as QOZB property.
Moving on, the IRS defines original use in conjunction with a QOZ as:
- Property first placed in service in a manner that would start depreciation and amortization if it were being used in a trade or business, and
- Property not previously placed in service in the QOZ.
Again, the above pertains to both real (fixed-in-place) property and personal (portable or moveable) property. And, if either defined property fits into the “original use” definition, it also falls under the need for “substantial improvement.”
Substantially Improving Personal Property
Returning to real property, “substantial improvement” is clear cut. A renovation proves substantial improvement, as does ground-up construction, as long as the 30-month adjusted basis exceeds the original adjusted basis. But how do you determine substantial improvement when it comes to a desk chair? Or piece of machinery? Or a mechanical pencil?
You really don’t.
When it comes to personal property, the focus is on a QOZB’s functional improvements or increased value with the addition of that tangible property to operations. In other words, the mechanical pencil alone isn’t subject to a “substantial improvement” analysis. Rather, the Opportunity Zone business that acquired that mechanical pencil in an effort to improve its adjusted basis is.
The common example used is that of a QOZ hotel. In this situation, a QOF might add “original use” personal property, such as mattresses, furniture, television sets, or other tangible property to help improve the hotel’s function. This, in turn, would be used to analyze the hotel’s overall “substantial improvement” requirements. After all, buying and implementing those items represents a capital investment. If that investment exceeds the original adjusted basis of that hotel, it could be considered substantially improved.
When Personal Property Isn’t Personal
Because much of the Opportunity Zone focus seems to be on buildings and other real property, confusion can sometimes arise concerning other types of property. But the QOZ regulations, especially those connected to “substantial improvement,” apply to all property connected to a Qualified Opportunity Zone.
So, when it comes to examining substantial improvement and Opportunity Zones, personal property really isn’t all that personal. Rather, it represents tangible assets that are acquired to help improve a QOZB’s operations and ultimately, its adjusted basis.
There are material risks associated with investing in QOZ properties and real estate securities including liquidity, tenant vacancies, general market conditions and competition, lack of operating history, interest rate risks, the risk of new supply coming to market and softening rental rates, general risks of owning/operating commercial and multifamily properties, short term leases associated with multi-family properties, financing risks, potential adverse tax consequences, general economic risks, development risks, long hold periods, and potential loss of the entire investment principal. Costs associated with transactions may impact investors’ returns, and may outweigh the tax benefits. Realized does not provide tax or legal advice. This material is not a substitute for seeking the advice of a qualified professional for your individual situation. This material is for general information and educational purposes only. Information is based on data gathered from what we believe are reliable sources. It is not guaranteed as to accuracy, does not purport to be complete and is not intended to be used as a primary basis for investment decisions. It should also not be construed as advice, meeting the particular investment needs of any investor.
