Understanding Original Use for Opportunity Zone Investment

Original use is one of the most important concepts outlined in the newest regulations for opportunity zone investments, according to Phil Jelsma, of Crosbie Gliner Schiffman Southard & Swanson. Opportunity zones require that a property is substantially improved by a qualified opportunity zone fund or subsidiary or the property’s original use commences with the qualified opportunity fund or subsidiary—but what exactly constitutes original use?

“The new regulations provide that original use commences when the property is placed in service for purposes of depreciation or amortization,” Jelsma, a partner and chair of the tax practice team at CGS3, tells GlobeSt.com. “Generally, if the property has been depreciated by another person, it will not meet the original use test and must be substantially improved unless it has been vacant for at least five years. Original use is deemed to commence upon purchase by a QOF or QOF Sub if the property has been vacant for at least five years. Improvements made by a lessee to leased property meet the original use requirement.”

Despite the clarity provided in the regulations, original use is complicated, and investors or owners may not know the property’s history. “It may be difficult for a purchaser to determine if the property has been previously depreciated or amortized by any prior owner,” says Jelsma. “If the property is new construction or was a part of the seller’s inventory, it may be simple but existing improvements are likely to have been depreciated by a prior owner.”

For ground-up developers, the original use clause is actually a benefit. “The new regulations definitely help ground-up development and open the door for using ground leases whereby the current owner ground leases property to the QOF or QOF Sub that entitles and improves the property,” adds Jelsma. “Related party leases are allowed under the new regulations provided the lease is entered into after December 4, 2017, the terms of the lease in arms length and the lessee may not prepay rent more than 12 months in advance.”

While not a benefit, the clause won’t impact redevelopment properties, according to Jelsma. “Original use will not impact redevelopment, which must meet the substantial improvement test but will provide clarity for new development,” he says. “In some respects, ground leases may provide a useful tool for property purchased prior to December 31, 2017 where the owner has capital gains it would like to invest in the property.”