IRS issues proposed regulations on withholding for foreign investors in qualified opportunity zone funds (NPRM REG-121095-19; Apr. 14, 2021)
Only ‘eligible gains’ qualify for deferral under §1400Z-2(a). Eligible gains are 1) a gain treated as a capital gain or is a qualified §1231 gain, 2) a gain that would be recognized and taxed for Federal income tax purposes, and 3) the sale or exchange giving rise to the gain is not with a related person.
A gain by a nonresident alien individual or foreign corporation could be an eligible gain if it is effectively connected with a US trade or business which is normally taxed for Federal income tax purposes. To ensure collection of the tax, the IRS imposes withholding requirements on payments of ECI to foreign persons. In some cases, the imposition of these withholding rules can delay investments into qualified opportunity zone funds running afoul of the 180 day investment period rule.
Under the proposed regulations, certain foreign persons and certain foreign owned partnerships may be eligible to reduce or eliminate withholding under §1445 (Withholding of tax on dispositions of United States real property interests) , 1446 (Withholding of tax on foreign partners’ share of effectively connected income , or 1446(f) ((Special rules for withholding on dispositions of partnership interests) on capital gains arising from transfers qualifying for deferral under §1400Z-2(a) (capital gains invested in opportunity zones).
These rules will apply only when the regulations are published as final in the Federal Register, applications for eligibility certificates submitted before will not be processed by the IRS.