James Mann, Partner
Since the issuance of the opportunity zone tax regulations in October, we have been helping many of our clients structure cannabis-oriented projects located in Qualified Opportunity Zones (QOZs). We are advising both investors and entrepreneurs, sometimes helping to bring the two together. Unfortunately, we have become aware of misinformation that is being spread in the cannabis community. Anecdotally, some people are claiming that cannabis is a “sinful business” and therefore investors in cannabis enterprises are not eligible to receive the extraordinary benefits of the new opportunity zone tax incentives. Nothing could be further from the truth.
To summarize briefly, for investors with capital gains, qualified opportunity zones provide four separate tax benefits:
Immediate deferral of capital gains tax 10% reduction of the capital gains tax ultimately due if the investment is held five years Additional 5% reduction of the capital gains tax ultimately due if the investment is held seven years Permanent exclusion of capital gains tax due on the appreciation in the value of the investment if it is held for 10 years or more (Please see our previous posts on opportunity zones and cannabis opportunity zones.)
Investors with capital gains make investments in Qualified Opportunity Funds (QOFs), and the QOFs in turn make investments in projects located in QOZs. The projects can be structured as partnerships, corporations, or outright ownership of business property in a QOZ. There are a number of requirements for these projects, but three important conditions are that:
Substantially all of the tangible property owned or leased by the project be “QOZ business property” The project be an active trade or business The project is NOT described in Internal Revenue Code §144(c)(6)(B)
Internal Revenue Code §144(c) provides the requirements for local municipal tax-exempt bonds used to redevelop “blighted areas,” subsection (B) giving a list of businesses that the proceeds of the tax-exempt bonds can’t be used to support: “any private or commercial golf course, country club, massage parlor, hot tub facility, suntan facility, racetrack or other facility used for gambling, or any store the principal business of which is the sale of alcoholic beverages for consumption off premises.” These businesses are not inherently
sinful, it’s just that Congress decided they were not appropriate beneficiaries of this particular type of tax-exempt bond. It’s certainly true that if these were the ONLY businesses in your town it would look a lot more like Potterville than Bedford Falls, but it’s clearly misleading to call them sinful.
So what does this list have to do with cannabis? Well, nothing at all. Congress clearly knows how to describe a cannabis enterprise. Internal Revenue Code §280E:
No deduction or credit shall be allowed for any amount paid or incurred during the taxable year in carrying on any trade or business if such trade or business (or the activities which comprise such trade or business) consists of trafficking in controlled substances (within the meaning of schedule I and II of the Controlled Substances Act) which is prohibited by Federal law or the law of any State in which such trade or business is conducted.
As long as cannabis is on Schedule I, a business won’t get a deduction for an expense paid or incurred in carrying on trafficking in cannabis (“trafficking” is defined elsewhere in the Controlled Substances Act). This provision of the tax code is extremely specific and targeted.
Now contrast that with a cannabis-oriented QOZ project – an investor with capital gains invests in a QOF. The QOF in turn invests in an LLC that is building a warehouse in an opportunity zone that will be leased to a cannabis enterprise. If the investor holds her interest in the QOF for ten years, she will get all four of the QOZ tax benefits described above. The cannabis enterprise will be subject to §280E (as long as §280E exists) but that does not affect the investor’s entitlement to the capital gains benefits.
One purveyor of misinformation has written: “It would seem logical that the statute would not need to expressly name specific types of criminal activity as excluded benefits to ensure that the tax benefits are limited only to desirable business conduct; the assumption (arguably) is that any criminal activity would be prohibited, and not entitled to special benefits. Why would the IRS extend tax benefits to a ‘criminal enterprise’?” The idea that the IRS has the discretion to extend or deny tax benefits outside of the specific provisions of the incredibly detailed Internal Revenue Code is silly. The reason §280E was enacted is because the Tax Court allowed a drug dealer ordinary business expense deductions, and Congress decided that it needed to enact a statute to deny tax benefits under the specific circumstances of trafficking in Schedule I or Schedule II controlled substances – in the absence of §280E, the IRS does not have the ability to deny the tax benefits of the deductions.
There’s a lot more to this analysis than the above, of course – there are numerous court cases, including Supreme Court cases, on the availability of tax benefits to criminal enterprises and the limitations on the ability of the IRS to deny tax benefits on public policy grounds. There are also other important precedents and numerous scholarly articles.
This type of uninformed advice underlines a larger problem in the cannabis community, namely the need for better advisers. As the cannabis sector becomes larger and more complex, business owners and investors need up-to-date and sophisticated advice. Many general cannabis practitioners remain blissfully unaware of the intricacies of the federal tax code, and cannabis participants should demand better.
The information in this article is provided for general informational purposes only, and may not reflect the current law in your jurisdiction. No information contained in this post should be construed as legal advice from Greenspoon Marder LLP or the individual author(s), nor is it intended to be a substitute for legal counsel on any subject matter. No reader of this post should act or refrain from acting on the basis of any information included in, or accessible through, this post without seeking the appropriate legal or other professional advice on the particular facts and circumstances at issue from a lawyer licensed in the recipient’s state, country or other appropriate licensing jurisdiction.