Tax Advantages of Investing in Qualified Opportunity Zone Funds Triangle Commercial Association of Realtors February 7, 2019
Tax Advantages ofInvesting in Qualified
Opportunity Zone Funds
Triangle CommercialAssociation of Realtors
February 7, 2019
Welcome and Introductions
Chris Judy, Partner919‐534‐1230 / [email protected]
Wilson Hicks , Tax Manager919‐780‐5108 / [email protected]
Disclaimer
This information has been prepared based on the proposed regulations 1400Z issued 10/19/18. The temporary or permanent regulations have not been issues. This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, tax, legal or accounting advice. The application and impact of laws can vary widely based on the specific facts involved. You should consult your tax, legal and accounting advisors before engaging in any transaction.
More Information
OZ History• Included in Tax Cuts and Jobs Act –
– Signed into law December 22, 2017– Code Section 1400Z– Proposed regulations issued October 19, 2018– Two additional guidance packages expected later this year & spring 2019
• Purpose to:– Encourage development / investment in low‐income areas– Poverty rate >20%, Family income < 80% of median
• Maps– Each state to designate up to 25% of qualified tracts– NC submitted 252 zones, certified on May 18, 2018– Zones will remain eligible for 10 years
OZ Tax Benefits
• Temporary Deferral– If capital gain is reinvested in OZ Fund within 180 days of Sale– Deferred gain recognized on earlier date of:
• Disposition of OZ investment or December 31, 2026
• Step‐Up Basis– Basis for the capital gains reinvested is increased / gain reduced
• 10% if held 5 years• 15% if held 7 years
• Permanent Exclusion– Capital gain held at least 10 years in “Qualified Opportunity Fund”
Designated Zones
• Maps– 12% of entire US land area– North Carolina: 252 zones certified on May 18, 2018
• NC Department of Commerce
https://public.nccommerce.com/oz/
State of NC Maps
Triangle Region
Raleigh
Durham / Chapel Hill
Johnston County
Rules for Qualified OZ Fund
1. Must be a Corporation, Partnership or LLCa. No disregarded entities (single‐member LLC)
2. Must be organized in one of 50 states, DC or US Possessions3. Must Self‐Certify as a Qualified OZ Fund
a. Complete form 8996b. Must include annually with your income tax returnc. Must ensure semi‐annually – 90% of assets invested in Qualified OZ Propertyd. Newly created QOF up to six months to investe. After construction completed working capital < 5%
Qualified OZ Property
1. Stock in Opportunity Zone Business
2. Partnership interest in Opportunity Zone Business
3. Qualified Opportunity Zone Property
Who Can Qualify1. Any investor with taxable capital gain from sale of property
‐ $2.3 Trillion of unrealized gains on stocks & mutual funds alone‐ Gain can’t be triggered from a related party (20%)
2. Qualifying gains:a. Long‐term or short‐termb. Gains on carried interestc. Depreciation recapture 1250 propertyd. Capital gain distributions from mutual fundse. Collections on installment salesf. Gains will retain same character when recognized in 2026
3. Gains not qualifying:a. Depreciation recapture on equipment – 1245 propertyb. Sale of partnership interest with hot assets – 751 assets
Timing of Investment
1. Capital gain must be invested in QOF within 180 daysa. Only the gain portion of the sale qualifiesb. No intermediary is required like 1031 exchangesc. No tracing of sales proceeds
2. Capital gains realized by partnershipsa. 180 day period starts on last day of partnership year end – December 31
3. Unqualified gains or principal a. Can be made to QOF but that portion receives no OZ tax benefitsb. Must be bifurcated and treated as separate investment (separate K‐1)
Substantial Improvement
1. The property acquired by Qualified OZ Businessa. Improvements must be made to double the basisb. Land or land improvements are not taken into considerationc. Improvement must be made within 31 months from acquisition of property
2. Example:a. Property purchased includes an old building for $1Mb. Allocation is $800K for land and $200K for buildingc. Building improvements of $200K must be made within 31 months
Qualified OZ Business
1. Any type of business can qualify includinga. Residential or commercial real estate development
2. Businesses that do not qualifya. Golf courses, country clubsb. Massage parlorsc. Hot tub or suntan facilitiesd. Racetrackse. Gambling facilitiesf. Liquor stores
Requirements for OZ Business
1. 70% of assets must be invested in qualified OZ property
2. At least 50% of gross income from active conduct of business in OZ
3. Substantial portion of intangible property from business in OZ
4. Less than 5% of property can be cash or cash equivalentsa. After property is completed
Failure to Satisfy 90% Test
1. Penalty = federal underpayment interest ratea. Currently 5%b. Calculated after six months and end of yearc. Calculated based on dollar amount under 90% testd. No penalty if due to reasonable causee. Calculation made on Form 8996 filed annually with return
Developer Financial Considerations1. Investment requirements
a. New or b. Substantial improvement
2. Carried interesta. Roll no gain vs minimal gain
3. Capital stack impacta. Leverage
4. Timing of raises – capital deploymenta. 6 month baselineb. 31 month written plan
5. Other tax incentives – historic credit, low income housing credit
Other Consideration
1. Operating agreement should statea. Purpose to operate as OZ Fund orb. Qualified OZ Business
2. Compliance with:a. Securities Act of 1933, as amendedb. State securities laws – “Blue Sky”
OZ Investment Risks1. Future tax rates2. Market exit risk3. Political support4. Tax penalties
Investor Flow of Funds
Realize GainMarch 2018
Invest in OZSep 2018
Recognize GainDecember 31,
2026
QOF SoldJan 2029
Gain via Personal Asset
Gain via K‐1Realize GainMarch 2018
Invest in OZJune 2019
Recognize GainDecember 31,
2026
QOF SoldJan 2029
Investor Summary
• Exit period expires Year 2047• Step‐up on exit appears inclusive of depreciation
• Covered land play
Holding Period (years)
<5
5 – 6
7 – 9
10+
Original Gain Taxed
100%
90%
85%
85%
OZ Gain Taxed
100%
100%
100%
0%
Investor Structure
Sample OZ Structure
Taxpayers
Qualified Opportunity Fund90% Test
SPE(Qualified OZ Business)
70% Test
Project within Opportunity Zone
$$ 60% Stock or Partnership Interest
40% Stock or Partnership Interest
$$Developer/Partner
Own Asset in Zone1. Market pricing reaction2. Sell and roll back into QOF – related party3. Raise equity4. Example – NNN lease & buildout
Takeaway – requires analysis & planning