Qualified Opportunity Zones (QOZ) are designated areas that provide tax advantages for real estate investors. These large-scale projects are often out of reach for the average investor. But by pooling financial and intellectual resources in a real estate syndication fund, investors are able to tackle properties and projects larger than an individual could manage on their own.
More specifically, the IRS defines an Opportunity Zone as “…an economically-distressed community where new investments, under certain conditions, may be eligible for preferential tax treatment. Localities qualify as Opportunity Zones if they have been nominated for that designation by the state and that nomination has been certified by the Secretary of the U.S. Treasury via his delegation of authority to the Internal Revenue Service.”
To take advantage of the associated tax benefits, the IRS requires that QOZ properties are purchased with a Qualified Opportunity Fund (QOF). According to the IRS, a QOF is “…an investment vehicle organized as a corporation or a partnership for the purpose of investing in Qualified Opportunity Zone property (other than another QOF).”
Approved QOZ properties also include qualified opportunity zone stock, a qualified opportunity zone partnership interest, and qualified opportunity zone business property.
The list of designated Qualified Opportunity Zones can be found at Opportunity Zones Resources (site includes a visual map of the census tracts designated as QOZ) and in the Federal Register at IRB Notice 2018-48.
Interested in setting up a fund? Here’s how to do it.
Flash Guide to Setting Up a Qualified Opportunity Fund
The following are the basics in preparing, organizing, and implementing a fund of your own. As always, I recommend you consult the appropriate legal and accounting professionals and both state and federal governing bodies in order to ensure safety and compliance.
Step 1 – Preparation
Determine Sponsor/Manager Designation and Payment/Distribution Structure and Duties
The manager, referred to as the “sponsor,” is the Individual who collects, manages, and distributes funds; designates properties for purchase and sale; and manages all properties throughout their hold time.
You will need to delineate the terms and timelines in which this individual gets paid for their services, as well as the percentage of the total investment fund due from this individual as equity (commonly between 5 and 20 percent) to ensure said individual has some “skin in the game.”
Sponsors get paid in a variety of ways, most often a combination of one or more of the following:
- flat percentage management fee on all income,
- fee or percentages of acquisitions and distribution,
- or a percentage of rental income during hold period, periodic distribution periods, and various others as determined by circumstance or agreement.
These fees depend entirely on the real estate being acquired and managed and whether the duties will include real estate broker services, bookkeeping and portfolio management, property management, or other tasks.
Determine Investor Qualification/Contribution Guidelines and Distribution Structure
Real estate syndication guidelines require the individual investor members be considered “qualified investors.” This is a bit of an arbitrary term.
To paint a picture of criteria you would use to determine qualification, imagine a retired woman on a fixed income with $100,000 in the bank versus a dual-income couple wanting to redirect their funds from one of a variety of options within their investment portfolio.
Once qualified, you will need to determine the guidelines for investment.
- Will there be a minimum contribution amount?
- Will there a be a minimum hold time for the principal investment?
- At what rate and frequency will proceeds be paid out to members?
As with sponsor compensation, there are various options for structuring compensation, such as a consistent percentage return. Additional options include a return on generated income and proceeds based on percentage of initial contribution of the total fund, or levels of consistent return rates based on predetermined contribution levels, or something similar. Funds are most often distributed to investors on a quarterly or semi-annual basis.
Clear designation of duties and compensation is essential for accountability and clarity for all members, whether sponsor or investor. Take the time to define each role and function to provide a firm foundation upon which to organize and launch.
Step 2 – Organization
Once these structures are determined and your preparation is complete, you will have the necessary information at your disposal to complete the next steps required to set up your fund. These include naming and setting up your entity, registering it with the appropriate agencies, and creating several documents for the company and investors.
- Form Business Entity: Most commonly an LLC or LLP.
- Obtain EIN, Register in Your State, Open Checking Accounts: You’ll need a trust account and operating account. Set up accounting procedures according to state and/or federal laws and rules regarding trust accounting.
- Draft Operating Agreement for LLC: This is where your diligence above will be outlined and clearly stated for all functions internally and related to members and managers.
- Investor Agreements: These agreements are for the members, clearly outlining contribution/distribution procedures, fees, rights, and responsibilities as determined above.
- SEC Requirements/Registration: Real estate syndication is regulated by the U.S. Securities and Exchange Commission or state securities agencies (sometimes both), as it usually involves the sale of securities in the form of an investment contract. A securities offering must be registered and/or approved by the regulatory agencies, unless exempt, and generally requires following a strict set of rules and filing of exemption notices with applicable securities agencies. Verify your reporting requirements with your attorney, as well as state regulators and the SEC.
Once your systems, procedures, and documentation are in place, filed, and approved, you are ready to move on to Step 3.
Step 3 – Implementation
It’s time to gather interested investors. Make sure the materials you create are simple and clear with projected returns noted as such and investor agreements available to applicants for thorough review.
Having a specific QOZ target for acquisition will help you market the opportunity more effectively using real-time figures, research data, and more realistic projections than an example created from a similar purchase. Investors will feel more comfortable seeing photos of a live site or project in process and will be better able to visualize their dollars at work.
After qualifying the applicants and gathering the appropriate paperwork and personal data, take time to sit down and go over the investor agreement, making clear the expectations for each party so they are confident in the timelines for required contributions, as well as proceeds.
A well-informed investor is a happy investor. Communicate that you’ll provide periodic reporting, so they’ll know when to expect property and fund performance updates, records required for their annual income taxes, and so forth. Setting and keeping clear reporting procedures builds confidence and trust and helps members relax and enjoy the very best part of investing—making money!
At final acquisition of your first property, pay out any appropriate fees to the sponsor, set the clock ticking, and reap the benefits of your labor!
- IRS Form 8996 Instructions and Form Drafts
- IRS Q&A
- Securities and Exchange Commission – Private Fund Advisor
- Structuring techniques and distribution methods for real estate syndications
- Real estate syndication basics and overview
- SBRE – resources to raise and manage capital
Want to learn how you could be saving more on your real estate taxes using loopholes, deductions, and more? Get the inside scoop from Amanda Han and Matthew MacFarland, real estate investors and CPAs, in Tax Strategies for the Savvy Real Estate Investor. Pick up your copy from the BiggerPockets bookstore today!
What other questions do you have about Opportunity Zones and how to set up a Qualified Opportunity Fund?
Leave a comment below.