So I'm currently in the process of buying a house hack property that's in an Opportunity Zone (OZ) and am currently buying under my name for the lower interest rate. The intent was to transfer the property after purchase to an LLC, which I cleared with the loan company.
After diving deeper into OZs though, I realized that there are many more requirements to actually take advantage of them rather than just buying an OZ, such as the need to invest through an Qualified Opportunity Zone Fund(QOZF) and the need for substantial improvement. This means I'll be looking to set my LLC up as a two-person LLC and make sure the structure requirements meet all of the QOZF qualifications, such as being taxed as a corporation, etc.
Does anybody know if this will still work if it's technically originally purchased under my name however? Or have I already made an irreversible mistake in not doing the OZ property purchase under the QOZF?
Thanks to anybody who contributes their input, I know it's not a substitute for legal advice but specific info like this on OZs seems to be pretty hard to find. I'll probably be reaching out to a lawyer/taxperson who is knowledgeable in OZs also, I was just hoping the collective BP knowledge might help to give me some insight. Thanks everyone!
If you buy the property under your name and then transfer it into a QOF entity that is more than 20% held by you, there could be a risk that the transfer is seen as a related party transaction, which could invalidate your QOZ benefit. Note that you also need to be using eligible gain in your QOF for the purchase to get the tax benefit. If you are closing the purchase outside of the QOF entity with eligible gain (say your down payment), then you are not satisfying the basic QOZ requirements to get the benefit, i.e. purchasing with eligible gain inside your QOF. I suppose you could contribute your eligible gain into the QOF and then pay yourself back the down payment when you transfer the property into the QOF, but then it looks like a related party transaction, which is not permitted. I would check with an attorney/tax specialist before you go down this path.
So even though I'm really the one investing in the QOZ property (whether personally or through my own QOF), there doesn't seem a clear and easy way to retroactively change the status of my ongoing purchase so it would qualify for QOZ benefits? I had seen the description about related party transactions, but was hoping via intent of the QOZ that there would be a way to qualify despite making this purchasing error.
Since the deal hasn't closed yet, do you think there's some way to create to quickly create the QOF and sub that in for the buyer then? Or would that change the purchasing contract so completely that it's not even an option?
Thanks for your insight.
I think closing the purchase with the QOF as the buyer (like assigning the purchase agreement from you to the QOF) would be less risky than closing it in your name and then transferring the property to your QOF. But your lender may not agree to do that. The reason why you're getting a low rate is because you are acquiring the property in your name as an individual. You might consider finding a lender that will lend to your entity. There are a few out there that cater to investors using an entity for their acquisitions, but they charge higher interest rates than a Fannie/Freddie type lender. Or try and find a hard money lender that will lend to your QOF entity to close the transaction and then later refinance with one of those other lenders (they should have lower rates than a hard money lender). I can refer you to a hard money lender in the Bay area if you're interested.
Edward— you do need to create the QOF first and buy the property directly in the QOF. To qualify for OZ benefits, the property must be acquired by the QOF from an unrelated party (and be located in an OZ and substantially improved, as you noted). If you quitclaim the property from yourself to the QOF, it doesn’t meet the first prong and won’t be eligible for the related benefits.
From my understanding, set up the OZF first, and then buy the property.
I am planning to buy some run down properties or land in OZ, this coming year. But first need to set up a corporation first.
There is a very detailed question and answer PDF from the IRS, to clarify some ambiguities.
Thanks for the responses everyone! I had mistakenly thought that I couldn't change the contract to a QOF since I had already entered escrow so I was trying to work around that, but it looks like I can still make that change so I will be working to establish a QOF asap!
From what I saw the recommendation is to set up an two-person LLC with another person having a minimal share for the QOF (taxed as a corporation), and then set up a QZOB underneath it in the same way and hold the property under that. Does that sound about right? Or does the extra QZOB layer seem unnecessary if it's just a single property that I'm nearly singularly deploying the cash into?
What does this two person LLC mean? Why do you need another person?
I think an LLC taxed as a partnership is a better answer from a tax perspective. If your QOF is only going to hold the one asset, then a single-tier QOF is do-able, but you have to be aware of the 90% asset test compliance requirement and manage your cash in the QOF accordingly. I just wrote a blog post on using a single-tier vs 2-tier QOF structure here:
@David Song By two person LLC I mean having myself as a 99.9% interest owner and someone else as a 0.01% owner, similar to what Philip wrote about in his insightful blog post. This established it as a partnership, otherwise if you do a single-person LLC you need to designate it be taxed as a corporation to qualify, otherwise it will be a disregarded entity. I'm still learning so I don't really know whether the partnership or corporation taxation would be better for my situation, but it's looking like the partnership.
@Philip M. Thanks for sharing the blog post, it was really helpful! That's a great point about the cash flow, I didn't think about that potentially being an issue to stay within the 90% asset requirement. I was only planning to do the one OZ property to cash out for retirement and doing all other properties as basic long-term hold, so the single tier QOF would be ideal, but I would definitely need to find a way around that cash flow issue. Would you be willing to share more details about the cash withdrawals issues you ran into because of basis limitations on the deferred gain? I'm having a bit of trouble trying to Google up the resources to understand what happened there. Thanks!
great article. This helps a lot. Do you have a CPA that you can recommend?
I think what some people failed to look over is that the property will be a house-hack which is a partial personal residence.
This complicates the whole QOZ situation.
@Basit Siddiqi is that the case from a tax substantiation of substantial improvements viewpoint? I wasn't aware that would be a problem, if you could elaborate that on slightly it would be much appreciated!
The QOF is suppose to make an investment in rental real estate or a business within the qualified opportunity zone...not for the purchase of a personal residence...
@Basit Siddiqi If I buy a property and improve it with an ADU, then should it matter whether I also live there or not given that it's purchased under the LLC and not my personal name? Or is that problematic in terms of the rental/cashflow purposes?
The longterm plan is still to eventually move out and rent everything, so not sure if that makes a difference.