Opportunity Zone Improvements: Retail Value or My Cost?

Question

Opportunity Zone Experts. When I invest in an OZ, I must make improvements equal to the building's value.

Does the government consider retail value improvements or do I have to provide receipts for dollars spent? I can do the work far cheaper than retail value, do I have to do significantly more because I'm doing it myself? Can I do it myself?

@Natalie Kolodij

Brandy Coffey · Answer

“Opportunity Funds” is quickly becoming a discussion topic in Sarasota. Locals and investors are talking more frequently about Opportunity Funds, Opportunity Zones, and the tax incentives they provide, but very few people are familiar with how they pertain to Sarasota.

According to fundrise.com, “Opportunity Funds promote investment in the development of low-income communities across the US, by offering investors federal tax advantages that are only available through the new Opportunity Zone program.”

In the simplest of terms, the government is providing tax breaks and incentives to investors in exchange for providing much-needed capital to low-income areas. The Opportunity Fund is the investment vehicle required to receive the tax benefits.

When an investor realizes capital gains from selling an appreciated asset, they must typically pay taxes on that amount. However, if they choose to reinvest their capital gains into an Opportunity Fund, their tax burden is substantially minimized.

The Opportunity Fund then reinvests at least 90% of its holdings into partnership interests, businesses, and/or properties within a qualified Opportunity Zone. The properties may include real estate, factory equipment, businesses, etc. and provides an opportunity for the investor to improve the community in which they reside.

The longer the investor reinvests their capital gains in the Opportunity Fund, the more benefits they receive. Several tax advantages include:

• Capital gains placed in a certified Opportunity Fund will not be taxed through the end of 2026 or when the investment is sold, whichever comes first.
• Any gains are permanently shielded from taxes if the investment has been held in the Opportunity Fund for 10 years.
• In addition, for tax purposes, after seven years, the initial investment will be discounted by up to 15 percent.

According to CNBC (link: https://www.cnbc.com/2018/10/19/investors-can-get-tax-breaks-for-investing-in-opportunity-zones-treasury.html), the tax advantages are summarized below:

• The proposed regulations clarify that only capital gains are eligible for preferred tax treatment.
• Investors who can participate include individuals, corporations, businesses, REITs, and estates and trusts.
• Treasury said additional guidance will be released before the end of 2018, with final rules likely to come in the spring.

Natalie Kolodij · Answer

Tax wise you never get to count the value of your time.

So if you choose to do the improvements yourself- you'll only be able to count costs of materials, permits, ect.

Now- do you have a separate business that does contracting work? We may be able to structure it to have it come into play.

Spencer Hogan · Answer

@Mindy Jensen Keep in mind that the basis of the land is excluded from the "substantial improvements" requirement. This may get you closer if you weren't already factoring this in.

For example, if you bought an existing property for $1M allocated as $800K towards the improvements and $200K towards the land - you would only need to invest another $800K towards improvements over 30 months to meet the "substantial improvement" requirement.

Natalie Kolodij · Answer

30 months from Purchase to complete the renovations.

Matt Chodosh · Answer

Those interested in learning about Opportunity Zones may enjoy my most recent blog post.

@Mindy Jensen @Natalie Kolodij @Dante Pirouz @Justin F. @Brandy Coffey @Spencer Hogan

"A Brief Overview of Opportunity Zones"

Matt Chodosh · Answer

@Mindy Jensen  , You certainly can do the work yourself. Kolodij's answer is a good general rule. As Natalie alluded, you would be able to pay your "contracting company" and these costs likely would contribute to the IRS requirement of "Substantial Improvements." The IRS has only published "proposed regulations" most of the details are still unknown. For this reason, it is better to err on the side of caution.

As to your question on the timeframe. A Qualified Opportunity Fund, not to be confused with Qualified Opportunity Zones, has 30 months from the date of acquisition to make "substantial improvements" of equal to or greater than the value of the pre-existing property. Again, the IRS has not published final regulations, which may affect some timelines.

@Dante Pirouz , Opportunity Zones present three potential tax benefits.

1. Deferral of capital gain;

2. Possible reduction of the amount of gain ultimately recognized through a basis adjustment; and

3. Forgiveness of additional gain in the QOZ investment.

Unfortunately, your previously invested property purchases do not qualify. Though, it sounds like you may have an active trade or business in the area, which could qualify for future tax benefits if moved into an opportunity zone, amongst other requirements.

Justin F. · Answer

My understanding: You need to invest more dollars $$ in the renovation / development of the parcel than what you paid to acquire it. If you acquired it for $29K or less, than you could have done it as an OZ if you had set it up that way previously.

Mindy Jensen · Answer

Thanks @Natalie Kolodij. Obviously not what I wanted to hear...

Do the renovations need to be finished in 2019 or can they be finished later if started in 2019? This building comes with a vacant lot attached, and building on that would definitely cost more than I'm paying for the property... But no way would I finish in 2019.

Dante Pirouz · Answer

@Mindy Jensen @Natalie Kolodij  Is the primary advantage of investing in OZ the tax savings? Are there any other advantages? I purchased 2 of buildings in the last 2 years in OZ zones and I'm just wondering what if any advantage there is for my business. We invested about $30K-$50K in renovations in these properties. Is that something we could write off and are there time limits to know about?

Thanks!!

Opportunity Zone Improvements: Retail Value or My Cost?

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