Qualified Opportunity Zones
USAF · Phoenix, AZ · Member since 2015 · 65 posts · 26 votes
Has anyone taken advantage of a Qualified Opportunity Zone investment?
See link for more info - https://www.irs.gov/newsroom/opportunity-zones-frequently-asked-questions#designated
The essence is that you can invest capital gains into a qualifying fund and defer capital gains, even completely diminishing the taxes if you leave the funds invested for a specified period.
If anyone has taken advantage of this, how did you go about it? Also how has it turned out so far? Any advice you would give to someone looking to go this route?
Thanks.
Adam
@Adam Treece I'm a real estate investor and an attorney specializing in Opportunity Zone investments. My partner and I created our own OZ fund in April and have been reinvesting capital gains from recent sales of our non-OZ holdings into our Qualified Opportunity Fund. We've been focused on purchasing value-add single family and small multi-family in our local Opportunity Zones in Central Kentucky -- the deal economics on our OZ purchases thus far are looking great (in many cases, they're properties that would have been worth buying even without OZ benefits). We're generally using hard money financing as a supplement to our OZ equity for the upfront purchase/substantial improvement, and then putting long-term financing in place once renovations are complete.
My favorite part of the OZ upside in this space is the tax-free upside after a ten-year hold. Based on the language in the statute, we'll get a "step-up in basis to fair market value" when we sell our interest in the Opportunity Fund -- so no tax, including depreciation recapture, upon sale in 10+ years. Since we have to sell our "interest in the fund" to get that full benefit, we'll need to execute a portfolio sale (rather than selling each home as a single asset) when we decide to exit. That'll enable us to take depreciation-sheltered income from the homes over the next ten+ years (including quite a bit of bonus-depreciation in the year renovations are completed) which we'll never have to recapture.
I agree with @Kory Reynolds about the loss of control risks that come with LP investment in larger funds. But if you're an active real estate investor able/willing to reinvest your own gains in OZ properties, then the incentives can add major value to what you're already doing.
I do tax work for a hefty number of clients, and after discussing QOZ with all of those who have recently had significant capital gains...only a select few of them ended up investing in a QOZ fund. This was for a number of reasons which I'll note below. I will note we have a handful of clients in the business of setting up syndicates who have and plan to continue to set up QOZ funds that they are able to find ample funds for.
Due to how the rules work / requirements, how it works for most people is they'll put their funds into a syndicate like entity - the amount of the gain deferral needs to be significant enough that you won't eat it up with compliance costs.
1) loss of control - many of them didn't want to make the jump from running their own investments/business, to giving up that control to a fund. Of course for many folks this is not a problem, but it is a consideration depending on your goals.
2) Zones are qualified for a reason - I worked with a few folks who looked heavily into setting up QOZ projects/funds, but the locations didn't make business sense for them. Maybe it does in your neighborhood, but something to consider.
3) The gain deferral on the original gain is not permanent and sunsets at a specific time. Unlike a like kind exchange which is completely on you for the timing, and if, the gain is recognized.
4) There is currently a sunset about 30 years down the road when QOZ funds need to be closed - unless something changes legislatively, I imagine a sudden sale of a high number of QOZ projects could create excess supply, and a problem with selling prices, potentially resulting in a significant reduction in the amount of tax free gain benefit.
It is certainly a huge potential tax benefit, and I know it will work out well for a number of people. Just need to take all factors under consideration. My advice would be to weigh everything, focus on the whole picture and not just the tax deferral. In the end it should also make good business sense. IE you save 15-23.8% capital gain tax up front, but only get an investment that returns 4-5%, but in a non QOZ you could get 10%. I am sure there are QOZs with great returns as well - just illustrating the point.
@Adam Treece I'm a real estate investor and an attorney specializing in Opportunity Zone investments. My partner and I created our own OZ fund in April and have been reinvesting capital gains from recent sales of our non-OZ holdings into our Qualified Opportunity Fund. We've been focused on purchasing value-add single family and small multi-family in our local Opportunity Zones in Central Kentucky -- the deal economics on our OZ purchases thus far are looking great (in many cases, they're properties that would have been worth buying even without OZ benefits). We're generally using hard money financing as a supplement to our OZ equity for the upfront purchase/substantial improvement, and then putting long-term financing in place once renovations are complete.
My favorite part of the OZ upside in this space is the tax-free upside after a ten-year hold. Based on the language in the statute, we'll get a "step-up in basis to fair market value" when we sell our interest in the Opportunity Fund -- so no tax, including depreciation recapture, upon sale in 10+ years. Since we have to sell our "interest in the fund" to get that full benefit, we'll need to execute a portfolio sale (rather than selling each home as a single asset) when we decide to exit. That'll enable us to take depreciation-sheltered income from the homes over the next ten+ years (including quite a bit of bonus-depreciation in the year renovations are completed) which we'll never have to recapture.
I agree with @Kory Reynolds about the loss of control risks that come with LP investment in larger funds. But if you're an active real estate investor able/willing to reinvest your own gains in OZ properties, then the incentives can add major value to what you're already doing.
Thanks @Kory Reynolds and @Scott McIntosh. Both great responses to the question and provide some great insights.
Seems like OZ investing can be a good tool, but at the same time seems very niche. Thanks for the responses...very helpful.
@Scott McIntosh
Hey scott. Question. If I buy a property value at 175k. How would I determine the land value? The assessments for taxes are completely diff numbers.
From what I understand the substantially improve test is
Purchase value minus land value = amount plus 1 dollar need to be invested to be passed as substantially improved.
Is that how it works? Am I missing something? Please clarify. Appreciate it.
@Derek W. the IRS is going to rely on the value you assign to the land on your partnerships tax return. There’s no single ‘right’ value — just needs to be in a reasonable range and defensible in the event of an audit. Tax assessments, appraisals, and/or comps for recent sales of raw land in the area could all be a reasonable basis for your valuation. Not uncommon for accountants to use a 10-20% shorthand for the value of residential land and I think something like that would hold up in most cases as well.
Watch this webinar by attorney John Hyre:
https://www.taxreductionlawyer.com/new-opportunity-zones
@Scott McIntosh
Thanks for the quick reply scott. So what do u think of this. With regards to the property I am purchasing. Based on property records the assessed value of land to property ratios is 62 percent.
175 k at 62 percent would equal 108k (land)leaving building value to be at 67k. If I invest 70k into the property I should be good?
Another question is I am buying a mixed used property. The commercial unit I am actually planning on opening a food establishment. Would investing in that pass the opportunity fund substantially improve test?
In scenarios like this is actually doable. Imagine buying a property for 250k and having to spend another 250k just to get the tax breaks? The new tax law would only benefit the top 0.5 percent.