Did you recently buy in an Opportunity Zone?

12 Replies

I'm closing on a new deal in an Oppurtunity Zone, as designated by the tax reform bill passed in late 2017. Are there BP folks that buy in these areas? Do you need to setup a fund before closing to take advantage of the 10 year tax basis change or capital gain exemptions? Would love a bit of free info here before calling a tax law attorney.

Thanks!

Andrew

I would prefer to just do a 1031 exchange or pay the tax and not have this money tied up for 10 years to save some tax. I've looked into it and if I wanted to buy something and put enough money into it to qualify and keep it as a rental or business then yes it is icing on the cake, but not enough reason by itself to change my investment strategy.

Good points John. In this case we are buying the investment because we actually like the location and it is gentrifying, not because it is on an OZ. I just want to make sure I have the option to avoid the long term capital gains in ten years if I so choose. I just want it to be an option, rather than having to 1031 it. Not saying I won't 1031 it.

Here's an unlike scenario but an example scenario nonetheless: Ten years from now my youngest is 14 and I dump the proceeds estimated $138,580 in CG into her 529 and she doesn't pay a dime in college tuition. Not going to go this route because I'd like my girls, if they go to college, to fund some of it themselves. But it's simply an example. I don't want to regret not being able to take advantage of a goofy law. Right or wrong I want the option in the future.

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@Andrew Gingerich 
While a 1031 is viable for some people, Qualified Opportunity Zones allow you to role money from ANY capital gains into purchasing real estate.

There are several requirements in order to benefit from the new .... rule number 1 and number 2 are simple. The property must be in a QOZ and you must purchase with a QOZF (fund). But the fund is self-certifying, and if this is a property you were planning on buying in an LLC (or C,S Corp) and you have the amount of unrealized capital gains to purchase and significantly improve the property, it would certainly be worth looking into. I'd recommend a CPA to discuss the situation with.

If held for 10 years, there is no point to 1031 the property.... all of your profits from that property are tax free!

@Andrew Gingerich

Congrats on the acquisition!  Yes, quite a few BP members active in the OZ space, too.  I have an Opportunity Fund that my partners and I use for personal investments, and I also am an attorney with a legal practice focused on creation and compliance for OZ funds. 

To answer your question, yes, you do need to have a Qualified Opportunity Fund (QOF) setup before you purchase the property, and must purchase it in the name of the QOF.  You're probably tracking this requirement too, but the equity you use to purchase the property must be recently realized (within 180 days, in most cases) capital gains in order to receive the OZ benefits.  You can pair it with as much debt as you like, but if you have a mix of capital gain and non-capital gain equity in the fund, you'll dilute your tax benefit when you sell in 10+ years.  The rules get a little trickier if some/all of your gain is 1231 gain, or if you received the gain through a partnership (i.e. came to you on a K-1).  When you engage someone to help you with creation of your fund, I'd encourage you to ask them about those pieces and ensure the money you plan to redeploy in your OZ fund is done so on the right timeline.  

Originally posted by @Bo Goebel:

@Andrew Gingerich 
While a 1031 is viable for some people, Qualified Opportunity Zones allow you to role money from ANY capital gains into purchasing real estate.

There are several requirements in order to benefit from the new .... rule number 1 and number 2 are simple. The property must be in a QOZ and you must purchase with a QOZF (fund). But the fund is self-certifying, and if this is a property you were planning on buying in an LLC (or C,S Corp) and you have the amount of unrealized capital gains to purchase and significantly improve the property, it would certainly be worth looking into. I'd recommend a CPA to discuss the situation with.

If held for 10 years, there is no point to 1031 the property.... all of your profits from that property are tax free!

Only the gains on that new property though, now if you sold one that generated gains- those gains get paid.

If you wait 10 year ALL of your profits aren't tax free- only newly generated gain/appreciated in the property purchased. 

The original capital gain is recognized in 2026, or when the property is sold- whichever is sooner. 

So really- If tax rates change over between now and then you could end up paying MORE on that initial capital gain vs. if you just paid it today. It's a gamble. 

@Natalie Kolodij @Andrew Gingerich
You are completely correct, Natalie. Thank you for clarifying, as I was a little vague in my explanation. 

The point that I was trying to make is that the capital gains that would be realized from the sale of a property are completely FORGIVEN if held for 10 years. With a 1031, you simply DEFER (possibly indefinitely) that gain. 

Gamble on the taxes you owe today, yes. But I'd argue that in most scenarios that risk is compensated for because you have a total of seven years (if closed by December) of your deferred taxable money generating a return. The fact that you can then sell any property and realize $0 of taxable income from the appreciation (both natural and forced) is possibly a tremendous cherry on top. 

For long-term, value-add, buy and hold investors like myself, it is an incredible tool. 

@Bo Goebel thanks for the info. This is very helpful stuff. Yes, I agree it could be an incredible tool down the road. Seems like having yet another tool in the tool box is a no brainer. Again, appreciate the comments.

@Scott MacIntosh it looks like you have to be putting capital gains into the QOZ rather than non-capitalized gains. I.e you can't simply put after tax income savings into the QOZ and avoid paying capital gains ten years from now. Bummer. I don't want to sell an asset right now just to have capital gains to put into the new purchase. 

I really appreciate all the feedback here.

Andrew

we closed our first deal in Baton Rouge a few weeks ago. it's at 95% capital deployed in an OZ, which is great for the 90% threshold. I think one issue in the OZ space is the ability to invest in and outside of the OZs themselves. I worry that too many practitioners will exploit the flexibility to the detriment of investors. so beware of that imo from the investment standpoint. 

otherwise, merry investing

hey @John Underwood, enjoyed the post. can you elaborate more on your thinking re: not enough reason to change your investment strategy? 

I hear something like this often specifically in regards to changing the investment strategy to meet the OZ requirements. i've had a few investors and developers who like flips have concerns about the potential for inclusion events where they could be taxed on their original investment into an oz simply by using their flip strategy to buy and sell property within 3-4 months. so i'm wondering if you have similar concerns re: the conflict between OZ and current strategy. thanks. 

Originally posted by @Nashid Ali:

hey @John Underwood, enjoyed the post. can you elaborate more on your thinking re: not enough reason to change your investment strategy? 

I hear something like this often specifically in regards to changing the investment strategy to meet the OZ requirements. i've had a few investors and developers who like flips have concerns about the potential for inclusion events where they could be taxed on their original investment into an oz simply by using their flip strategy to buy and sell property within 3-4 months. so i'm wondering if you have similar concerns re: the conflict between OZ and current strategy. thanks. 

 To fully utilize the OZ you have to be invested there for 10 years. I think there may only be 9 years of this window left.

I dont want it to force me into a deal I wouldn't have done otherwise. If it aligned up on a property I wanted to keep long term and had gains from another deal I wanted to shelter then great. 

Too many things have to align and I don't want to force something into a mold that doesn't fit.

I think a 1031 exchange would be better for me and I don't have a long holding requirement to make it work. I can just keep trading up to better properties until my kids inherit my assets and I would have never paid any capital gains tax. They will inherit at the new stepped up basis.

@John Underwood thanks for the reply and your logic is valid. I will clarify, though I still think your main concerns still hold, the window to invest into OZs is until 2028.

Here's a timeline

2026 - last year to invest in OZ fund

2028 - last year to deploy capital into an OZ project (develop property, business etc)

2047 - last year to recoup benefits

So yes the 10 year holding is where you get the big nut from the tax free profits on your OZ benefits. You have until 2047 to claim those benefits. And Lord forbid you pass any time before then, your kids will inherit those assets without an inclusion event so they would also have until 2047.

Still, I think you're right about the 1031 being a better fit and I definitely agree it's best not to force your money into a holding period you don't want for an OZ deal you otherwise would not do.

Eliminate as many moving parts from the equation.  What is the key distinction between a 1031 and and OZ.  It's not the type of real estate.  You can 1031 into an OZ.  It's not the tax deferral because there's windows for each.  It's only the time restriction to purchase and liquidity.  You can sell property without a 1031 and take up to 180 days to reinvest in an OZ or fund. 

But to get the maximum tax deferral you have to hold for at least 10 years (For history buffs that's about 1/2 of a complete real estate cycle historically) . So it is very possible that you would be trying to sell your OZ property at the bottom of the next market. Just something to think about because I hear people talk every day about how a 1-2 year hold period for a 1031 is long. And a 5-7 year hold for a DST is crazy long. Where does a 10 year OZ horizon stack up in that mix?

The other thing that I'm seeing at work is the "pretty pony" syndrome.  Ozs are in vogue.  So what is happening to acquisition prices?  They're outstripping proformas.  And that is not a good buying scenario.  Again, the same people who talk about having to overbuy in a 1031 scenario are also going to be trying to buy into an overheated commodity that is already dominated by the bigger OZ funds.

I'm just not seeing it.  An OZ is a good concept and if you got in early you got some cream.  But now you're most likely in competition to overpay for mediocre assets.  But you do have an extra 180 days to do so.

@Andrew Gingerich, is playing it exactly right.  He's ignoring the acronyms and buying value.  He located a property meets his criteria.  It just happens to be in an OZ.  He could have 1031d if the property wasn't in a zone.  But it was so he doesn't have to.  That's the way to play that!!

Otherwise @John Underwood, your play is guaranteed - defer defer defer and die!  OK so maybe the guaranteed death is a little morbid but what a legacy to leave your children.  And if you look outside the initial calendar parameters the 1031 is really much more flexible and can be used to position ahead of a cycle rather than having to react inside a cycle.  Same conclusion @Nashid Ali came to.

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