My First Opportunity Zone Experience and How Others Can Do the Same

My First Opportunity Zone Experience and How Small-Time Investors and Newbies Can Take the Same Action 

Over the past year there have been numerous articles and blogs centered on Opportunity Zones, ranging from their intention, to how to form a Qualified Opportunity Fund (QOF), to how investors can defer gains and eliminate gains on forced appreciation. Because Opportunity Zones are still relatively new and come laced with requirements, the information can be extremely daunting, even to an experienced investor.

This blog is not a “why invest in Opportunity Zones” or "the in’s and out’s of Opportunity Zones", but rather a quick story on how a small part-time investor (me!) set up a successful Qualified Opportunity Fund with the assistance of the right supporting team. The purpose is to make the experience tangible to other investors so they too can take action on QOFs if they indeed fit your investment criteria. Regardless if you invest in Opportunity Zones are not, I want to make the point that breaking down a challenge to the next logical step makes a complex problem rather achievable.

***Note that I am not a CPA nor an attorney so please validate all information with the appropriate professionals.***

2-Minute Drill on Opportunity Zones

As mentioned, I will not going to go into detail about the benefits of Opportunity Zones, but below are the highlighted benefits to provide context for this article:

1. Defer capital gains

2. Eliminate a portion of capital gains

3. Permanent tax-free gains on 10 years of appreciation

4. This one is not part of the law but a potential intangible benefit: The intent of this legislation is to drive investors into these Opportunity Zones to help spur economic development.  This probably will not happen in all areas, but if you are in an Opportunity Zone where larger Qualified Opportunity Funds (QOF) choose to make large long-term plays, you can ride that tailwind and all ships may rise.

Unrealized Capital Gains, Now What?

I was fortunate to have a high-scale flip go very well where I profited 75k, all which would be taxed as capital gains. I had taken the time to read up on Opportunity Zones and was intrigued enough to considered passively investing with one of the many large syndicators. This would allow me to defer the gains, but it would also take the 75k off the table for me to continue to scale my rental portfolio.

Around this same time I attended the Midwest Real Estate Networking Summit (shout out to Brie Schmidt and John Casmon for hosting!) where I heard Neal Bawa speak in great detail on Opportunity Zones. He provided a breakdown of Chicago Opportunity Zones and one of the current areas I invest in was in the upper 80th percentile compared to all Opportunity Zone nationally. I was already investing in the area, and now I had capital gains that would qualify within the 180 days. However, I had no idea how to make this actually happen.

Vacuuming the Truck – Asking For Help to Get From A to B to C ..... to Eventually Z

I'm sure a portion of you {like maybe 4 out of the 12 who actually read this :)} know the analogy "vacuuming the truck" from BP episode 276. For those who don't, it's a great example of how to avoid overwhelming paralysis analysis and simply take the next logical step towards your goal.

I was down the right track by at least reading about Opportunity Zones and attending the conference.  Attending that conference might not sound like a big deal, but I have a full-time job where I travel during the week so it is a big deal to miss out on my three wonderful kids over a 2-day Sat/Sun conference. It goes without saying, my wife is a rock.

Taking the time to read and attend the conference put me in position to potentially succeed, but I feel this is where a lot of people unfortunately stop. They get educated but don't act on the education for two main reasons; fear or complexity. The whole reason I want to share this article is so others at this juxtaposition can force themselves to step out of their comfort zone and take the next necessary step.

Teamwork - Not Just Your Team Members, but Their Network

I obviously had no idea how to set-up a Qualified Opportunity Fund and it was so new that I found conflicting answers within my research.  So my first step was to validate all tax implications with my accountant. He spoke to another accountant who was well-versed in QOFs and we received his blessing that this would indeed qualify if I was within the 180 day window from the time I received my profits from the flip - 4/15/19.  Finding a deal was not the problem as I had just put a 3-flat in an Opportunity Zone under contract. Time was of the essence and we needed to get my QOF established.

The next step was to get my attorney involved.  My closing attorney is great but this was new to him. He didn't throw his hands in the air, but instead picked up the phone and found a colleague at his firm that had set up QOFs so we roped him in. This colleague had already scrutinized the existing legislation, and wanted to ensure that my property would be an "active trade of business." 

We set-up the new QOF and Operating Agreement, and also worked with my accountant to make sure I had the correct paper trail of money from my LLC (the sale from the flip that created capital gains) to Tom Shallcross, to my newly-established QOF. This was actually somewhat simple as unlike a 1031 exchange, there is no need to have proceeds held in an intermediary account. Lastly, I had my attorney work with my hard money lender to ensure the upcoming loan was made out to the correct entity and off we went.

I didn't need to understand every nook and cranny, but just had to understand each step at a high-level while I let the experts do their thing. Before you knew it, I went from vacuuming my truck to selling my truck.

Closing

This process took a few weeks, and in parallel I was closing with a direct to seller deal on a 3-flat in an Opportunity Zone.  The seller stayed on board because we had built up very solid rapport, and I was not taking advantage of him.  He felt good about the deal, I felt good about the deal, and we were in a solid spot.  I thought I might have to offer him a little more to have him avoid getting antsy and going a different route, but instead offered to put down a higher escrow account to show I was serious and that while it may take three weeks to close, my offer would become a signed contract as I meant business. We had just finished a rehab two blocks over which provided legitimacy in his eyes and also gave me confidence that my numbers were solid and worth the higher upfront escrow amount.

If he really needed to close in a week I would have closed cash before having the QOF established and figured it out from there. Worst case scenario, I miss out on the QOF benefits but I still liked the fundamentals of this deal regardless of the tax benefits.

Investing in An Opportunity Zone Area

There is no one size fits all strategy, but unless you are happily swimming in capital gains, it is ill-advised to make an investment in Opportunity Zone solely to defer and/or minimize gains. The fundamentals of the deal must work on their own merits without the added benefits being provided by the Opportunity Zone. 

Remember, many of these areas were chosen with valid reasons. According to the Economic Innovation Group analysis, in the average Opportunity Zone, the median household income is $33,345 and the unemployment rate is 13.41%. Not all Opportunity Zones are created equal as some areas are much better than this. Different risk levels will apply to each area.

What’s Next?

The 3-flat will be rent-ready in several months after the 100k renovation. It's being modeled off the success of the nearby 2-flat we just rented so we have a very tight grasp on what finishes are needed to demand the rents we desire for the area. To give you an idea of our numbers, the existing 2-flat appraised for 178k and I was only all-in (purchase + rehab) for 133k. With rents totaling 2050/M in an area that local political leaders are investing in, this is by far one of my best deals. Again, the fundamentals of the deal first, then the tax benefits.

As for QOF, I have now spoken with several day/commodity traders and we are in the beginning talks of partnerships for future deals. They have capital gains they are looking to defer and a strong deal in an Opportunity Zone will provide the desired ROI while also leaving plenty of room in the deal for me to be satisfied with my share of the profits. Note this will be a separate QOF and Operating Agreement.

As an intangible benefit his has given me confidence to try things I once wrongly pre-conceived were only for the big boys. Some of you might shrug this off, and any attorney reading this will probably scuff that it's not a huge accomplishment.

That's probably accurate, but for me this was a really big step outside of my usual process. For the first time in a while, I had felt like a complete newbie, but was able to overcome it. It would have been real easy to just get the deal done in a week under my existing LLC and not worry about the QOF and it's benefits.

I'm now more open-minded and now always remind myself to ask two questions (which have been re-iterated by many on the podcasts) when faced with a new challenge - "how can I make this happen?" "What is the next step I have to take if I'm serious about this?"