All Forum Posts by: Scott McIntosh

@Thomas Hatley True, you could add a partner to your LLC and self-certify as an Opportunity Fund. However, OZ benefits only accrue to investments of deferred capital gain equity. Since you bought the property with non-capital gain equity, you wouldn't be eligible for any OZ benefits on your current investment. If you intend to fund "substantial improvement" of the property with deferred gain equity, then you may be able to enjoy OZ benefits on that portion of the investment.

Without knowing all the details, I'm inclined to think that it probably wouldn't be worth it to try to make your current entity work as an OZ fund.  But if you decide to buy others in the area, could certainly be worth structuring/capitalizing it to take advantage of OZ benefits for those acquisitions.

Hi @Raza Rizvi. Two different timelines at play here. 

1. You need to place your recently realized capital gains into a QOF within 180 days of realization to secure the deferral and eligibility for other OZ benefits. Based on the August sale, this gives you til late Jan-mid Feb 2020 to create the fund. Creating before the end of 2019 opens the door for a 15% exclusion on your deferred capital gain, whereas that exclusion would be capped at 10% if you wait until early 2020 to create/invest in the fund. 

2.  Once your money is in the Opportunity Fund, a new clock starts for deploying 90% of the capital in Opportunity Zone property or an Opportunity Zone Business. The first test is 6 months after the fund is created or  December 31, whichever comes first. BUT, the regulations allow a QOF to exclude recently contributed capital from the first testing date. So if you create the fund in NOV/DEC 2019, you won’t have to satisfy the 90% asset test until June 30, 2020. If you create the fund in January, you won’t have to satisfy the 90% test until December 31, 2020.

You can use a second-tier entity to stretch your timeline even further, but that’s probably outside the scope of your question. 

@Jared Kadry, the transaction is much cleaner for new acquisitions, but what you're describing is possible under certain circumstances. 

If the properties were purchased in a corporation or partnership after 31DEC17 and are the sole assets of that partnership, and if the renovations you describe would include capital expenditures equal to the basis assigned to the existing structure at purchase, then an unrelated Qualified Opportunity Fund could invest in the entity that currently owns the property by purchasing newly issued partnership interests in that entity. 

The existing partners in the entity wouldn't get any OZ benefits (unless they were a minority partner in the new QOF), but they would get access to OZ capital that it sounds like they need to complete the renovations as well as a continued share in the ongoing cashflows/upside of the properties.  

Because the OZ incentive relies so heavily on self-certification/self-reporting, OZ funds need to be a tax reporting entity so the IRS can use the fund’s annual tax returns to monitor compliance. 

@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. 

@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.  

Yes, @Alejandro Hinostroza, there is an angle here.  If the property hasn't previously been "placed in service" for depreciation purposes, then it could meet the "original use" requirements for Qualified Opportunity Zone Business Property.  QOFs who negotiate for the purchase of such a development can dramatically decrease the entitlement/development risk of the investment.  

@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.  

@Raza Rizvi

I’m an OZ attorney with a practice focused on fund creation and compliance. Happy to answer any questions you have about the process and/or setup your fund if you think it’s a good fit. 

Holly— as long as your recently realized capital gains are placed in your QOF within 180 days of realization you’ll get the deferral and be eligible for the other OZ benefits. Your QOF has a separate timeline for deploying the capital and just has to meet the 90% threshold every 6 months, so that should work with your anticipated closing timeline.