East Tennessee Preservation Conference May 17, 2019 G. Mark - - PowerPoint PPT Presentation

East Tennessee Preservation Conference

May 17, 2019

• G. Mark Mamantov

Bass, Berry & Sims PLC 900 South Gay Street, Suite 1700 Knoxville, TN 37902 865-521-0368 mmamantov@bassberry.com

• Opportunity Zones
• Historic Rehabilitation Tax Credit
• New Market Tax Credits
• Low-Income Housing Tax Credits

Federal Tax Incentives

• A tax incentive
• For wealthy investors
• To fund new business and development
• In “Qualified Opportunity Zones” (QOZs)

Opportunity Zones in a Nutshell

• Tracts of land nominated by governors (and D.C.’s

mayor), certified by U.S. Treasury Dep’t

• Had to meet certain “low-income community”

standards

• Ship has sailed.
• All QOZs have been set.
• It’d take an act of Congress to change them.
• Literally.

Qualified Opportunity Zones (“QOZs”)

QOZs – Tennessee

• Opportunity Funds (“O-Funds”) are the heart of the entire program
• To get the tax benefits, investors just have to buy shares in an “O-

Fund”

• Yep, that’s it
• O-Funds then identify and invest in qualifying projects within QOZs
• O-Funds must invest 90% of their assets in “qualified opportunity

zone property” (“QOZ property”) or pay a penalty

• This is tested, more or less, every six months.
• So O-Funds have relatively little time to find and invest in QOZ property

O-Funds

• Since O-Funds must invest 90% of their assets in “QOZ property”, it’s important to know

what qualifies.

• QOZ Property, generally, is a trade or business that meets the following requirements:
• “Substantially all” of its tangible personal property must be
• Purchased after 2017 from an unrelated party;
• Purchased new or “substantially improved” within 30 months of purchase; and
• Used in the QOZ during “substantially all” of O-Fund’s investment
• A “substantial portion” of its intangible property is used in the active conduct of business in the QOZ
• Less than 5% of its assets are “nonqualified financial property” (e.g., long-term financial

investments or interests in other companies/partnerships)

• Business cannot be a country club, massage parlor, hot tub facility, racetrack, health club,

wine/liquor store, or another O-Fund

• Two ways to Invest
• O-Fund can buy newly created stock or partnership interest in a QOZ business; and/or
• O-Fund can buy new or substantially improved property to be used in the QOZ business.
• Bottom Line, O-Funds are just like the rest of us: they want stuff, not old stuff, but fancy

new and improved stuff

• They just want their stuff to be used to conduct a trade or business substantially within the

boundaries of a qualified opportunity zone.

Qualifying Opportunity Zone Property (“QOZ property”)

• Additional proposed regulations were just

issued on May 1, 2019, and lawyers (including me) and accountants are still digesting what they mean.

• But some O-Funds are already up and

running, soliciting investors and looking to invest in QOZs

Questions Abound

• The U.S. “Income Tax” generally taxes all forms of profit
• But not all forms of profit are taxed the same.
• Two broad categories:
• “Ordinary Income” – profit from running a business, working, etc.
• “Capital Gains” – profit from selling an asset (e.g., real estate or

stock)

• “Capital Gains” are taxed very favorably (for most taxpayers)
• Taxed at lower rates – maxed out at 20% (versus 37% for

“Ordinary Income”)

• Delayed taxation – no tax is owed until you sell your asset and

“realize” your gain

The only tax stuff you really need to know:

Capital Gains in Action

I run a successful business

• I invest $10M in my

business

• I didn’t talk to my tax

accountant, and take all my income as ordinary income

• Each year I make ~ $500k,

taxed at 30%

• In 10 years, I’ll have

~ $3.5M in total profit You own stock in a successful business

• You buy $10M worth of stock
• Each year you don’t sell, you

don’t pay taxes

• In 10 years, you sell for $15M
• You’ve got $5M in “capital

gains”, taxed at 20%

• You pay ~ $1M in taxes,

leaving you $4M in total profit

• Taxpayers facing a capital gains tax bill can,

instead of paying the IRS, choose to invest their money in an O-Fund

• O-Funds confer three big benefits
• Deferred tax – any gains reinvested and kept in

O-Funds aren’t taxed until 2027

• Discount – if you hold your O-Fund investment for

at least 5 years, your tax bill is discounted (10% for 5 years, 15% for 7 years)

• No tax on O-Fund gain – if you hold onto your O-

Fund investment for at least 10 years, none of your gains from the O-Fund are taxed

The Tax Benefits

• f Opportunity Zones

Opportunity Zones in Action

Our Prior Example

• You bought $10M in stock

10 years ago

• You sell today for $15M
• You’ve got $5M in capital

gains, so you’re facing a $1M tax bill

Have I got an Opportunity for you!

• You take your $5M in capital gains, and

you invest it in an O-Fund

• In 10 years you sell your O-Fund stock

for $8M

• O-Fund benefits:
• (1) You owe nothing today
• (2) Your original $1M tax bill is reduced to

$850k

• (3) You owe nothing on the O-Fund gains
• So you’ve just turned a $1M tax bill into

$2.15M more cash in your pocket!

• In fact, your O-Fund could lose up to

20% of its value ($1M here) and you’d be no worse off than if you’d paid the IRS

• Everyone! (maybe)
• One possibility is that anyone could buy O-Funds and

benefit from paying no tax on the O-Fund’s gains

• Also possible that Treasury would limit that benefit to only

investors rolling over prior capital gains

• Securities laws may further restrict who really has an
• pportunity to invest in O-Funds
• But benefits scale exponentially with wealth
• Only investors with prior “capital gains” can use the

deferral and discount benefits

• No clear caps on deferral and discount, so the more

capital gains you have, the more you can benefit

Investors

$- $200,000.00 $400,000.00 $600,000.00 $800,000.00 $1,000,000.00 $1,200,000.00 $1,400,000.00 $1,600,000.00 Lowest Quintile Second Third Fourth Fifth Top 1% Other Income Capital Gains

1% 1% 2% 3% 15% 36%

Capital Gains as Share of Income

Source: CBO, The Distribution of Household Income and Federal Taxes, 2011, at 10 (2014).

• Real estate values will likely be inflated in QOZs
• Benefits are tied to specific parcels of real estate
• These benefits will likely allow businesses and investors to pay more for

land in QOZs than comparable property elsewhere

• Prior Owners vs. Real Estate Speculators
• Hard to guess when and by how much prices will rise
• Many current property owners may not know that they are in an

Opportunity Zone, let alone how that could affect their property value

• Speculators have incentive to buy now, quietly, before market reacts

Property Owners

• The whole point is to get O-Funds investing more in QOZ

businesses, right?

• That demand could encourage O-Funds to invest more favorably in

QOZ businesses

• But that benefit could be offset by
• Property owners demanding higher rent, sales prices
• Investors demanding higher returns on O-Fund investments
• Competing QOZ businesses willing to take investment on more standard terms
• Net effect likely depends on
• Number of attractive O-Zone businesses competing for investment
• Balance of power between O-Funds, Property Owners, Investors, and

Businesses

New Businesses?

• O-Funds generally must make new investments
• Larger businesses likely can structure deals to at least partially take advantage of O-

Fund investment

• Smaller businesses already located in QOZ may have difficulty finding realistic ways to

qualify and attract O-Fund investment

• Potential downside
• O-Fund investments could give new QOZ businesses competitive edge over existing

businesses

• Rising real estate prices, discussed earlier, could lead to higher rents
• Current or potential investors may look instead to new QOZ businesses
• Potential upside
• Increased economic activity in area could be good for business – depends on the

business and the nature of the economic changes

• Existing businesses might also benefit indirectly from access to new goods/services
• ffered by new QOZ businesses

Existing Businesses?

• Investor receives tax credits equal to 39% of

investment over a 7-year period

• Investment must be made through an

approved community development entity (CDE) that has NMTC allocation

• CDE usually makes a loan (QLICI) to a

qualified active low-income community business (QALICB)

• Very complex and expensive transaction to

undertake; cost prohibitive for smaller deals

New Market Tax Credits

• Tax credit for 20% of the qualified rehabilitation

expenditures (QRE) for certified historic structure and 10% for other nonresidential building placed in service before 1936

• Certified historic structure generally must be on

national register or in historic district and certified by NPS

• Project must be substantially rehabilitated
• 5-year recapture period
• Historic Boardwalk case really hurt the market for

these credits

Historic Rehabilitation Tax Credit

• “4%” or “9%” credits of eligible costs

relating to low-income housing rental projects

• Certain historic hotels have been used for

this purpose

• Very challenging to get tax credit

allocation, which is required

Low Income Housing Tax Credits

Local Property Tax Incentives

• PILOT - Property tax abatement
• TIF - Diversion of incremental property

taxes to pay or finance project costs

Typical PILOT Projects

• Offices
• Apartments
• Industrial and Manufacturing
• Retail

PILOT Delegation Requirements

• IDB can only negotiate, accept or waive a PILOT

with a formal delegation from the municipality that formed the IDB

• Certain retail PILOTs require approval of all

taxing entities

PILOT Transaction

• Real Property and/or Equipment
• Conveyance of property
• Deed
• Bill of Sale
• Leaseback under PILOT Lease
• Why the complicated structure?
• Constitutional limitations

PILOT Lease Terms

• Length
• Amount
• Fixed amount
• % of taxes
• Ramp up period
• Clawbacks

Typical TIF Projects

• Retail projects particularly in smaller cities
• Downtown revitalization and redevelopment of

blighted properties

• Other projects such as corporate relocations

Before: After:

Three Important TIF Concepts

• No abatement of taxes
• No effect on the valuation of the property
• As to the developer, a TIF is almost

always a grant, with potentially significant tax ramifications

Basic TIF Math

Base Taxes $10,000 Taxes after completion $110,000 Debt service component (assumed 15%) $15,000 Increment allocated to TIF $85,000

$0 $10,000 $20,000 $30,000 $40,000 $50,000 $60,000 $70,000 $80,000 $90,000 $100,000 $110,000 $120,000 1 2 3 4 5 6 7 8 Allocable Increment Debt Service Component Base Taxes

TIF Approval Process

• Plan preparation
• Public Hearing
• Government Approvals - approval of both

City and County to capture both increments

State Sales Tax Incentive

• Relatively New Legislation - TCA § 67-6-104
• Allows allocation of portion of state and local

sales tax revenues in economically distressed counties (Tier 4) for certain approved projects

• Requires capital investment of $5,000,000