Opportunity Zones for Real Estate Investors Michael Lortz , CPA, - - PowerPoint PPT Presentation

Opportunity Zones

for Real Estate Investors

Michael Lortz, CPA, LEED AP (503) 221 0141 mlortz@gmco.com

March 6, 2019

Disclaimer

The purpose of this presentation is to provide information, rather than advice or opinion. It is accurate to the best of the presenters’ knowledge as of the date the presentation was developed. The information, examples, and suggestions presented in this material have been developed from sources believed to be reliable. Accordingly, this presentation should not be viewed as a substitute for the guidance and recommendations of a retained professional and should not be construed as legal, tax, or other professional advice. We recommend consultation with competent professional advisors before applying this material in any particular factual situations.

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Agenda

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Background Investors Fund Structure & Qualified Assets Open Issues

Law / Guidance

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Part of Tax Cuts and Jobs Act (12/22/2017)

• IRC Sec. 1400Z-1, -2

IRS Notice 2018-48 (list of designated QOZs)

• More than 8,700 QOZs, including all 50 states, D.C., and 5 U.S.

territories

• Designations valid through 12/31/2028

Proposed Reg. 115420-18 issued 10/29/2018

• Rev. Rul. 2018-29 (land)

Form 8996 (QOF self-certification) Additional guidance expected late March / early April Oregon has proposed legislation to disconnect!

Qualified Opportunity Zones

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2010 population census tracts (1,200–8,000 inhabitants) Low Income Community (LIC) is a census tract…

• Poverty rate ≥ 20% or median family income (MFI) ≤ 80% of

statewide MFI (modified if metro-area)

• Also, census tract contiguous to designated LIC if MFI ≤ 125% of the

contiguous LIC may be designated

Designated by CEO of each jurisdiction (e.g. Gov. Brown)

• Maximum of 25% LICs designated, only 5% of which could be non-

LIC contiguous to LIC designations

Summary: Qualified Opportunity Zone = designated LIC https://www.cdfifund.gov/Pages/Opportunity-Zones.aspx

Qualified Opportunity Zones in Oregon

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834 census tracts  342 low income communities  86 qualified opportunity zones located in Oregon

• Multnomah County (17): Portland (Downtown, Gateway,

Rosewood), Gresham, Fairview

• Washington County (8): Beaverton, Forest Grove, Hillsboro,

Tigard, Tualatin

• Clackamas County (6): Clackamas, Oregon City, Wilsonville

https://www.oregon4biz.com/Opportunity-Zones/ Note: don’t forget about Vancouver, WA – waterfront!

QOZ in Downtown Portland

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Investors

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Eligible investors include C-Corporations, S- Corporations, partnerships, LLC’s, individuals, trusts, and estates Investor must have capital gains (long-term or short- term) from the sale of property to an unrelated (20% or less common ownership) person through 12/31/2026 Investor must invest capital gain (not basis) within 180 days of recognizing capital gain into Qualified Opportunity Fund (QOF) and make election on Form 8949 when filing income tax returns

Investor Example

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Sell stock in 2018 for $500,000 realizing $300,000 gain Within 180 days of sale, invest $300,000 into QOF Make election in 2019 when filing 2018 tax return and reporting stock sale Don’t…

• Have to invest $200,000 basis
• Have to use accommodator / QI
• Have to “identify” replacement property

Investors in PTEs

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Investors receiving capital gains from pass-through entities (PTEs) are considered to have recognized capital gain on last day of pass-through entity fiscal year, often 12/31

• Example: partnership with 12/31 FYE sells capital asset on

1/2/2018, giving partners 180 days from 12/31/2018 to invest in QOF, i.e. until 6/29/2019

If PTE provides information to investors regarding sale date, capital gain amount, and statement that PTE is not electing to invest gains in a QOF, then investors can individually elect to apply 180 days from PTE’s sale date

Investors & Tax Consequences

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Deferral: Investor’s initial capital gain is deferred until earlier of 12/31/2026 or disposition of investment in QOF (if disposition proceeds are less than investment, then less gain to recognize)

• If disposition of investment in QOF, may reinvest within 180 days into

another QOF if before 12/31/2026 and continue deferral

• Deferred gain’s tax attributes remain with it until recognition, e.g. short-

term rate, 25% rate on real estate depreciation, Sec. 1256 contracts, etc.

Reduction: Investor’s initial capital gain is reduced via basis adjustments:

• By 10% if hold QOF for 5 years (through 12/31/2026)
• By additional 5% if hold QOF for 7 years (through 12/31/2026)

Exclusion: 10-year hold allows investor to elect basis adjustment to FMV as of date that investment in QOF is sold (through 12/31/2047)

Investor Example cont.

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Invest $300,000 capital gain into QOF on 2/1/2019 – initial tax basis = -0- On 2/1/2024, tax basis in QOF increases from -0- to $30,000 On 2/1/2026, tax basis in QOF increases from $30,000 to $45,000 On 12/31/2026, investor recognizes taxable income of $255,000 ($300,000 - $45,000), which is 85% of original gain Sometime after 2/1/2029 but no later than 12/31/2047, investor sells investment in QOF for $1,000,000 resulting in a $700,000 gain –> NO FEDERAL TAX due to 10+ year hold

Qualified Opportunity Fund

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The QOF must be a U.S. entity taxable as either a corporation or a partnership and self-certify with the IRS via annual filing of Form 8996 with its income tax returns Must invest ≥ 90% of assets in Qualified Opportunity Zone Property (QOZP) acquired after 12/31/17

• Test dates are the last day of first 6-month period of QOF and on

last day of QOF’s FYE — results are averaged, e.g. if calendar-year QOF begins 2/1, then first test dates will be 7/31 and 12/31

• Assets are valued per applicable financial statement (e.g. audit) or

cost basis if no AFS

• Penalty at underpayment rate (e.g. 6%) applies on shortfall if QOF

fails test unless “reasonable cause” – rate adjusts quarterly

Qualified Opportunity Fund Example

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1/1/2019 LLC is formed to be a QOF, has a 12/31 FYE 2/1/2019 Investor contributes gains into LLC, which makes election to be treated as a QOF as of 2/1/2019 1st test date = 7/31/2019 (end of first 6 months) 2nd test date = 12/31/2019 (fiscal year-end) 3rd test date = 6/30/2020 (every 6 months) 4th test date = 12/31/2020 (every 6 months) etc.

Qualified Opportunity Fund

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Per Form 8996 instructions, the QOF’s organizing documents must contain a statement that the entity’s purpose is to invest in QOZP as well as a description of the QOZB(s) that QOF expects to engage in directly or through a first-tier operating entity Currently, no additional reporting requirements besides Form 8996, e.g. no audited financial statement or community impact statement required

Qualified Opportunity Zone Property

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QOZP includes:

• Qualified Opportunity Zone Business Property (QOZBP) =

tangible property used in a trade or business within a Qualified Opportunity Zone

• Ownership interest in Qualified Opportunity Zone Business

(QOZB) organized as corporation or partnership for income tax purposes that invests in QOZBP

• Note: preferred stock in corporations and special allocations within

partnership agreements are OK

Qualified Opportunity Zone Business Property

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Acquired by purchase (not from related party, 20% test) after 12/31/17 Original use of property commences with QOF / QOZB or property is substantially improved* by QOF / QOZB During holding period, substantially all use of property is within Qualified Opportunity Zone

* During 30-month period after acquisition, additions to

basis must exceed adjusted basis of property at start of 30- month period, e.g. must double the basis of an existing building (not including the land)

Structure Option 1 – QOF w/No QOZB

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QOF

Investor A Investor B Non-Qualified Assets QOZ Business Prop. Problem: It is often difficult for QOF to spend 90%+ of its cash

• n qualified property before its first testing date, which could

result in a penalty, e.g. substantially improving a building or ground-up construction typically takes more than 6 months.

Qualified Opportunity Zone Business

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Criteria:

• ≥ 70% of all tangible property, owned/leased is QOZBP
• ≥ 50% gross income derived from active conduct of its

business

• < 5% of average unadjusted basis of property attributable to

nonqualified financial property

• No portion of proceeds used for golf course, country club,

massage/hot tub/suntan facilities, racetrack/gambling facilities, or liquor store – but it appears that you can rent to them

Qualified Opportunity Zone Business Working Capital

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QOZB can hold working capital as cash, cash equivalents, or debt instruments with term ≤ 18 months If QOZB acquires, constructs, or rehabilitates tangible business property in OZ, then can qualify for working capital safe harbor:

• Written plan identifying cash being held for qualifying project
• Reasonable written schedule consistent with ordinary start-up
• f a business for deployment of cash within 31 months
• Working capital is spent in manner that is substantially

consistent with plan and schedule

Structure Option 2 – QOF w/QOZB

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QOF

Investor A Investor B Non-Qualified Assets QOZB Partner C QOZ Business Property

• Eligible for working capital

safe harbor

• No restricted businesses

Non-Qualified Assets

• e.g. assets purchased from related

parties

• e.g. financial assets ≤ 5%

Exit Strategy

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Problem: 10+ year gain exclusion is only applicable on sale of QOF ownership interest, i.e. not sale of property Potential solutions:

• Each QOF/QOZB structure only owns 1 piece of real estate
• QOF is structured as REIT so that investors can easily sell

shares and there is no tax at REIT level when assets are sold

Many Unanswered Questions

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Is working capital qualifying for 31 month safe harbor treated as tangible property in the interim? Is land purchased or contributed by related parties disregarded in tests? How can QOF reinvest interim gains from sales of property and what is impact on investors? What is definition of “substantially consistent” in working capital safe harbor? Are there real estate leases that would not meet trade/business definition, e.g. triple-net leased property? What is inside basis of property owned by fund for depreciation purposes and for Sec. 199A (new 20% deduction) purposes? How are distributions from refinance proceeds treated? Are multi-tiered entity structures allowed?

Observe today. Shape tomorrow.

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