Tax Advantages of Investing in Qualified Opportunity Zone Funds - - PowerPoint PPT Presentation

Tax Advantages of Investing in Qualified Opportunity Zone Funds

Triangle Commercial Association of Realtors February 7, 2019

Welcome and Introductions

Chris Judy, Partner 919‐534‐1230 / chris.judy@tjtpa.com Wilson Hicks , Tax Manager 919‐780‐5108 / wilson.hicks@tjtpa.com

Disclaimer

This information has been prepared based on the proposed regulations 1400Z issued 10/19/18. The temporary or permanent regulations have not been issues. This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, tax, legal or accounting

• advice. The application and impact of laws can vary widely based on the specific

facts involved. You should consult your tax, legal and accounting advisors before engaging in any transaction.

More Information

OZ History

• Included in Tax Cuts and Jobs Act –

– Signed into law December 22, 2017 – Code Section 1400Z – Proposed regulations issued October 19, 2018 – Two additional guidance packages expected later this year & spring 2019

• Purpose to:

– Encourage development / investment in low‐income areas – Poverty rate >20%, Family income < 80% of median

• Maps

– Each state to designate up to 25% of qualified tracts – NC submitted 252 zones, certified on May 18, 2018 – Zones will remain eligible for 10 years

OZ Tax Benefits

• Temporary Deferral

– If capital gain is reinvested in OZ Fund within 180 days of Sale – Deferred gain recognized on earlier date of:

• Disposition of OZ investment or December 31, 2026
• Step‐Up Basis

– Basis for the capital gains reinvested is increased / gain reduced

• 10% if held 5 years
• 15% if held 7 years
• Permanent Exclusion

– Capital gain held at least 10 years in “Qualified Opportunity Fund”

Designated Zones

• Maps

– 12% of entire US land area – North Carolina: 252 zones certified on May 18, 2018

• NC Department of Commerce

https://public.nccommerce.com/oz/

State of NC Maps

Triangle Region

Raleigh

Durham / Chapel Hill

Johnston County

Rules for Qualified OZ Fund

• 1. Must be a Corporation, Partnership or LLC

a. No disregarded entities (single‐member LLC)

• 2. Must be organized in one of 50 states, DC or US Possessions
• 3. Must Self‐Certify as a Qualified OZ Fund

a. Complete form 8996 b. Must include annually with your income tax return c. Must ensure semi‐annually – 90% of assets invested in Qualified OZ Property d. Newly created QOF up to six months to invest e. After construction completed working capital < 5%

Qualified OZ Property

• 1. Stock in Opportunity Zone Business
• 2. Partnership interest in Opportunity Zone Business
• 3. Qualified Opportunity Zone Property

Who Can Qualify

1. Any investor with taxable capital gain from sale of property

‐ $2.3 Trillion of unrealized gains on stocks & mutual funds alone ‐ Gain can’t be triggered from a related party (20%)

2. Qualifying gains:

a. Long‐term or short‐term b. Gains on carried interest c. Depreciation recapture 1250 property d. Capital gain distributions from mutual funds e. Collections on installment sales f. Gains will retain same character when recognized in 2026

3. Gains not qualifying:

a. Depreciation recapture on equipment – 1245 property b. Sale of partnership interest with hot assets – 751 assets

Timing of Investment

• 1. Capital gain must be invested in QOF within 180 days

a. Only the gain portion of the sale qualifies b. No intermediary is required like 1031 exchanges c. No tracing of sales proceeds

• 2. Capital gains realized by partnerships

a. 180 day period starts on last day of partnership year end – December 31

• 3. Unqualified gains or principal

a. Can be made to QOF but that portion receives no OZ tax benefits b. Must be bifurcated and treated as separate investment (separate K‐1)

Substantial Improvement

• 1. The property acquired by Qualified OZ Business

a. Improvements must be made to double the basis b. Land or land improvements are not taken into consideration c. Improvement must be made within 31 months from acquisition of property

• 2. Example:
• a. Property purchased includes an old building for $1M
• b. Allocation is $800K for land and $200K for building
• c. Building improvements of $200K must be made within 31 months

Qualified OZ Business

• 1. Any type of business can qualify including

a. Residential or commercial real estate development

• 2. Businesses that do not qualify
• a. Golf courses, country clubs
• b. Massage parlors
• c. Hot tub or suntan facilities
• d. Racetracks
• e. Gambling facilities
• f. Liquor stores

Requirements for OZ Business

• 1. 70% of assets must be invested in qualified OZ property
• 2. At least 50% of gross income from active conduct of business in OZ
• 3. Substantial portion of intangible property from business in OZ
• 4. Less than 5% of property can be cash or cash equivalents

a. After property is completed

Failure to Satisfy 90% Test

• 1. Penalty = federal underpayment interest rate

a. Currently 5% b. Calculated after six months and end of year c. Calculated based on dollar amount under 90% test d. No penalty if due to reasonable cause e. Calculation made on Form 8996 filed annually with return

Developer Financial Considerations

• 1. Investment requirements

a. New or b. Substantial improvement

• 2. Carried interest

a. Roll no gain vs minimal gain

• 3. Capital stack impact

a. Leverage

• 4. Timing of raises – capital deployment

a. 6 month baseline b. 31 month written plan

• 5. Other tax incentives – historic credit, low income housing credit

Other Consideration

• 1. Operating agreement should state

a. Purpose to operate as OZ Fund or b. Qualified OZ Business

• 2. Compliance with:

a. Securities Act of 1933, as amended b. State securities laws – “Blue Sky”

OZ Investment Risks

• 1. Future tax rates
• 2. Market exit risk
• 3. Political support
• 4. Tax penalties

Investor Flow of Funds

Realize Gain March 2018 Invest in OZ Sep 2018 Recognize Gain December 31, 2026 QOF Sold Jan 2029

Gain via Personal Asset Gain via K‐1

Realize Gain March 2018 Invest in OZ June 2019 Recognize Gain December 31, 2026 QOF Sold Jan 2029

Investor Summary

• Exit period expires Year 2047
• Step‐up on exit appears inclusive
• f depreciation
• Covered land play

Holding Period (years)

<5 5 – 6 7 – 9 10+

Original Gain Taxed

100% 90% 85% 85%

OZ Gain Taxed

100% 100% 100% 0%

Investor Structure

Sample OZ Structure

Taxpayers

Qualified Opportunity Fund

90% Test

SPE

(Qualified OZ Business)

70% Test

Project within Opportunity Zone

$$

60% Stock or Partnership Interest

40% Stock or Partnership Interest

$$

Developer/Partner

Own Asset in Zone

• 1. Market pricing reaction
• 2. Sell and roll back into QOF – related party
• 3. Raise equity
• 4. Example – NNN lease & buildout

Takeaway – requires analysis & planning