A PRIMER ON OPPORTUNITY ZONE INVESTING
Transcript of A PRIMER ON OPPORTUNITY ZONE INVESTING
2 A Primer on Opportunity Zone Investing
With you today
MARLA MILLER
Tax Managing
Director
215-636-5520
GRANT KEPPEL
Tax Managing
Director
904-224-9904
TRACI PUMO
Tax Managing
Director
561-207-3239
TIM SCHRAM
Tax Managing
Director
312-730-1276
4 A Primer on Opportunity Zone Investing
Overview
Created through the passage of
the Tax Reform Reconciliation Act
of 2017
New §§1400Z-1 and 1400Z-2 of the
Internal Revenue Code
Designed to encourage long-term
investments in economically
distressed communities
Bi-partisan effort
Used 12/31/26 to score revenue,
but may be extended
Intended to release the private
investment potential of over $6
trillion of captive capital gains
Treasury Secretary Steven
Mnuchin stated: “I think there’s
going to be over $100 billion
dollars in private capital that will
be invested in Opportunity Zones
… ”
5 A Primer on Opportunity Zone Investing
Overview
Tax preferential treatment provided for investing in designated
Opportunity Zones through investment vehicles called Opportunity Funds
Opportunity Zones will benefit the real estate, retail, private equity,
and other industries
This will have a major impact on high net worth individuals,
corporations, and fund managers
6 A Primer on Opportunity Zone Investing
Treasury and IRS guidance
On October 19, 2018, Treasury and the IRS released its much anticipated
guidance regarding Qualified Opportunity Funds (“QOF”), including
proposed regulations, a revenue ruling, and a draft IRS form
The Regulations are only proposed, as such they are subject to further
revisions
Treasury has stated that taxpayers may rely upon many of the proposed
rules, providing that the taxpayer applies the rules in their entirety and
in a consistent manner
The public hearing on the proposed regulations was held on February 14,
2019
Final regulations are anticipated to be released in late-April to mid-May
A second set of proposed regulations were issued on April 17, 2019
There may be a third set of proposed regulations or additional guidance
7 A Primer on Opportunity Zone Investing
Opportunity Zone designations
Opportunity Zones are census tracts
Opportunity Zones were nominated by the states and approved by
Treasury
8,761 census tracts were designated in all 50 states, the District of
Columbia, and five possessions
Census tracts need to be in low income communities or contiguous to
low-income communities (limited to 5% of nominations)
Notice 2018-48 lists the population census tracks approved by Treasury
as qualified Opportunity Zones
The list is final and essentially unchanging
10 A Primer on Opportunity Zone Investing
Capital gain required
Eligible taxpayer includes individuals, C corporations (including
RICs/REITS), partnerships, S corporations, and trusts and estates
Triggering event is the realization of capital gain
Must be treated as capital gain for Federal income tax purposes (short or
long term)
• Unrecaptured Section 1250 gains
• REIT and RIC capital gain dividends
• Collectible gains
• Certain Section 1256 contracts
11 A Primer on Opportunity Zone Investing
Capital gain required
Capital gain must be from an unrelated party
Ordinary gains do not qualify (e.g., §§ 475, 1221, 1245, 1250)
The tax attributes of the initial gain invested into a QOF are preserved
When a taxpayer disposes of its fungible interests in the QOF and cannot
determine the tax attributes of the gain being recognized, the taxpayer
should use the FIFO method. To the extent that the FIFO method does
not provide a complete answer, then the taxpayer should apply a pro-
rata method
Taxpayer will elect to defer gain on Form 8949 which will be filed with
its tax return
12 A Primer on Opportunity Zone Investing
Capital gain deferral
Investment in a QOF must occur within 180 days of
liquidation/disposition/sale to third party
Taxpayers cannot invest in opportunity fund property directly – all
investments must be made through QOF
Either a partnership or its partners (amount of eligible gain included in
the partner’s distributive share and resulted in an increase to the
partner’s tax basis) may roll-over gain into a QOF
• Partnership investment – date of sale
• Partner investment – end of partnership tax year or date of sale (if partner
notified)
• Note – on the K-1, the gains and losses will be a net number
Similar rules apply to S corporations and decedent’s estate
13 A Primer on Opportunity Zone Investing
Capital gain deferral – Section 1231New
Determination of tax treatment of Section 1231 gains/losses cannot be
determined until year-end
If the net Section 1231 amount is a gain – it will be treated as a capital
gain
If the net Section 1231 amount is a loss – it will be treated as ordinary
Section 1231 gain can only be invested in the 180 days beginning on the
last day of the taxable year of the sale
14 A Primer on Opportunity Zone Investing
Capital gain deferral
All of the realized gain does not need to be invested for the deferral
Can invest in more than one QOF
Ability for the investor sell complete QOF interest and invest in another
QOF
Capital gains must be invested in the equity of the QOF – includes
preferred stock and a partnership interest with special allocations
Can use equity for collateral
Mixed funds permitted, but only capital gain portion reaps the tax
benefits
16 A Primer on Opportunity Zone Investing
Capital gain deferral
QOFs are self-certified and can be created by the taxpayer or you can
invest in an established QOF – all investment must be through QOFs
A QOF must be an “investment vehicle”
Taxpayers will file Form 8996 to self-certify
NEW: Form 8996 will be revised for 2019
If a QOF is organized in a US possession or territory, it must be organized
for the purpose of investing in Opportunity Zone property where it is
organized
17 A Primer on Opportunity Zone Investing
Asset test
At least 90% of the assets must be invested in Opportunity Zone property
NEW: Newly contributed investments made in the preceding six months
are not included as part of the asset testing as long as the new assets
are being held in cash, cash equivalents or debt instruments with a term
of 18 months or less
The 90% test is the average of the QOZ property (average at six months
and year-end)
The first test date will be the end of the first six months in the tax year
that it is a QOF and the second test date will be the last day of the tax
year
• If the QOZ start date is May then the first testing date is November 30 and the next is
December 31
• If the QOZ start date is August (July through December), then the only testing date is
December 31
19 A Primer on Opportunity Zone Investing
Valuation of assets
If the QOZ has applicable financial statements (typically audited
financial statements), use the value of assets reported on those
statements for the asset testing
If there are no applicable financial statements, use the basis of assets on
the date of acquisition for the asset testing
Special rules permit the use of the most favorable method for businesses
that are owned by multiple QOFs
20 A Primer on Opportunity Zone Investing
Asset test reporting
The calculation of the 90% test will be made annually on Form 8996
Failing to meet the 90% will not result in termination
Penalty is equal to the shortfall multiplied by the underpayment rate
established under §6621(a)(2)
Can avoid the penalty if failure due to reasonable cause
21 A Primer on Opportunity Zone Investing
Stock or partnership interest
QOFs can acquire two types of Opportunity Zone property:
• Tangible property such as building and equipment
• Opportunity Zone stock or partnership interests in domestic operating business
LLCs will qualify (must choose to be treated as a corporation or
partnership), but not disregarded SMLLCs
Pre-existing entities can be utilized if they otherwise meet the other
requirements (including the requirement that substantially all tangible
property was acquired after 2017)
QOF cannot invest in another QOF (no tiers)
22 A Primer on Opportunity Zone Investing
Stock or partnership interest
Qualified Opportunity
Zone stock
Qualified Opportunity Zone
partnership interest
Domestic corporation acquired
after 12/31/17 as original issue
During substantially all of the
holding period, the corporation is
a qualified Opportunity Zone
business
Capital or profits interest in a
domestic partnership acquired
after 12/31/17
During substantially all of the
holding period, the partnership
is a qualified Opportunity Zone
business.
23 A Primer on Opportunity Zone Investing
Opportunity Zone business property
Tangible property acquired by the QOF after 12/31/17
Acquired from unrelated party (20% common ownership)
Original use of the property commences with the business or the
business substantially improves the property
NEW: Substantially all (70%) of the tangible property use was in the
qualified Opportunity Zone during substantially all (90%) of the QOF’s
holding period
24 A Primer on Opportunity Zone Investing
Original useNew
Original use of an asset starts on the date when the property is first
placed in service in the QOZ for purposes of depreciation or amortization
Used property is original use if it has not been previously used or placed
in service by any taxpayer in the QOZ
A building or structure that was vacant for at least five years prior to
being purchased by the QOF or QOZB will satisfy the original use
requirement
Leasehold improvements made by a lessee are treated as original use
property
25 A Primer on Opportunity Zone Investing
Substantial improvement
QOF has a 30-month window (“any”) to improve the acquired Opportunity
Zone property – not original use
Basis of the property increases by an amount that exceeds the amount of the
adjusted basis with respect to the property at the beginning of the 30-month
period
NEW: The substantial improvement requirement is made on an asset-by-asset
basis
Rev. Rul. 2018-29 stated that land can never have original use; however, land
will not be required to be substantially improved if it is used in an active trade
or business
NEW: General anti-abuse provision can be used to prevent “land banking”
Invest $2M in existing building and land ($1M relates to the land) – to meet the
substantial improvement requirement would need to invest an additional $1 M
plus $1 (not the $2M)
26 A Primer on Opportunity Zone Investing
Opportunity Zone business
For a subsidiary to qualify it must be a trade or business for which substantially
all (70%) of its tangible property (owned or leased) is qualified Opportunity Zone
business property
At least 50% of the business’s total gross income must be derived from the active
conduct of the business in the Opportunity Zone
NEW: A substantial portion (40%) of the business’s intangible property is used in
the active conduct of the business
Non-qualified financial property (NQFP) must be less than 5% of the average of
the aggregate unadjusted basis of the business’s property (e.g., cash, debt,
stock, options, warrants, partnership interests, futures contracts, etc.) – see
working capital safe harbor
“Sin” businesses are prohibited – sun tan parlors, horse tracks and casinos, golf
courses, country clubs, massage parlors, hot tub facilities, liquor stores (defined
as stores with the principal purpose of selling alcoholic beverages for
consumption off the premises)
27 A Primer on Opportunity Zone Investing
Opportunity Zone business – trade or business
New
Trade or business for purposes of the QOZ rules is a trade or business
within the meaning of section 162
Ownership and operation of real property, including leasing, is
considered the active conduct of a trade or business
Entering into a triple net lease is not enough
28 A Primer on Opportunity Zone Investing
Opportunity Zone business – 50% gross income test
New
Proposed regulations have provided three safe harbors:
• At least 50 percent of the services performed for the business, measured by
hours, is performed within the QOZ
• At least 50 percent of the services performed for the business, measured by
amounts paid for such services, is performed by employees and independent
contractors in the QOZ
• Both the tangible property of the business that is in a QOZ and the
management or operational functions performed for the business in the QOZ
are necessary to generate 50 percent of the gross income of the trade or
business
If the QOZB does not meet any of the safe harbors they may still meet
the test relying on facts and circumstances
29 A Primer on Opportunity Zone Investing
Working capital safe harbor – subsidiary
The proposed regulations exclude from the NQFP limitation a
“reasonable” amount of working capital held in cash, cash equivalents,
or debt instruments of 18 months or less
Working capital will be considered reasonable if:
• Amounts are designated in writing for the acquisition, construction, or
substantial improvement of tangible property in the Opportunity Zone
• There is a written schedule consistent with the ordinary start-up of a trade or
business for the expenditure of the working capital assets – cash flow schedule
• Working capital must be spent within 31 months of receipt by the business
NEW: Expanded to include expenditures used in the development of a
trade or business in the QOZ
NEW: Working capital safe harbor not violated if delay is due to
government action (e.g., permits or other government approval)
30 A Primer on Opportunity Zone Investing
Leased tangible property
New
Leased property may be treated as QOZB property
Leased property must be acquired under a lease entered into after
December 31, 2017
Substantially all of the use of the leased property must be in a QOZ
during substantially all of the period for which the QOZB leases the
property
No original use requirement
31 A Primer on Opportunity Zone Investing
Leased tangible property
New
No related party disallowance rule if lease meets the following
requirements:
• Lease must be at FMV
• Lease cannot allow prepayments relating to a period of use exceeding 12
months
• By the last day of the lease or 30 months (whichever comes first), the lessee
must become the owner of the QOZB property whose value is at least equal to
the value of the lease and there must be a substantial overlap of time using
both the leased and acquired property
• There is a general anti-abuse rule to prevent the use of leases to circumvent
the substantial improvement requirement
32 A Primer on Opportunity Zone Investing
Leased tangible property – valuation
New
Leased properties have two methods of valuing leases:
Financial statement - Amount of an applicable GAAP financial statement – if
leases are assigned a value
Alternative method – sum of the present value of all of the lease payments,
calculated at the time the lease is entered into
Once a method is selected, it must be applied consistently to all leased tangible
property for the taxable year
33 A Primer on Opportunity Zone Investing
Opportunity Zone businesses – examples that qualify
Retail stores
Grocery stores
Research facilities
Hotels
Restaurants
Office buildings
Manufacturing
Mixed use developments
34 A Primer on Opportunity Zone Investing
2019 proposed regulations – additional guidance
New
If QOZ sells an asset before 10 years, there is a 12 month safe harbor to reinvest
the cash – the regulations do not include a provision that would allow a QOF to
sell assets without recognizing gain, so the sale is a taxable event
QOFs organized as partnerships and S corporations may sell their assets and,
assuming that the investor has held the investment in the QOF for more than 10
years, the investor will pay no tax on the gain – does not apply to C corporations
Transfer of QOZ interest by gift ends the tax benefits, but transfer at death or to
a grantor trust does not
Carried interest does not receive the special tax treatment
Debt financed distributions are not taxable unless they exceed the partner’s
basis in the partnership interest
Substantial improvement is determined asset-by-asset, not in the aggregate
35 A Primer on Opportunity Zone Investing
2019 proposed regulations – additional guidance
New
Secondary purchase of a QOF interest is permitted
Tiered partnerships are not permitted – taxpayer must invest capital
gain into a QOF
QOF stock is not stock for purposes of determining corporate affiliation
QOF C corporation can be a common parent of a consolidated group, but
not a subsidiary member of a consolidated group
Proposed regulations adopted a broad anti-abuse provision
36 A Primer on Opportunity Zone Investing
Previously owned property
New
Property must be acquired after 1/1/18. The related party rules prohibit
owning more than a 20% common interest Here are some potential
workarounds:
Sell the property to a QOF as an asset, but taxpayer and affiliates may not
own more than 20% of the profits and capital accounts of that fund
Lease the property to a new QOF, if lease after 1/1/18. The new guidance
permits a related party lease as long as certain requirements are met (e.g.,
lease at FMV, no disguised sale, prepayments of 12 months or less). The lease
must be a true lease under Federal law. You may be the majority owner,
since it is not deemed to be a pre-existing party.
Contribute the asset to the QOF – not considered a sale so no 20% related party
issue. Amount of your carryover tax basis in the property is deemed to be
your investment in the QOF. The value of this asset will not get the tax
incentives. But, it will not taint the QOF for others.
38 A Primer on Opportunity Zone Investing
Tax benefits
Tax
deferralTax deferral on capital gain invested in QOF to the earlier of an inclusion
event or 12/31/26
10% tax
reductionHold the fund for 5+ years
15% tax
reductionHold the fund for 7+ years
Tax
exemption
Hold the fund for 10+ years and appreciation of QOF investment (not the
original gain, but post-acquisition gain) is exempt from taxes (sell by
12/31/47)
Tax basis in
investmentTax basis in investment is $0
39 A Primer on Opportunity Zone Investing
Example
On August 15, 2018, taxpayer sells stock with a basis of $1,000,000 to an unrelated third party for $2,000,000 resulting in a capital gain of $1,000,000.
Instead of paying the $238,000 (23.8% tax rate) in federal capital gains tax, the taxpayer invests $1,000,000 in an QOF
Taxpayer sells his investment in the QOF after August 15, 2028 for $2,000,000
Taxpayer defers paying tax until 2026
Tax due is $202,300 (tax basis of $150,000 (15%)) – held more than 7 years
No additional tax due on the $1,000,000 in capital gains on the O-Zone investment –held more than 10 years
Cir
cum
stances
Resu
lts
40 A Primer on Opportunity Zone Investing
Tax considerations
If the taxpayer dies, the capital gain is still recognized on the original
investment – no step up at death
Capital gains rate when recognized – not when deferred
Combine with other Federal tax credits – low income housing, new
markets, historic tax credits
Combine with other State credit and incentive programs
41 A Primer on Opportunity Zone Investing
QOF investment - FMV decreases
If the value of the investment decreases, then the taxpayer is taxed at
the lower value (excess of FMV in the QOF over the taxpayer’s basis in
the QOF interest)
Example: Taxpayer has a gain of $2M in 2018 and invests in a QOF. In
December of 2026, an appraiser values the investment in the QOF at
$1M. In the 2026 return, taxpayer will recognize a capital gain of
$700,000 (15% step up of original gain). With the tax rate of 23.8%, the
lower value will result in a tax of $166,600.
42 A Primer on Opportunity Zone Investing
Other matters
State tax conformity
Structuring issues – direct or indirect
Exit strategies – one fund per property?
NEW: Treasury and IRS announced that it will provide additional
guidance on what happens if a QOF fails to meet the required 90 percent
investment standard and information reporting requirements
NEW: Revised Form 8996 will be issued for tax year 2019
43 A Primer on Opportunity Zone Investing
Outstanding questions
The following are some of the outstanding questions or areas needing
clarification:
Identification of conduct that may lead to decertification of a QOF
Information reporting requirements
Whether the final regulations should contain exceptions to the general 180 day
rule
Whether aggregate testing will be permitted
45 A Primer on Opportunity Zone Investing
Real estate update
How has the opportunity zone program impacted the real estate market?
What due diligence should taxpayers perform before making an
investment in a QOF?
What are the differences between an investment in a QOF and a like
kind exchange?
46 A Primer on Opportunity Zone Investing
Opportunity Zone vs like kind exchange
Opportunity Zone Like kind exchange
Capital gain from any investment
Property must be in Opportunity Zone
Only invest the capital gain (all or part)
No tracing and no intermediary required
Existing property – substantial
improvement required
180 days to invest in a QOF
Allows deferral only to sale or 10 years
(max of 2047)
Up to 15% basis step up on original
investment
Exclusion of appreciation of gain while in
fund
Original gain cannot be excluded via a
step-up in basis upon taxpayer’s death
Real property only
Geographically flexible within the US
Must invest all proceeds
Requires tracing of funds and qualified
intermediary
No substantial improvement required
45 days to identify replacement property
Deferral as long as a like kind exchange
No basis step up
No exclusion on appreciation
Original gain can be excluded upon death
of taxpayer
Can defer gain on sale to a related party
48 A Primer on Opportunity Zone Investing
Family offices and high net worth individuals update
What investments are you seeing in the family office market/high net
worth individuals?
Does the opportunity zone program provide impact investing
opportunities?
What are the estate and gift tax planning issues that should be
considered?
What should family offices and high net worth individuals consider
before investing in a QOF?
51
BDO is the brand name for BDO USA, LLP, a U.S. professional services firm
providing assurance, tax, and advisory services to a wide range of publicly
traded and privately held companies. For more than 100 years, BDO has
provided quality service through the active involvement of experienced and
committed professionals. The firm serves clients through more than 60
offices and over 650 independent alliance firm locations nationwide. As an
independent Member Firm of BDO International Limited, BDO serves multi-
national clients through a global network of more than 73,800 people
working out of nearly 1,500 offices across 162countries.
BDO USA, LLP, a Delaware limited liability partnership, is the U.S. member
of BDO International Limited, a UK company limited by guarantee, and
forms part of the international BDO network of independent member firms.
BDO is the brand name for the BDO network and for each of the BDO
Member Firms. For more information please visit: www.bdo.com.
Material discussed is meant to provide general information and should not
be acted on without professional advice tailored to your needs.
© 2019 BDO USA, LLP. All rights reserved.