INVESTING IN QUALIFIED

OPPORTUNITY FUNDMarch 15, 2019

Michael Benguigui

Senior Tax Manager

Our firm provides the information in this webinar

presentation for general guidance only, and does not

constitute the provision of legal advice, tax advice,

accounting services, investment advice, or professional

consulting of any kind.

The information provided herein should not be used as a

substitute for consultation with professional tax, accounting,

legal, or other competent advisers.

Before making any decision or taking any action, you should

consult a professional adviser who has been provided with

all pertinent facts relevant to your particular situation.

Today’s Topics

Background of Opportunity Zone Investment & Benefits

Sec. 1031 Exchange vs. QOF Investment

Eligible Gain, Eligible Taxpayers & Choice of Entity

Certification Process

QOF Asset Testing Requirements & Testing Dates

Valuation Method for Applying the 90 Percent Asset Test

What is Qualified Opportunity Fund Property?

Different ways to structure a QOF Investment – compare and contrast

Working Capital Safe Harbor

Excluded Businesses

Other Items for Consideration

Background – Qualified Opportunity Zone

The Tax Cuts and Jobs Act added new Code Sec.1400Z, which provides a

new elective federal income tax deferral opportunity for investments in a

qualified opportunity zone (“QO Zone”);

Investments in QO Zones are intended to encourage equity investments

that will be used to start businesses, develop abandoned properties or

provide low-income housing in low-income, economically distressed

communities;

Qualified Opportunity Zone Property must be located in any of the

approximate 8,762 Qualified Opportunity Zones in all 50 states, DC, and 5

U.S. Possessions

A detailed map can be found here: www.saxllp.com/QOZ-designations

The QOZ designations will remain in effect until December 31, 2028.

Passaic County - QZ Tracts

Introduction – Qualified Opportunity Fund (QO Fund)

First Incentive: Tax deferral of previous Capital gain – need to be

from sale or exchange

The capital gain is deferred & only need to invest the capital gain

proceeds so the proceeds related to return of capital does not need to

be invested with a QO Fund;

Proceeds needs to be invested in the Fund within 180 days, & no cash

tracing to the original sale of investment;

If Investor dies, the gain is immediately triggered;

The gain is deferred to the earlier

• (i) the date on which interest in the QO Fund is disposed or

• (ii) December 31, 2026;

Gain is the lesser of the

• (i) original deferred gain or the FMV at the time of disposition or

• (ii) FMV at December 31, 2026;

Gain is subject to tax rates in effect in 2026

Introduction – Qualified Opportunity Fund (QO Fund)

Second Incentive: Basis increase of a QO Fund:

If the investor holds its interest in a QO Fund for at least five years, the

tax basis is increased by 10% of the deferred gain;

If the interest is held for at least seven years, the basis of the deferred

gain is increased by an additional 5% of the original gain;

Potential of an overall basis step up of 15% on the deferred gain;

Third Incentive: Investors that hold an interest in QO Fund for at

least 10 years can receive the added benefit of paying no tax on any

realized future appreciation in such investment:

Permanent exclusion would only be beneficial for any gain appreciation

after December 31, 2026;

Investor can make the election to have “the basis of such property shall

be equal to the fair market value of such investment on the date the

investor is sold or exchanged;

Cash Investment which is not from deferred gain does not receive step

up in basis or any other QO Zone benefit

Example

You Invested $2 MM in 2014 in Amazon shares;

Sold the Stock in 2019 for $3 MM; result $1 MM of capital gain;

Invest $1 MM gain into a QOF and the $2 MM does not have to be reinvested.

Tax Benefits for Deferred Gain

2019 2024

20242019

Dec. 31, 20262026

2026

Tax Benefits for OZ Investment

Defer paying $200,000 tax

on the gain (i.e. 20% tax

on $1 MM capital gain)

$20,000 (10% of $200,000)

of Tax forgiven since met

the 5 year holding period

$10,000 (5% of $200,000)

of Tax forgiven since met

the 7 year holding period

Regardless of holding period, must

pay $170,000 of tax ($200,000 -

$30,000), so 17% of the tax on $1

MM gain from 2018 is due

by April 15, 2027

Defer paying $200,000

tax on the gain (i.e. 20%

tax on $1 MM capital

gain)

$20,000 outside tax

basis increase

Additional $10,000

outside tax basis

increase

Outside tax basis in the Fund increases

to FMV of Fund Investment (i.e. sell

Fund Interest with no tax) at the time of

the sale of the Fund interest; provided

met the 10 year holding period (i.e.

2028) & not before 2047

Dec. 31, 2026

Comparison Sec. 1031 deferral vs. QOF Investment

Qualified Opportunity Zone:

Doesn’t have to be the entire Capital gain to invest; LKE has to be debt and equity proceeds

Cash is fungible; hence no QI is required;

Can be capital gain from sale of any capital asset (no limited to R/E);

Can be S-T or L-T gains, LKE must be long term capital gain;

Like Kind Exchange:

Effective 2018, only Real Estate Investment can be used for Section 1031 gains, all other

assets can no longer defer gain under Sec. 1031;

Side note: Bonus and Section 179 depreciation is important factors when disposing and

purchasing personal property

Replacement property can be any real property located any where in the U.S., vs QOF

investment is limited to QOZ;

Beneficial in instances in which the sold property has been refinanced and the cash funds

received at sale is less than the cash needed for QOZ deferral, hence can use debt;

Comparison Sec. 1031 deferral vs. QOF Investment

Comparision of Tax Deferred Investments

Comparison 1031 Exchange Opportunity Zone

Use of Property Must be like-Kind Does not need to be like-kindNature of Property Must be real property Can be real or personal property

Identification of Reinvestment 45 days No requirementClosing on Reinvestment 180 days 180 daysProceeds to Invest Entire proceeds of sale Only the gain on sale & tracing of

funds is not requiredPartnership Interests Not allowed AllowedStock in Corporations Not allowed AllowedRecognition of Deferred Gain Upon sale of replacement

property unless further deferred to newlike-kind property

“Recognition Date” – earlier of sale of investment in QO fund or Dec 31, 2026

Tax Basis Step-Up None • 10% if 5 years before December 31, 2026• 15% if 7 years before December 31, 2026

Eligible Gain & Eligible Taxpayers

Only Capital Gains (can be short or long term) from both actual

and deemed sales or exchanges (developer/ ordinary income is

not eligible):

Net Section 1231 gains (from sale of tangible real property used in a

trade or business)

Unrecaptured Section 1250 capital gain

Ordinary Depreciation recapture is not eligible

If deferred short-term gain in 2019, the deferred gain at 2026 will

continue to be short gain (does not convert to long term);

Again, will pay short or capital gain rates in effect in 2026

Eligible Gain & Eligible Taxpayers

Individuals

Corporations (including RICs and REITs)

Partnerships

S Corporations

Trusts

Estates

Choice of Entity as QOF

QOF entities are limited to the following entity types:

Partnerships (GP, LP)

Real Estate Investment Trusts (REITs)

Corporations

S Corporations

LLCs

Caution: An individual, trust, estate or single-member LLC cannot be

a QOF.

Certification Process

An eligible taxpayer self certifies as a QO Fund;

does not need separate application;

No approval or action by the IRS required;

Taxpayer merely completes a form 8896 and

attaches to the Taxpayer’s Federal return;

Form 8996 must be filed timely, extension

included;

What Form Does the Reinvestment in the QOF Take?

Investor must receive an equity interest in a QOF, can be either

partnership or Corporation interest in exchange for taxpayer’s

capital gain;

Equity investment can consist of preferred or common equity;

Partnership interests entitled to special allocations are ok;

No debt can be received in exchange for the capital gain proceeds

that are reinvested – has to be cash;

Query – debt finance distribution after initial investment in QOF?

Can taxpayer invest non-capital gain proceeds? Yes, but not eligible

for QOZ program deferrals

QOF Asset Testing Requirements

QOF must invest 90% of its assets to a Qualified Opportunity Zone

Property

Asset Test is based on the average of (1) QO Zone Property held by

the Fund on the last day of the first 6 months period of the Fund tax

year, and (2) on the last day of the Fund’s taxable year;

Penalty – nondeductible noncompliance penalty (monthly); can try

for reasonable cause for penalty abatement; good luck!

QOF Asset Testing Dates

Valuation Method for Applying the 90 Percent Asset Test

The value of each asset is based on the value reported on an

“applicable financial statement,” defined as:

An audited financial statement, or

A financial statement filed with the SEC, or

A financial statement filed with a federal agency other than the IRS.

If a QOF does not have an applicable financial statement, the cost

basis of assets is used for the testing (no depreciation taken into

account).

What is Qualified Opportunity Fund Property?

A QO Zone Property is either one of the following:

QO Zone Business Property (i.e. tangible business property held in a

QOZ Fund),

QO Zone Stock,

or QO Zone Partnership Interest

Two tier structure can take advantage of beneficial rules in terms of

the Asset Test (discussed later)

Qualified Opportunity Fund Property

Qualified Opportunity

Zone Property

QO Zone Partnership

Interest

Qualified Opportunity

Zone Business Property

QO Zone Stock

Qualified Opportunity Zone Property

The Investment must be acquired by cash after December 31st,

2017;

Tangible property used in a trade or business acquired by purchase

after 2017 from an unrelated party (discussed later related party);

The original use must start with the QOF or “substantial

improvement” must be made (discussed later);

If acquiring QOZ stock or partnership interest, must be acquired at

original issuance by the QOF for Cash after December 31, 2017.

Qualified Opportunity Zone Business Property

Qualified Opportunity Zone Business Property – tangible property

used in a QOF’s trade or business:

The original use of the acquired property must start with the QO

Fund, or

The QO Fund substantially improves the used property;

Substantial improvement requirement is met if 30 months after the

date of acquisition the additional improvements to the property

exceed the cost of acquiring the property (only count cost of

building and improvements, not Land);

QOF does not have to acquire new property, rather the property

must have never been used before in an Opportunity Zone

Example – Substantial Improvement

If a fund were to pay $1 million for a warehouse and land, with the

building valued at $400,000, the fund must spend at least what the

building is valued in order to meet the substantial improvement

standard. The improvements must be done within 30 months from

when the property is acquired in order not to violate the QOZ 90%

Asset test.

There is currently no relief available the 30-month time frame in

which extraordinary circumstances arise while renovations/

construction is taking place

Related Party

Note that capital gain from a sale or exchange with a related person

is not eligible for deferral. Need to look at direct and indirect

relationships.

Related party can be created by family attribution, i.e. brother, sister,

and spouse;

Common ownership of two related entities (i.e. partnership or

corporation) and such persons own more than 20% in value of the

outstanding stock of such corporation(s), and/or more than 20% of

the capital interests, or the profits interests, in the partnership(s).

Related Party - Example

Real Estate owner decides to sell 80% of a property they already

own pre-2018 to a QOF but retains a 20% ownership in the property;

this okay. If previous owner owns 21% then the property is ineligible

OZ benefits;

Note that the gain from such sale cannot be re-invested in the same

QOF since previous owner held more than 20% the said sold

property.

Different ways to structure a QOF Investment – Exhibit A –

Direct Investment

Different ways to structure a QOF Investment – Exhibit

B – Indirect Investment

*GP = General Partner MM = Managing Member

If a QOF holds $10 million in assets that it plans to invest in real

property, at least $9 million (90% of the property) must be situated in

QOZ in order to satisfy the 90% asset test.

By contrast, if the QOF invests in a subsidiary that holds real

property (i.e. QO Zone Business Property), then only $7 million

(70%) of the property must be located within a QOZ.

Furthermore, if the QOF only invests $9 million into the subsidiary,

which holds 70% of its assets within the QOZ, investors in the QOF

could receive the QOF tax benefits while investing only $6.3 million

(63%) of its investment within the QOZ.

How does a partnership or corporation qualify for QOZ

Business?

How does a partnership or corporation qualify for QOZ

Business

Result: the operating partnership or corporation could use the $2.7

million in the following manner:

$450,000 in financial assets (i.e. 5% of its assets)

$2,250,000 million in non-qualifying assets

Working Capital Safe harbor assets does not count towards the 70%

test for tiered structure!

Contrast if the QOF holds the QO Zone business property directly, it

would be able to use $1,000,000 in what ever manner it wishes, i.e.

cash, stock, bonds.

Working Capital Safe Harbor

Added by the Proposed Regulation - working capital safe harbor allows

QOZ businesses to hold cash for a reasonable amount time as working

capital (generally, cash, cash equivalents, or debt instruments with a

term of 18 months or less) for 31 months if:

1. There is a written plan that identifies property held for acquisition,

construction, or substantial improvement of tangible property in the OZ,

2. There is a written schedule consistent that the property will be

developed using the funds within 31 months, and

3. The QOZ business complies with such schedule, hence the cash must

be used substantially consistent with the plan

Query – what if the QOF buys another building which was not part of

the plan? Will the IRS allow this?

The safe harbor affords only upper-tier QOFs with undeployed/newly

called capital to comply with the 70% asset testing during the start-up

phase (discussed further below);

One-Tier (Direct) vs. Two-Tier (Indirect) Investments

Direct Indirect

90% of assets must be in QOZ Business

Property

70% of assets must be in QOZ Business

Property

All intangible property taken into account for

10% permitted non-QOZ Business Property

Property Unlimited amount of intangible

property so long as substantial portion is

used inactive trade or business in the QOZ

No “active” conduct of trade of business

requirement

At least 50% of total gross income from

active conduct of trade or business in QOZ

No Working Capital Safe Harbor; cash is

counted towards the 90% asset test

Working Capital Safe Harbor; unlimited cash

subject to substantial compliance with

specific requirements

No Working Capital Safe Harbor; cash is

counted towards the 90% asset test

Working Capital Safe Harbor; unlimited cash

subject to substantial compliance with

specific requirements

No reference to lease of property by a QOZ QOZ Business may lease property

Qualified Opportunity Zone Business – Excluded Businesses

Private or commercial golf course

Country Club

Massage Parlor

Hot tub or suntan facility

Racetrack

Establishment where principal sale is of alcoholic beverage for

consumption off premise

State Tax Treatment – NJ – follows Federal!

Risks Associated with OZ Investment

• Underperformance of Real Estate Investments - The value of the ten

year capital gains exemption is dependent upon the creation of capital

gains;

• Timing of Subscription and Potential Tax Benefits – can miss the 180

day investment period;

• Significant Change in Capital Gain Rates - A future reduction in capital

gains rates, for example to zero, would eliminate the economic advantage

associated with the tax incentives;

• Death - in the event that a capital gain was realized and invested in a QOF,

the decedent’s estate continues to owe the deferred (albeit potentially

reduced) tax liability rather than experiencing a step up in basis on death;

• Early Redemption - Accelerates the payment of the deferred liability which

must be paid in full without any reduction, and capital gains must be paid on

the appreciation associated with the Opportunity Zone investment (i.e., the

exemption from capital gains taxes is lost).

Other Federal Tax Benefits Research & Development

(R&D) Credits

The credit is dollar-for-dollar of a company’s qualified expenses (i.e.

wages) for performing qualified research activities. Startup

businesses with no federal tax liability and gross receipts of less

than $5 million are able to take the R&D tax credit against their

payroll taxes. The Protecting Americans from Tax Hikes (PATH) Act

of 2015 permanently extended the R&D tax credit and expanded its

provisions. Initial R&D analysis is required, and will require a R&D

study. Many states have also implemented R&D credits.

Other Federal Tax Benefits Low-Income Housing Tax Credit

(LIHTC)

LITHC is a federal tax credit for creating affordable housing

investments in low-income communities. The credit is either

approximately 4% (rehabilitation projects and new construction

financed with tax-exempt bonds) or 9% (generally available for new

construction) per year for ten years, incurred for the development of

low-income units in a housing project. Developers typically sell the

tax credits to investors.

Sax’s Qualified Opportunity Fund Resources

Tax Advisory & Compliance Services

Structuring & Planning

Attest Services

Applicable Financial Statements

Due Diligence

THANK YOU!QUESTIONS?

Michael Benguigui

Senior Tax Manager

mbenguigui@saxllp.com

973-472-6250