The Opportunity of Opportunity ZonesBy Abe Schlisselfeld | December 18, 2018
Last week, my colleague Michael Hurwitz and I had the privilege of speaking at DC Finance’s Real Estate and Family Office special meeting on Opportunity Zones. If I could sum up the sentiment at the event about this hot new topic, it would be: “Opportunities exist, but they are complex.”
Mike and I were joined by Richard Catalano, a Tax Partner at Clifford Chance US LLP on a panel called the “Opportunity of the Opportunity Zone.” Our panel, ably moderated by Jay Bernstein, a partner in the REIT/Capital Markets practice at Clifford Chance US, was a fast-moving overview of the opportunities in front of real estate owners and high-net-worth investors, including family offices and REITs.
As with any presentation that purports to shine light on tax-based investment opportunities, we could barely scratch the surface, but, as was clear from the questions we received, the topic is of significant concern to real estate investors and calls for close scrutiny as informed investors look toward exploiting opportunity zones. Let me set the stage by quoting directly from the IRS advisory:
“Opportunity Zones, created by the 2017 Tax Cuts and Jobs Act, were designed to spur investment in distressed communities throughout the country through tax benefits. Under a nomination process completed in June, 8,761 communities in all 50 states, the District of Columbia and five U.S. territories were designated as qualified Opportunity Zones. Opportunity Zones retain their designation for 10 years. Investors may defer tax on almost any capital gain up to Dec. 31, 2026 by making an appropriate investment in a zone, making an election after December 21, 2017, and meeting other requirements. (See the full advisory: https://www.irs.gov/newsroom/whats-hot)
With that said, we see three primary areas of tax benefits to investors:
- A temporary deferral until tax year 2026 when tax is due on the appreciated gain on the sale of assets (artwork, real estate, cash, stock) that are invested in a qualified opportunity zone;
- A basis adjustment that allows for an exclusion of 10% after five years of holding the investment, an additional 5% after 7 years, finishing at a total of 15%. So by way of example, if the opportunity zone asset was sold after Year 7 the gain on the appreciated asset would be adjusted to 85%.
- Any appreciation from the day of investment to the day of sale incurs 0% income tax.
When I speak with clients about this new law I always remind them that the regulations are still being finalized but that in general the law as written to be tax-payer friendly. I tell them to keep in mind as well that the law is designed for new investments post-2017.
So, what are some of the initial steps real estate investors might consider? First, generate a gain by selling real property or equities to an unrelated entity. This is key as the buyer and seller may not have more than 20% common ownership. Second is to be able to reinvest the gain into a qualified opportunity zone fund within a 180-day period.
Importantly, the Opportunity Zone Fund has a 31-month period from the date of fund formation to complete its development project. This is challenging given the complexities of development projects, but the intent of the law is to encourage investments in qualified opportunity zone properties or land that are close to “shovel ready.” A written property improvement development plan with goals and timeframes is going to be a must-have.
As I stated earlier, there are complexities, but along with them are some opportunities. Among these are the differences in how the regulations treat the taxation of investments in different types of funds – basically single and double tier funds.
- Single tier funds are set up to purchase properties, land or businesses where 90% of the investment is directed to qualified opportunity property.
- Double tier funds are established to purchase stock or partnership interests that own qualified opportunity properties, and they carry a lower requirement for investment into property renovation or improvement of just 70%. The remaining 30% can be invested elsewhere.
Other complexities abound: for instance, the treatment for tax purposes of opportunity zone investments that are combined with investments outside a zone. Also, what are the characteristics of single asset funds as opposed to multi-asset funds, and how are they treated? And, to make things even more complicated, the opportunity zone assets must be reassessed for valuation every year, which poses internal management challenges.
Real opportunities await from opportunity zone investing. For family office investment teams, REIT investors and their advisors, my recommendation is to educate yourselves as quickly and thoroughly as you can now in order to take advantage of the new regulations, understanding that they are still being finalized. Seek out the appropriate tax and legal advice and see if it makes sense to make 2019 a zone of opportunity.
About Abe Schlisselfeld
Abe Schlisselfeld, CPA, EA, is the Co-Partner-in-Charge of the Real Estate Group at Marks Paneth LLP. With more than 20 years of experience in public accounting, Mr. Schlisselfeld’s concentration lies in the real estate industry, where he advises commercial and residential real estate owners, real estate management firms and REITs (real estate investment trusts) on all facets of accounting and taxation. He is a member of the Executive Committee of Marks Paneth, which sets policy and strategy... READ MORE +
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