Opportunity Zones for Real Estate Investors - Michael Lortz, CPA, LEED AP - NAIOP Oregon Chapter

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

Background
Investors
Fund Structure & Qualified Assets
Open Issues

                                    3

Law / Guidance

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!

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Qualified Opportunity Zones

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

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Qualified Opportunity Zones in Oregon

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!

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QOZ in Downtown Portland

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Investors

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

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Investor Example

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

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Investors in PTEs

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

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Investors & Tax Consequences

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)

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Investor Example cont.

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

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Qualified Opportunity Fund

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

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Qualified Opportunity Fund Example

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.

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Qualified Opportunity Fund

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

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Qualified Opportunity Zone Property

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

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Qualified Opportunity Zone
     Business Property
  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)

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Structure Option 1 – QOF w/No QOZB
                    Investor A              Investor B

                                  QOF

     QOZ                                                      Non-Qualified
Business Prop.                                                   Assets

    Problem: It is often difficult for QOF to spend 90%+ of its cash
    on 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.

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Qualified Opportunity Zone Business

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

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Qualified Opportunity Zone
   Business Working Capital
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
  of a business for deployment of cash within 31 months
• Working capital is spent in manner that is substantially
  consistent with plan and schedule

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Structure Option 2 – QOF w/QOZB
                                   Investor A                Investor B

      Partner C
                                                 QOF

                                                                                Non-Qualified
                QOZB
                                                                                   Assets

QOZ Business Property                  Non-Qualified Assets
•   Eligible for working capital       •   e.g. assets purchased from related
    safe harbor                            parties
•   No restricted businesses           •   e.g. financial assets ≤ 5%
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Exit Strategy

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

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Many Unanswered Questions

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?

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Observe today. Shape tomorrow.

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