Resources2019-04-11T10:51:47-05:00

Understanding Opportunity Zones

Enacted as part of the tax reform package that was signed into law in December 2017, the Opportunity Zones program is a new tool that allows individuals and corporations to take capital gain incurred from the sale or exchange of property – appreciated stocks, buildings, family businesses, and more – and roll the gain into businesses or projects located within Opportunity Zones.

With that investment comes tax benefits:

01

Tax deferral on gains you roll into an Opportunity Fund (until 2026 at the latest).

02

Tax reduction (up to 15%) on gains rolled into your Opportunity Fund.

03

No tax on appreciation of your investment if you “cash out” of your Opportunity Fund after 10+ years.

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EXAMPLE:
Jane has stock she bought for $300 that has now appreciated to $1,300.

She wants to maximize her potential benefits under the Opportunity Zones program. She invests her $1,000 in gain in an “Opportunity Fund” for at least 10 years.

On the original $1,000 in gain, Jane would defer the $238 she would otherwise owe in tax until 2026 and ultimately only pay $202.30 in tax in 2026 – a savings of $35.70.

If Jane makes a great investment in an Opportunity Zone, and her $1,000 gets tripled to $3,000 over 10 years, she does not owe any tax at all on that $2,000 in appreciation.

That potential for total elimination of tax on the growth of an Opportunity Zone investment has the startup investment community abuzz with excitement.

And with $6.1 trillion in unrealized capital gains currently sitting idle in portfolios and balance sheets across the country, the potential capital supply for this program is unparalleled.

Interested in learning more about Opportunity Zones?  

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Frequently Asked Questions

A Qualified Opportunity Fund (QOF) is a legal vehicle – like an LLC – taxed as a corporation or a partnership and organized specifically to invest in Qualified Opportunity Zone Businesses/Property (see question #2 for what this is). Setting up a QOF requires nothing more than a lawyer and an accountant to draft the documents and demonstrate that the investment meets the tests in the Internal Revenue Service’s (IRS) regulations. You can use your independent gain event to create your own fund (that you 100% control) and invest in your own projects, if you so choose. Or you could find an already existing QOF and invest in that entity. You could also find a third-party fund manager to invest your money for you, so that the investment is deployed in locations/projects that you would like to focus on. If you are interested in creating your own fund or finding third-party funds operating in Alabama, contact us to get started with the process.

Only capital gains invested into a QOF qualify for the favorable OZ tax treatment – even the 10-year hold benefit. Those gains can be short-term or long-term gains. Investing ordinary gains (like depreciation recapture) or ordinary income (like money sitting in a savings account) into a QOF can be done – but that portion of the investment will get no tax benefits from the Opportunity Zone program.

Opportunity Zone investments are equity investments – meaning that you will own property or a stake in a business operating in the Opportunity Zone. That property will (hopefully) generate rent, and the business will (hopefully) generate income, which can be distributed back to Opportunity Zone investors proportionate to their ownership in the property or the business (assuming the underlying corporate documents permit distributions). The key is in how the Opportunity Zone investors exit the investment – whether that is selling the property, selling the business, or having the underlying investment take out a loan to buy out investors. Most Opportunity Zone investors need to be assured that they’ll ultimately see a return of equity in addition to a return on equity.

One critical note here – rents and dividends are ordinary income and are not tax free just because they arise from a project located in an Opportunity Zone; instead, they’re taxed just like any other ordinary income during the duration of the holding period.

For most gains – like selling publicly traded stock or an art collection – you’ll have six months from the time of the gain event to invest in a QOF. Let’s assume Sue sold stock on January 1, 2019. Sue would have six months (until June 30, 2019) to invest any or all of that gain into a QOF. Once she has invested her money with the QOF, the fund manager (which could be Sue if she creates her own QOF) has six more months to spend 90% of what she invested on a qualified project.

All tax benefits are triggered the moment an investor invests gain dollars into a QOF and stay in place as long as a fund keeps 90% of its capital deployed into qualified Opportunity Zone projects (tested every 6 months).

Yes – assuming the QOF’s corporate documents permit you to exit (and provide you with a way to get your cash out of the deal), you can exit an Opportunity Zone investment at any time. Exiting before the end of the ten-year holding period means that you won’t get the back-end tax benefits, but you’ll still get to defer your invested capital gain until you exit the fund and – if you hold for at least 5 years – you’ll see some reduction in the amount of capital gains tax you have to pay on the original gain when you exit.

If you’re a developer and you know you don’t want to be in an Opportunity Zone deal for a ten-year period, you’re in luck – a number of deal structures have evolved in the marketplace to facilitate developer exits before Year 10. Contact us for additional information.

Qualified Opportunity Funds can directly own tangible property in Opportunity Zones – like buildings, solar panels, HVAC units or other stationary equipment – or they can indirectly invest in “qualified Opportunity Zone businesses” (including real estate developments – see below). Because of the current favorable regulatory structure around indirect real estate investments, we are seeing most OZ deals structured as indirect investments by Opportunity Funds into special purpose entities created to develop and manage real property.

To be a “qualified Opportunity Zone business,” your enterprise must meet two sets of tests. First, 70% or more of its tangible property must:

  1. Have been acquired after December 31, 2017 from an unrelated party (with some potential workarounds; contact us for additional information);
  2. Be located/used in the Opportunity Zone for what is considered “substantially all of the time”; and
  3. Be either “original use” property (e.g., new equipment bought and put into service in the OZ) or “substantially improved” property (typically used for real property – see Q&A below).

In addition, the business must (among other things):

  1. Derive 50% of its income from the “active conduct” of its business within the Opportunity Zone;
  2. Use a substantial portion of its intangible property in the Opportunity Zone;
  3. Not keep excessive amounts of cash or cash equivalents (“non-qualified financial property”); and
  4. Not be a “sin business” like a massage parlor, retail liquor store, or casino.

The application of these tests – especially those around the 70% tangible property requirements – can create some confusion with project sponsors and investors alike. We encourage you to contact us or consult your professionals with any questions.

Yes, active business can (and are) raising Opportunity Zone capital. However, there are a number of unresolved questions – like what it means to receive 50% of revenue from “active conduct” of a business within a zone or how much working capital is “reasonable” before it creates non-qualified financial property – that are preventing widespread operating company investment. We anticipate that many of these questions will be resolved in a second round of guidance to be released by the IRS this spring – please contact us to receive the latest updates on this second set of proposed regulations.

Though nonprofits cannot receive investment directly, they can benefit from the program in a number of different ways, including as tenants in a building financed with Opportunity Zone equity or by creating for-profit subsidiaries to run cash-producing enterprises (which could receive OZ equity). Please contact us for additional information on how nonprofits can get engaged in the Opportunity Zones ecosystem.

DISCLAIMER: OPAL Investments is not a Registered Investment Advisor, Broker/Dealer, Financial Analyst, Financial Bank, Securities Broker or Financial Planner. Any information provided pursuant to this Agreement is for information purposes only, and may change depending on future IRS rules, regulations, rulings or interpretations. This is not legal or accounting advice and is not intended to form a lawyer-client relationship. None of the information provided pursuant to, or related to, document is intended as investment advice, as an offer or solicitation of an offer to buy or sell, or as a recommendation, endorsement, or sponsorship of any security, company, or fund. Consult a licensed attorney and a certified professional accountant with knowledge of the Opportunity Zones program before making any investment or structuring decisions, including the merits and risks involved.

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