Bought an apartment building in Opportunity Zone

[Kimmy G.]

Hi everyone,

My friend and I bought an apartment building in 2018, and it turned out to be located in an opportunity zone. Are we qualified for the tax benefits for Opportunity Zone, for example the step-up in basis if we sell it after 10 years? And if so, how do we tell IRS that we want to make it qualify?

Here are some details. We bought it using an LLC (the LLC's sole purpose is to hold this one apartment building). It was bought with a commercial loan with 25% down payment. The down payment was from our savings (not capital gains from other investments). There were small repairs done but nothing substantial. And 90% of the current tenants are inherited from the seller.

Thank you so much for your answers!

An additional question is: I'm buying an other apartment building in an opportunity zone using another LLC (which also only holds this one building), but this LLC is a single-member LLC (I'm the only member). Would this still be qualified for Opportunity Zone investment? Thanks!

[Scott McIntosh]

@Kimmy G.

In order to be eligible for Opportunity Zone Benefits, the property needs to owned in the name of a Qualified Opportunity Fund (or a Qualified Opportunity Zone Business owned by your Fund).  In addition, the benefits for OZ properties only apply to investments made by investing deferred capital gain in a Qualified Opportunity Fund.  It is possible to convert an LLC to a Qualified Opportunity Fund where the LLC owns property purchased after 22DEC17, however, I agree it doesn't seem like it would be worthwhile for the apartment you already own.

With regard to your anticipated purchase:

1. The IRS requires a Qualified Opportunity Fund be a "corporation of partnership." It can be a partnership within an LLC shell, but cannot be a single-member disregarded entity. This is because the OZ rules/benefits rely so heavily on self-reporting, and so the IRS needs a tax-reporting entity to track the funds initial basis, subsequent improvements, etc. So you'd need to add a partner to your new LLC (they could own as a small as .01%), and probably do some other modifications to your operating agreement to satisfy the IRS requirements for a Qualified Opportunity Fund.

2.  Before deciding whether to take the steps above, consider whether:

(a) you have recently realized capital gains you could use to fund the purchase.  If you go to the trouble to set up a Qualified Opportunity Fund, but use all cash for the purchase/renovation, you won't reap any tax benefits.  That said, the whole world (almost) of capital gains is eligible for deferral -- short or long term gain, sales of property, businesses, stock, bitcoin, art, etc. 

(b) you can meet the "substantial improvement" threshold for the property, which is defined as improving the property in a way that doubles the basis in the structure within 30 months.  Because its the basis in the structure that matters, you get to deduct the value of the land in making that determination.  For example: Purchase apartment for 800k.  Land comps and/or PVA valuations nearby justify a land value of 300k.  You need to made 500k in capital improvements to the property within 30 months for it to be treated as Qualified Opportunity Zone Property. 

Good luck with the project -- I've made several OZ investments and the structure/compliance is pretty manageable once you get the hang of it, but definitely requires another layer of planning/analysis in addition to identifying the property location.  The benefits are fantastic, though!