Qualified Opportunity Fund Investment: 3rd Party vs DIY

My Qualified Opportunity Fund (QOF) is set up and ready to go. [If you missed my first post, I provided an introduction to the new Opportunity Zone (OZ) tax law there.]

Since the clock was ticking on my 180-day window for rolling my capital gain into a QOF, I had to make a decision on whether to invest in existing 3rd Party QOF’s or start my own do-it-yourself (DIY) QOF. A number of large real estate QOF’s have formed since the new OZ tax law came out. They tend to focus on large multi-family and commercial real estate projects with projected internal rates of return between 10 and 15 percent over 10 years (the holding period to maximize the OZ tax benefits). On a compounded basis, a 10% growth rate over 10 years gets you a roughly 2.6x multiple on your original investment.

After attending a number of OZ seminars over the past few months and after multiple discussions with my CPA, I decided to set up my own QOF and fund it with the bulk of my capital gain. I did allocate a small percentage of my gain to an institutional QOF run by one of the real estate crowdfunding platforms for comparison purposes.

Why did I decide to go my own way? In listening to a number of QOF pitches, I found that investments were focused on carefully researched OZ areas where conditions are ripe for economic development and gentrification. While careful vetting and professional management provided some comfort and risk mitigation, the goals of these QOF’s didn’t quite match my needs. They are much more focused on capital appreciation over the 10-year holding period than on short-term cash flow.

This strategy makes perfect sense given that the OZ tax benefit is maximized by tax-free capital appreciation of the OZ assets rather than short-term cash flow, which is likely taxable to some extent. However, I want both appreciation and cash flow. My personal goal is to exit my corporate job and focus full time on my QOF and other investments. I need some cash flow for everyday living needs. Instead of paying for professional management, I decided to DIY my QOF (with advice from a full-time CPA knowledgeable on the OZ law, of course) and tailor it to my investment objectives.

What did I do to set up my QOF? Under the new tax law, the QOF must be in the form of a corporation or partnership for tax purposes. With guidance from my CPA, I opted to set up an LLC taxed as a partnership (with its own Tax ID) with my wife and I as partners. Then I set up a bank account in the name of my LLC and transferred my capital gain into the account within the 180-day window.

Since 2018 was the year in which I would have recognized my capital gain, my CPA made the OZ deferral election on Form 8949 of my 2018 tax return.

For the new entity’s first tax year (2019 in my case), it will have to self-certify as a QOF by filing Form 8996, Qualified Opportunity Fund, with its federal income tax return. That’s it.

Now comes the fun part: deciding how and where to invest my QOF funds. In my next post, I will discuss my QOF investment strategy.