All Forum Posts by: Chris Montgomery

There are pros and cons to choosing an OZ over a 1031.  If you decide to do an oz investment on your own I'd definitely recommend using an experienced attorney, as the compliance for OZ regs can be somewhat complicated.  I'll give you the high level below:

One of the pros is the one you mentioned - you only have to invest the cap gains, not the entire proceeds.  You can generally invest into any type of real estate or business as long as it's located in an oz.  There is an excluded list of 'sin businesses' that you have to avoid.   A few more considerations:

- Unlike 1031s there is a substantial improvement requirement.  You have to invest 1x the purchase price (excluding the land) into the real estate you purchase.  So you can't simply buy a cash flowing property but instead will need to do significant improvement or new development.

- You also can't invest into a triple-net leased property.

- You need to keep your investment in your fund for at least 10 years in order to avoid capital gains tax at the exit.  If you do, you'll also avoid depreciation recapture, which is a significant benefit.

- An OZ fund has to be a partnership or corporation - can't be a single member llc

- The deferal on the taxes on your current gain are only deferred until 2026.  It's a nice deferral but will be paid at whatever the tax rate is in 2026.  There is proposed legislation to extend this date but it has not passed yet.

- If you are investing in a business there are several tests to pass to ensure that at least 50% of your business is in an oz - tests based on revenue, employees, etc.

There are more considerations as well and the devil is in the detail.  We're closing our 5th fund so I'm obviously a big believer in the benefit of OZs but you want to do meaningful research before setting up your own fund.   It's easy to set up a fund but more difficult to stay compliant.  There are quite a few timing considerations about when to invest into the fund and how quickly the fund must deploy capital.

I hope that helps.

I run an opportunity zone fund in Colorado. Many of our investors were making the decision between OZ investing or a traditional 1031.  There are pros and cons to each.  Let me know what questions you have and I'd be happy to answer.

@Basit Siddiqi   Your comment above says that a refinance would never be considered a disguised sale.  That's true in the non OZ world, but the final OZ regs had specific considerations regarding a refinance within 2 years.  I've pasted in a summary below.  I'm not attempting to give accounting advice but I think it's important for people to carefully consider the nuances of the OZ regs that don't exist in the 'normal' real estate world.

The Final Regulations retain the rule included in the Proposed Regulations limiting the ability of a partner to receive debt-financed distributions while maintaining its qualifying interest in a QOF by applying modified disguised sales rules to debt-financed distributions from a partnership QOF. In essence, a debt-financed distribution to a partnership QOF investor within two years of the investor’s qualifying contribution to the QOF will cause the QOF investor to recognize all or part of its deferred gain. However, if the QOF investor keeps its interest in the partnership QOF, the QOF investor remains eligible for the 10-year benefit. For our technical readers, see Treas. Reg. § 1.1400Z2(a)-1(c)(6)(iii)(A)(2) on pages 388-389 of the Final Regulations. However, the normal exceptions to the disguised sale rules, such as the exception for distributions of operating cash flow, apply to distributions from QOFs. Even after two years, consideration must be given to the partnership disguised sales rules to determine if a debt-financed distribution could impact a QOF investor’s QOZ benefits.

I'm a fund manager not an accountant, so don't take this as professional advice but I'm happy to tell you our thoughts.  Also happy to pass along the contact info for the accounting firm that we use who know oz's inside and out.

1)  We take bonus depreciation anytime we can.  Taking bonus depreciation now and not having it be recaptured at disposition after 10 year hold is a huge benefit of an oz fund.  We do cost segs on all of our multifamily projects.  I haven't done a cost benefit analysis of paying for a study on a duplex, but the general rule is to accelerate as much depreciation as you reasonably can.

2)  We've leveraged all of our assets so are not in your exact situation, but we've been advised that you need to make sure to not pull out fund from a refi before 2 years have passed so it doesn't look like a disguised sale to the IRS.  The specifics of your situation matter, so I'd suggest talking to an accountant or a tax lawyer before making the decision on how much to pull out so you avoid an inclusion event.

I run a Colorado OZ fund.  SC Hansen does all of our accounting work and is based in Denver.  Contact information below:

Josh T. Hansen, CPA | Managing Partner

Office: 303-753-8200 

724 S. Pearl St. | Denver, CO 80209

I run a Colorado based Opportunity Zone fund that develops multi family housing.  Let me know if you have specific questions.  Most of the above information is correct.  A few high level points to keep in mind:

- As Whitney said, you don't 1031 into an OZ Fund, but invest in the fund as a 1031 alternative.

- Unlike a 1031 exchange you only have to invest the capital gains from your sale, rather than the entire amount of the sale.  You also don't need a qualified intermediary at the time of sale.  You do however need to invest into the fund within 180 days of realizing the gain.

- Taxes on your current gain are deferred until the end of 2026.  If you keep your investment in the fund for 10 years, your capital gains from the investment are tax free.  You are also able to avoid depreciation recapture which is a huge benefit.  

- Keep in mind that the deferred taxes on your current gains are due at the end of 2026 and you'll typically need to pay those outside of the investment in the fund.  Some funds may be able to provide a distribution based on refinance proceeds in 2026 to help with that, but in today's interest rate environment it can be risky to count on that so it's best to expect to pay the taxes from other funds.

- The OZ tax savings are significant (often in the 35 to 40%) range, but you don't want the tail to wag the dog.  The most important thing to do is to select a fund that has solid fundamentals on the project(s) that the fund is investing in.  Nobody needs a tax break on a project that loses money!

Feel free to reach out if you have any questions.  Those are just a few of the high level considerations when deciding to invest in Opportunity Zones and selecting a fund. 

@Nick Frey  Thanks for the vote of confidence in what we’re doing in opportunity zones at Four Points.

You are correct. The situation you outlined above is one of the other scenarios where an OZ fund can be a good backup or alternative to a 1031. If your capital gain is coming to you through a partnership, your 180 investment clock does not begin until the (unextended) due date of the partnership tax return. For a calendar year partnership that day is March 15, so you have 180 days from the March 15 to invest in a partnership. In your example of selling a property in July 2021, your partnership return is due March 15 2022 and you could have until mid September 2022 to invest into an OZ fund. Plenty of time to receive your funds back from an intermediary if you decide to initially pursue a 1031 which does not move forward. One note: if the partnership sells the property in July ’21, and the partnership will not be investing into an OZ fund as a partnership, the partners individually have the option to invest immediately after the sale of the property OR they have the option to wait and start the 180 day clock on March 15. If you’ve already decided to not pursue the 1031 you don’t have to wait to invest in the OZ fund.

As for your second question about multi-family supply and demand, that a bigger, complex question. We should discuss over a beer sometime. Personally I think it’s a complex and nuanced answer that depends on macro, local and political issues. As you know, we’re focused exclusively on Colorado and to an extent Utah. There is an extreme housing shortage in the middle income area with all trends pointing to an increase of people moving into our area. Even then, we don’t look at the Colorado market as one market but look at each sub-market individually and right size each of our investments to the local market with every investment decision based on our expectations regarding demand, potential for absorption and strong visibility into the supply entering the local market.

Your point is a good one, and I tend to agree that more and more money will be entering the market in Multi Family Housing whether through OZ funds, 1031 or traditional investment. When money chases an opportunity at scale there is always the risk of a market being flooded and our local focus is not immune from national trends. The counter balance to that concern is that construction costs are high and every deal needs to make sense as you balance cost, risk, and potential income. Candidly, it can be hard to make deals work. To a degree that development challenge puts the brakes on money flowing into certain areas too quickly. We are also in a low interest rate world and if/when those rates increase it will also tend to have a slowing effect on new development.

I think I just typed a lot of words to say ‘It depends’. Let’s grab that beer sometime and discuss. The opportunity zone incentive is a massive tax incentive that requires a 10 year hold period. To maximize the value of the incentive the OZ fund ultimately needs to be investing in projects that make financial sense. The 10 year hold is both a challenge and an opportunity. Knowing up front that we are going in with patient capital we can focus on building a high quality product in an area that shows increasing demand. Will our forecast be perfect over 10 years? No. But if we do our job right, we’ll have a quality cash flowing project, have a tax free exit after 10 years that avoids depreciation recapture, have control over our exit timing, and make a positive impact in our communities.

@Sean Ross  I thought I’d weigh in on point 4) regarding OZs being a backstop for 1031. In my experience as a fund manager, it depends on the situation, the timing, and the investors access to cash. Until March 31st of this year an OZ fund was an easy backstop since the OZ investment 180 day investment window had been extended by the IRS through March 31, 2021 and the 1031 had not been extended. Now that the extension has expired it depends on the situation.

OZ funds and 1031 exchanges share a 180 day investment period after the date of sale. As you mentioned you often cannot get funds back from a failed 1031 exchange until day 181 after sale. For some people that will mean that they cannot make a timely investment into an OZ fund. However, unlike a 1031 which requires an intermediary and requires the specific cash from the sale to be invested into the exchanged property, the OZ regs do not require an intermediary and do not require that it is the same cash being invested. In the OZ world, you are required to invest within 180 days but money is fungible. If you still have your sales proceeds tied up with an intermediary, you can invest other cash into the OZ fund, and then simply have the intermediary return your funds to you from the failed exchange. It’s as if the 1031 never happened. Obviously this requires access to additional cash outside of the cash tied up with the intermediary, but it remains a possibility for use as a backstop. In practice, some intermediaries also return funds prior to the 181st day, whether they should or not.

I agree with Philip with both of the strategies 2 strategies that he laid out.

We’ve successfully done #1 several times. Purchased a property in an OZ, attributed a reasonable value to the land and then paid a contractor to complete the rehab in an amount that exceeded the non-land basis. There are a lot of properties that this strategy does not work for, but if you find one that needs substantial rehab or one where it makes sense to do an addition as discussed in point #2 then it fits the OZ requirements.

The regs also indicate that an OZ fund can meet the original use test by purchasing a property that has never been placed in service, which is generally defined as never having been depreciated. We’ve reviewed this with our attorneys and it’s clear that you can purchase new construction prior to obtaining a Certificate of Occupancy and prior to ever being depreciated and successfully meet this test. It’s less clear to me if you’d meet that standard by taking an existing residential property and converting it to a rental without actually doing substantial improvement. I suspect that might be considered abusive.

In addition, if a property has been vacant continuously for 3 years it automatically meets the test and does not have a further rehab requirement.

A couple other notes from Joy’s original question of ‘Could it be that simple?’ The basics are simple but there are a lot of small details to be aware of. Examples include the need for the QOF to be a multi-member entity, compliance with the 90% and 70% testing rules every 6 months, compliance with working capital safe harbor rules, etc. Most QOF manager don’t hold any real estate at the QOF level but rather set up a lower tier QOZB and purchase the real estate in that entity. If you plan to set up your own fund with your own gains it is certainly possible, but at a minimum I’d recommend having an attorney and CPA that are familiar with the OZ rules to guide you.

Disclaimer: I’m not a lawyer. I run several multi investor OZ funds but the above is just my opinion and not legal advice. My lawyer’s are happier when I put in a disclaimer. :)

Investors seeking to leverage Opportunity Zone incentives have until March 31, 2021, to place capital gains realized, in some cases, as far back as January 1, 2019. The Opportunity Zone program allows for investments to be made through 2026, but as part of Notice 2021-10, the IRS offered new relief to Opportunity Zone investors and Funds by extending the investment deadline for gains whose eligibility window had closed last year.

‍Any capital gains realized on or after October 4, 2019, and any partnership gains realized on or after January 1, 2019, still qualify for investment in an Opportunity Zone Fund until at least March 31, 2021.  This deadline extension recognizes the impact of the pandemic on the investment markets and enables more capital to be placed into Opportunity Zones Funds.‍

‍180 Day Investment Window‍

Typically investors have 180 days from the date they realize capital gains to invest them in an Opportunity Zone Fund. For example, without this extension, an investor who realized a $250K gain from the sale of stock on April 1, 2020, would have until September 28, 2020, (180 days) to place their investment in an Opportunity Zone Fund. That investment window has now been extended to March 31, 2021. This most recent notice further extends previously granted relief from IRS Notice 2020-39 and Notice 2020-23, from June and April of last year respectively.‍‍

‍‍Sample Capital Gains That Qualify:

Partnership Gains - Partnership gains realized anytime in 2019 are eligible for investment until March 31, 2021. Partners in a partnership, shareholders of an S corporation, beneficiaries of estates, and non-grantor trusts benefit from the extension.

Gains realized via partnership are most commonly realized at the end of the calendar year. Therefore, partnership gains start the 180 day investor clock on Dec 31 and remain eligible until Jun 28 of the following year. As a result, partnership gains from 2020 are also still currently eligible on their standard clock.‍

Commercial Real Estate Gains - 1231 net gains from 2019 receive additional time under this new notice. Beginning in 2020, 1231 gains do not need to be netted - you can realize a loss and invest a gain separately. Individual 1231 gains from 2020 are also eligible until at least March 31, 2021. Note: 1231 gains scenarios can be particularly complicated. I recommend that you talk to your tax advisor or CPA about your specific situation.  ‍

‍Unrecaptured Depreciation - Section 1250 gains realized on or after October 4, 2019 are eligible for investment until March 31, 2021. Otherwise, these gains are on their typical 180 day clock.‍

‍Individual Gains - Individual gains, including gains from the sale of stocks, bonds, futures, funds, and personal property dating back to October 4, 2019 are eligible for investment until March 31, 2021. Otherwise, these gains are on their typical 180 day clock.‍

Note on 1031 Exchanges - Investors can sell an existing property, put any portion of their capital gains into an OZ Fund, and extract the principal. Therefore, any gains from property sold on or after October 4, 2019, even if intended for an ultimately failed 1031 exchange, are still eligible for OZ incentives.

‍*Please note, there are unique circumstances for each investor. The information provided here is merely for reference purposes. Please consult your tax advisor or CPA for considerations specific to your situation. ‍

‍How Will This Extension Benefit Investors?‍

Investors now have a larger window of opportunity to place gains in a QOF to leverage Opportunity Zone tax incentives. For example, investors that chose to realize gains during the stock market sell off in March of 2020 can still place these gains in an OZ Fund. This notice offers one last chance to re-invest those gains in a heavily tax advantaged vehicle.‍

‍Disclosure: I'm not a tax advisor so please consult with your advisor on your personal situation.  I run an opportunity zone fund and am happy to answer questions on our fund, but the information above applies to all Opportunity Zone funds.