All Forum Posts by: Philip Ma

@Brian McCombs I have a blog on how I started my own private QOF here: https://www.biggerpockets.com/...

Hope that helps.

Hi Joy, I think that's possible, assuming you could get the turnkey company to sell you the property at their cost or wholesale it to you at cost and then trust that you will engage them to do the rehab. Assuming it's an existing property, then you would be engaging them to do enough rehab work such that the value add would double the tax basis of the building (to meet the substantial improvement requirement of the QOZ rules). Depending on the value of the property, that could be an attractive amount of rehab work for a contractor. 

I guess it depends on how flexible the turnkey company is with their business model. The ones I have come across want to buy the property, do the rehab, and then sell it fully rehabbed. That probably won't work for a QOF because the QOF then has to double the basis of the fully rehabbed building (but see my #2 scenario below). 

If you had the QOF buy a fully rehabbed property from the turnkey co and try and split the price between their original cost and their rehab work, it could be risky under the QOZ rules because the QOF didn't really scope out or perform the substantial improvement of the property. UNLESS the prior owners of the property never treated it as a rental property, i.e. never depreciated it because it was their primary residence or it was part of inventory (in the case of the turnkey co). Then maybe you could take the position that the turnkey property was "original use" by the QOF (see p. 489-90 of the final regs for the definition of "original use.")  I would definitely check with a tax professional on that scenario.

A couple of strategies that I have been looking at are:

1) QOF buys a property from a wholesaler unrehabbed. Then it engages a local contractor to do the rehab. Scope out a budget for the rehab that would equate to doubling the basis of the building. Let's say you could find a wholesale property for $75K and you could justify attributing $25K of the value to the land. Then you scope out a rehab project with a contractor with a budget of $50K and figure out how to maximize value with that budget. e.g. new roof, kitchen remodel, bathroom remodel, etc.

2) QOF buys a lightly rehabbed property from a turnkey company. The price is low enough and there is enough value add opportunity for the QOF to do substantial improvement and generate more rental income/appreciation. Say you bought a lightly rehabbed property for $100K from a turnkey company and could justify attributing $25K to the land. Now you need to spend $75K on substantial improvement, but you have an opportunity to add a bedroom and bathroom to the house. The numbers could still work for the QOF in that scenario.

But maybe the "original use" argument on a fully rehabbed turnkey could work if the property was never depreciated as a rental property in the past.  Interested to hear other views on that.

@Manas M. My pleasure, I'm glad you found it useful. 

On your #1, my reading of the example is that the "intent and expectation" language is meant to emphasize that the developer does not intend to depreciate the building but rather to sell it as inventory to the QOF. I don't think the developer would derive any tax advantage under the QOZ rules for having that intent. This fact pattern is just providing a clear (extreme) example of the QOF satisfying the original use test. The actual definition of original use on page 489-90 has nothing about intent of the seller/developer, so I am not concerned if the builder does not have specific intent to sell to a QOF in my purchases. 

On your #2, typically a builder would treat the new construction building as inventory on their balance sheet, not as a depreciable asset (unless they couldn't sell the inventory and decided instead to operate the building as a rental). On my last new construction purchase, I negotiated for a statement in the purchase agreement which stated the the seller/builder would not be placing the property into service for purposes of depreciation prior to the close of escrow. They had no problem agreeing to that statement (it was a small sized builder, so they are probably more flexible than the big names). While a statement like that provides me with some comfort in the event of audit, I don't see it as necessary to satisfy the original use requirement. 

In the bigger picture, I think that the risk is extremely low on your position being challenged, but that's obviously up to you. I would run it by a tax professional familiar with your facts and the QOZ rules. Keep in mind that it's a new law, so even the tax professionals are guessing on some of the grey areas. Hope that helps. 

Hi Manas, I have my own QOF and have been acquiring new construction properties located in QOZ areas from the builder. I take the position that acquiring and renting out a new build constitutes "original use" under the QOZ rules and therefore does not require further substantial improvement. I wrote a blog post about it here: https://www.biggerpockets.com/...

If you look on page 489-490 of the final QOZ regs, it has a definition of "original use" which I believe supports this position, i.e. you as the buyer would be the first person to place the tangible property into service for depreciation purposes.

On your question about using 50% eligible gain (in a QOF LLC) and 50% non-eligible gain for the Qozbp purchase, I think it's possible if you structure the 50% of personal funds as debt to your QOF, i.e. you set up a note just as you would with a 3rd party lender and make monthly payments to yourself out of the QOF at a market rate of interest. I would work with a tax attorney or CPA to ensure that the note would hold up under audit as a debt instrument.

Hope that helps.

Hi Bethany,

See my blog on how I set up my own QOF to acquire QOZ property.  Hope this helps you get started:

https://www.biggerpockets.com/...

Hi Jinsoo, see my blog on how I set up my QOF here:

https://www.biggerpockets.com/...

I have spoken with a few attorneys and CPA's in setting up my fund. In the end, I went with an entity formation service that knew nothing about the QOZ rules. I just had to instruct them on some QOZ specific language I wanted in the operating agreement, which is not really required by the regs, but I put in for good measure. In my opinion, a CPA knowledgeable about the asset test rules is a better resource than an attorney in terms of ongoing compliance.  

On your #2,  the "substantial improvement" requirement of the OZ rules requires you to double the basis in the building, but not the land part of your acquisition cost. Depending on how much rehab needs to be done and where the property is located, it may be worth doing a supportable cost segregation analysis between the building and the land so you don't invest more than you need to in the rehab.

On your #4, I have checked with multiple legal and tax professionals (but don't take this as legal/tax advice), and feel comfortable executing the BRRR in my own QOF. I'm just now completing my first cash out refi on my first set of OZ properties. One thing to keep in mind is that the properties should stay in your QOF entity, so you have to look to commercial lenders who will lend to your entity, and that will mean higher interest rates than Fannie/Freddie lenders. As Scott mentioned, with a 2nd tier QOZB entity under your QOF, you get more breathing room to deploy your capital. I ended up going from a single tier to a 2-tier structure so that I could execute the BRRR and stay above those asset test thresholds when the cash comes back in.

I am a QOF investor so hopefully can provide some insight on your question. You are right that if your property is located in a QOZ, then it will be attractive to a QOF investor. However, if it is an existing property, it has to have significant value add opportunity to make sense because to get the tax benefit, the investor has to "substantially improve" the property (under the tax rules that means doubling the basis in the building) within 30 months after acquisition. I see sellers marketing their property that is fully rehabbed as being located in a QOZ. I quickly move on because if it's already rehabbed or added to, I would have to spend even more to double the basis in the building. Only if it is brand new construction where a builder built it on vacant land would I be interested because then I can take the position that the property is "original use" under the tax rules and therefore does not have to be substantially improved. The fact that you were investigating adding 24 units to your property is a great selling point to a QOF investor (as long as you don't actually do the addition). In terms of MLS vs other channels, I would definitely post the property on LoopNet because they have a search parameter box that one can check as to whether the property is located in a QOZ or not. I'm guessing they have census tract data in the database that can automatically determine that. As a QOF investor, I can set up alerts on LoopNet to notify me when a property in a certain city or county that is also in a QOZ is listed. I haven't found any MLS's or free listing web sites that have that as a search parameter. For an MLS search, a realtor can get close by using zip codes, but the QOZ's are defined by census tract, so that is the most precise way to search. Hope that helps you in marketing your property to QOF investors.

Yes, it should be OK to have a mortgage on the property and not blow the 90% asset test.  

If it is an existing property, then yes, you must satisfy the substantial improvement requirement.  If it is brand new construction and has not been previously depreciated by the prior owner, then you could take the position that it is original use and you don't need to substantially improve it.