All Forum Posts by: Scott McIntosh

@John Perry yes, that structure works. There are a number of qualifications requirements for QOZBs, but it sounds like your investment will be a ground up development in an OZ which should be easy to qualify. 

Your point about investing all or just some of your QOF into construction of the complex could have implications about treatment of depreciation recapture if you hold the investment for 10+ years, so that should factor into your planning. 

With regard to ‘cashing out’, the current regulations allow for a leveraged distribution at/after 2 years for most OZ development deals. Or if you sell the asset, you have 12 months to reinvest the proceeds in other OZ property or businesses in order to keep your deferral and continue progressing toward a tax-free sale after 10+ years. 

Lesley— I have a legal practice focused on structuring Opportunity Zone investments. I've created my own QOF that I use for BRRR investing in my local opportunity zones, and have structured QOFs for a dozen or so other clients. Happy to discuss and see if I can help. At least for me, the deferral is great but I'm in it for the tax-free upside in 10 years!!

Manish— any annual dividends (or rent cash flows if you’re actively operating your own QOF) are taxed the same as any other dividend/rental income. OZ benefits only affect your initial deferred gain equity and the proceeds at sale if you held for 10+ years. 

@Cass Lowrie echo Mike B’s recommendation. Unlike 1031 exchanges, Short term capital gains are eligible for deferral until 2026 when you reinvest them in a Qualified Opportunity Fund. If you’re open to a longer-term hold period for the properties you will buy/rehab with those proceeds, it could be a great fit for you. I’ve set up QOFs for a number of clients in similar situations to you — happy to discuss with you further, if you’d like. 

@Alex Beard

You can invest non-capital gains in an opportunity fund, but you don't get any of the tax benefits.  In your situation, an Opportunity Zone investment wouldn't make sense. 

That said, if you decide to flip your first property and have a significant gain, that could be the right time to start an OZ fund to get the tax deferral on your flip gains so you can move the full pre-tax gain into your next investment. 

Good luck!

Are you interested in creating your own fund to actively purchase and improve properties in Opportunity Zones near you, or are you looking for a more passive OZ investment? 

@Pankaj Kumar

First of all, congrats on accidentally stumbling into a $130k profit!  That's a pretty phenomenal situation to be in.  Now that you're in that spot, you've got two viable options to defer some/all of your gain. 

A.  1031 exchange or partial exchange, with a potential refi down the road to get some extra cash out (as @Dave Foster outlined).

B.  Reinvest the gains (or any part of them) in a Qualified Opportunity Fund.  The fact that you're not an accredited investor may keep you out of certain passive investments in institutional funds, but doesn't disqualify you from the OZ benefits. 

I've created qualified opportunity funds for dozens of clients who wanted to actively reinvest their recently realized capital gains in Opportunity Zone Properties or Businesses -- some started their fund with as little of $500 in long-term capital gains and others have had millions of short-term capital gains. Once the fund is created, it functions largely like a standard real estate investment LLC, with some additional compliance/reporting requirements. The mechanics are as follows:

1. Create a "personal captive" Qualified Opportunity Fund (needs to be a partnership or corporation -- not a single-member disregarded entity). Partnership structure within an LLC generally works best when the plan is to reinvest in real estate.

2. Open a bank account for your QOF, and deposit recently realized capital gains into that account within 180 days of realization (or 180 days of the end of the tax year, if the gains come to you on a K-1).  This triggers the capital gains deferral for you, which your CPA can record on IRS form 8449 using code "z" for the deferred gain. 

3.  Find and purchase property within a designated opportunity zone that you'd like to own as a long-term rental, and that needs "substantial improvement."  Substantial improvement is defined as capital investment that doubles the basis in the structure within a 30 month period.  Structure is italicized because you can back out the land value, which helps alot in making the threshold achievable.  For example, if you buy a single-family home in an opportunity zone for 85k and you can reasonably attribute $35k as the value of the lot, your threshold for substantial improvement is capital improvements that result in additions to basis of 85k-35k = $50k. Alternately, if you buy and develop raw land in an OZ, that threshold does not apply. 

4.  Find a good tenant, begin collecting rental income, and remain actively involved in your rental property business.  Note that you can use as much leverage in an OZ investment as you like, so in your scenario you could choose to use your full gain to fund a cash purchase and renovation of one property (like the one described above) or to leverage that transaction and buy several others. 

5. Attach IRS Form 8996 to the annual partnership tax return for your OZ fund, certifying that at least 90% of your funds assets were qualified opportunity zone property. 

6.  Enjoy the OZ benefits during the time you remain invested in your qualified opportunity fund -- capital gain deferral until the end of 2026, 15% reduction in the amount of your deferred capital gain subject to tax in 2026, and a step-up in basis to fair market value at sale, if you hold your interest in the Qualified Opportunity Fund for 10 years or more. 

Standard Legal Disclaimer: The OZ Legislation and Regulations are ~250 pages long to date, and additional guidance is still forthcoming.  The description above of the mechanics of an OZ investment was written as a general overview, and is not a substitute for individual legal advice.  Contact an attorney with expertise in structuring Opportunity Zone investments if this is an area you'd like to pursue further.  

Mark— have you considered creating your own OZ fund and using it for investment properties you actively own/manage in the OZ? Lots of existing properties in opportunity zones that could easily qualify under the ‘substantial improvement’ threshold. Compared to new development, you’d be cash flowing in a matter of months rather than years. 

@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!

All capital gains (both short and long-term), including net 1231 gains, are eligible for deferral through investment in a qualified opportunity fund.  Lots of factors to consider when evaluating a 1031 vs. OZ deal, and a number of situations where gains from certain sales wouldn't be eligible for a 1031 but could still qualify for OZ investment.