Articles Posted in Opportunity Zone Funds

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The final IRS Regulations released December 19, 2019 modify and clarify some of the previously proposed regulations, and retain most of the previously proposed regulations, for real estate investors and developers in Opportunity Zone projects. 

The IRS Release of the final Opportunity Zone regulations – consisting of 350 pages of explanations of what was changed and what remained unchanged from the proposed regulations released in October 2018 and May 2019, and almost 200 pages of regulations and examples – contains mostly good news for real estate investors.  The regulations provide detailed requirements for investors seeking to qualify for the tax benefits provided from an investment in one of the over 8,700 designated Opportunity Zones, codified as Sections 1400Z-1, and 1400Z-2 of the Internal Revenue Code.  This article focuses specifically on those portions of the final regulations that impact real estate investment and development in designated Opportunity Zones.

The final IRS Regulations made the following modifications to the proposed regulations on real estate related investments issued in October 2018 and May 2019:

  • Gross capital gains from sale of depreciable property and non-depreciable real estate used in a trade or business for more than one year, otherwise known as “1231 assets” in the Code, are now 100% qualified for tax deferral, without the need to net out capital losses;
  • Capital gains allocated to investors by a limited partnership or limited liability company can be invested in a qualified opportunity fund (“QOF”) for up to 180 days from the due date of the pass-through entity’s tax return, which further extends the time period for investors to make a qualified investment in a QOF from the proposed regulations that would have started the 180 day period on the last day of the pass-through entity’s taxable year;
  • Property that has been vacant (defined as more than 80% unused as measured by square footage of usable space) for at least one year before the date the qualified opportunity zone was designated, or for at least three years after the date the qualified opportunity zone was designated, will now qualify as “original use” property, and will not be required to be “substantially improved” to meet the requirements for qualified opportunity zone business property (“QOZBP”);
  • All real property that is part of a “brownfield site,” including land and structures, will be treated as satisfying the “original use” requirement to be classified as QOZBP, provided that the land is improved after its acquisition, and the cost of remediation of contaminated land may be included in the calculation of substantial improvements to the property;
  • All real property in a designated opportunity zone that is purchased from a local government held as a result of abandonment, bankruptcy, foreclosure or receivership, , will satisfy the “original use” requirement for classification as QOZBP;
  • The 31 month working capital safe harbor for cash held by a QOF may be sequentially applied to each cash contribution on the date received by the QOF, which may extend the working capital safe harbor for a maximum 62-month period;
  • Capital gain realized from the sale of an asset to a QOF, if reinvested into the same QOF, will not qualify for either the deferral of original capital gain or tax free capital gain at the end of the 10 year holding period – which means that capital gains from sale of an asset to one QOF have to be invested in another QOF if the seller of the asset desires to defer the capital gains tax on the sale of the asset to a QOF;
  • Capital gain that is realized by an investor over time under the installment method can be invested within 180 days from the date of each installment payment, or may optionally be invested for all installment payments that are payable after December 31, 2017, even for installment sales that were entered into prior to December 31, 2017;
  • The 31 month working capital safe harbor for cash held by a QOF in connection with a real estate development has been expanded to provide that if a governmental permitting delay has caused the delay and no other action could be taken to improve or complete the project during the permitting process, then the 31-month working capital safe harbor will be tolled for a duration equal to the duration of the permitting delay;
  • If a project owned by a QOF that otherwise meets the requirements of the 31-month working capital safe harbor is located in a qualified Opportunity Zone that is or becomes a Federally declared disaster area, the project may receive up to an additional 24 months to utilize its working capital assets if the project is delayed due to that disaster;
  • With regard to leases of property between unrelated parties, there will be a rebuttable presumption that the terms of the lease were market rate and therefore satisfy the market-rate lease requirement for treatment of the leased property as qualified opportunity zone business property;
  • Clusters of commonly-owned buildings can be aggregated for purposes of applying the substantial improvement requirements; and
  • Taxes payable on deferred capital gains, due for the tax year ending December 31, 2026 or upon any earlier disposition of the QOF investment, will be calculated based on the tax rates in effect for the taxable year in which the taxes are payable (not the tax rates for the year in which the deferred capital gains were originally realized).

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JMBM’s Investment Capital Law Group is pleased to announce that Catherine DeBono Holmes, Chair of the Group, will participate as a panelist for PLI’s 21st Annual Commercial Real Estate Institute.

Date:   November 7-8, 2019
Place:  Live in San Francisco or via Webcast

Cathy will participate on the panel focusing on Opportunity Zone Real Estate investments. The panel will cover:

  • How to structure a Qualified Opportunity Fund
  • The tax benefits of Opportunity Zones
  • Guidance on the Opportunity Zone program – what we know, what we don’t know, and what else is coming

Click here for more information, or to register.

PLI programs offer CLE credit in all U.S. jurisdictions that have mandatory CLE requirements and some foreign jurisdictions with CPD requirements. Please check www.pli.edu/credit for details.

 

Cathy HolmesCatherine DeBono Holmes is the chair of JMBM’s Investment Capital Law Group, and she has practiced law at JMBM for over 30 years.  She has also worked as a senior member of the JMBM Global Hospitality Group and JMBM Chinese Investment Group. Within the Investment Capital Law Group, she helps real estate developers and business owners, brokers, investment advisers and investment managers raise and manage investment capital from U.S. and non-U.S. investors. She has acted as lead counsel on numerous hotel, residential and mixed-use developments and transactions in the U.S., Europe, China, South America and Asia Pacific regions, as well as hotel management and franchise agreements and public-private hotel developments. She has also represented private investment fund managers, registered securities broker-dealers and investment advisers on securities offerings, business transactions and regulatory compliance issues. She is a frequent speaker and author on a range of topics related to capital raising transactions, including EB-5 financing and Opportunity Zone financing. Cathy can be reached at CHolmes@jmbm.com.

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By Catherine Holmes, Brad Cohen and Jamie Ogden

The latest IRS Proposed Regulations Released April 17, 2019 provide greater flexibility to real estate developers seeking capital from investors for Opportunity Zone projects.

Some of the problems posed for real estate developers and others under the new Opportunity Zone (“OZ”) tax incentive program, codified as Sections 1400Z-1, and 1400Z-2 of the Internal Revenue Code, have been potentially solved by the latest round of IRS proposed regulations. In particular, the proposed regulations now provide helpful guidance and assurance regarding:

  • development of property that was acquired by a developer prior to December 31, 2017;
  • clarification regarding when real property will be considered to meet the “original use” requirement;
  • capital contributions received from new investors in a “qualified opportunity fund” (or “QOF”) with multiple closings;
  • distributions of debt financed proceeds by a QOF to investors during the 10 year required holding period;
  • greater flexibility to deal with “real world” problems (such as delays in governmental permitting);
  • sales of assets by QOFs before the 10-year holding period for investors and reinvestment of proceeds of sale;
  • sales of assets by QOFs organized as limited liability companies or limited partnerships after the 10 year holding period for investors;
  • clarification that a property rental business is considered an active trade or business (other than a triple net lease); and
  • clarification that depreciation recapture should not be taxable upon a sale of property by a QOF .

This article explains how these new proposed regulations help real estate developers and their eligible investors qualify for the tax benefits under the OZ program.  For information regarding the potential benefits to investors in a QOF and the basic requirements necessary to qualify as a QOF, see our prior article “How Real Estate Developers Can Use Opportunity Zone Funds to Finance New Real Estate Projects.”

Real property acquired before December 31, 2017 can now qualify for development by a QOF through a ground lease arrangement between a real property lessor and an affiliated real property lessee.

One of the requirements for a real estate development to achieve the status of “qualified opportunity zone business property” (“QOZBP”) under Section 1400Z-2 is that the property being developed must have been purchased after December 31, 2017.  Developers who acquired their properties before that date were prevented from qualifying for the OZ tax incentives unless they sold at least 80% of the property to an unaffiliated purchaser, and retained no more than a 20% capital and profits interest.  However, the latest proposed regulations offer another option to a developer in this situation – it can form an affiliated QOF, enter into a ground lease with the QOF as lessee, and have the QOF finance the development of the property. The requirements for ground leases between affiliates under the latest OZ regulations are that:

  • the lease is entered into after 2017;
  • the lease is on market rate terms when it is entered into;
  • the lease does not contain a prepayment of more than 12 months;
  • there is not a plan, intent or expectation that the QOF would purchase the property for other than fair market value to be determined at the time of purchase.

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Recent posts on the Investment Law Blog have focused on Opportunity Zone Funds, a new source of financing for real estate development projects, created by the Tax Cuts and Jobs Act of 2017.

While these articles have focused broadly on real estate investment, I recently spoke with Bryan Wroten of HotelNewsNow, specifically about hotel development and Opportunity Zone investment.

His article, “What opportunity zones mean for US hotel development,” describes both the opportunities and challenges that hotel developers face when it comes to taking advantage of Opportunity Zone development.

The article also describes how the Peachtree Development Group is taking advantage of opportunity zones for viable projects that were already in their pipeline.

Read the full article here.

— Catherine DeBono Holmes

 

Cathy HolmesCatherine DeBono Holmes is the chair of JMBM’s Investment Capital Law Group, and has practiced law at JMBM for over 30 years.  She has also worked as a senior member of the JMBM Global Hospitality Group and JMBM Chinese Investment Group. Within the Investment Capital Law Group, she helps real estate developers and business owners, brokers, investment advisers and investment managers raise and manage investment capital from U.S. and non-U.S. investors. In the last ten years, she has represented over 100 real estate developers obtain financing through the EB-5 immigrant investor visa program for the development of hotels, multi-family and mixed use developments throughout the U.S. She also advises real estate developers on Qualified Opportunity Zone investments. She has also represented private investment fund managers, registered securities broker-dealers and investment advisers on securities offerings, business transactions and regulatory compliance issues. For the last two years, she has been named as one of the top 25 securities lawyers in the country by EB5 Investors magazine. Contact Cathy at CHolmes@jmbm.com or +1 310.201.3553.

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By Catherine Holmes, Brad Cohen and Guy Maisnik

On October 19, 2018, the IRS issued the first set of proposed regulations and a New Revenue Ruling on new Internal Revenue Code Section 1400Z-2 governing Opportunity Zone investments.

Under the new Opportunity Zone tax law, taxpayers who realize taxable capital gains from the sale of any asset (stock, property, etc.) and who reinvest those gains into “Qualified Opportunity Funds” (“QOFs”) or “Qualified Opportunity Zone Property” (“QOZP”) will be eligible to receive significant tax benefits, including deferral of their original gain, reduction of their original taxable gains after holding periods of five years or seven years, and no tax on capital gains realized from the new investment in a QOF or QOZP after a holding period of 10 years.

The first set of proposed regulations issued by the IRS under Code Section 1400Z-2 cover a number of issues that apply to individual taxpayers with respect to gains eligible for deferral, types of taxpayers eligible for deferral, the “180-day rule” defining when a qualified investment must be made in order to qualify for the deferral, and how to elect a deferral of the initial capital gain. In addition, the proposed regulations, along with new Revenue Ruling 2018-29, provide guidance to real estate developers seeking to form QOFs or determine whether their properties qualify as QOZP. This article focuses on the regulations and the Revenue Ruling that apply to QOFs and QOZP, and addresses how those regulations and the Revenue Ruling will help real estate developers seeking to raise Opportunity Zone investments to finance real estate development.

How to designate an entity as a QOF and how that Impacts the 90% Test for Eligibility as a QOF

The Regulations specify that any corporation or entity taxed as a partnership, including pre-existing entities, may self-certify as a QOF by using a form that has been proposed by the IRS. The Regulations further allow the QOF to choose the month in which the entity elects to be designated a QOF. If the QOF does not designate a month on the tax form, the Regulations provide that the designation will commence with the first month of the taxable year of the entity. This is important, because a QOF must hold at least 90% of its assets in QOZP as measured on the last day of the first 6-month period of the taxable year of the QOF and on the last day of the taxable year of the QOF. Therefore, if a QOF designates January as the first month of designation, the first six month test will apply in July. If a QOF designates any month after June of the taxable year, the Regulations state that the first test period will be the end of the first taxable year. Continue reading →

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by Catherine DeBono Holmes and Bradford S. Cohen

Real estate developers have a new source of investment for their development projects, created by the Tax Cuts and Jobs Act of 2017

A new tax incentive for investment in low-income areas designated as “Opportunity Zones” was included in the Tax Cuts and Jobs Act of 2017, signed into law on December 22, 2017. Under this section of the Act, codified as sections 1400Z-1, and 1400Z-2 of the Internal Revenue Code, taxpayers with taxable capital gains from the sale of any asset (stock, property, etc.) who reinvest those gains within 180 days of the date of sale of the asset into “Qualified Opportunity Zone Property” will become eligible to receive significant tax benefits. These potential tax benefits are expected to result in substantial new investment by investors in real estate projects that meet the requirements of “Qualified Opportunity Zone Property.” This article explains what the requirements are for designation as Qualified Opportunity Zone Property, and discusses the structure of Opportunity Zone investments.

What are the potential benefits to persons who invest in a Qualified Opportunity Zone Property?

There are three potential benefits that investors may receive from an investment of their taxable capital gains into a Qualified Opportunity Zone Property:

Deferral of Capital Gains Tax – Investors will receive a deferral of taxation on 100% of the taxable capital gains invested in Qualified Opportunity Zone Property until the earlier of the date that their investment is sold or December 31, 2026;

Reduction of Capital Gains – Investors who invest by December 31, 2019 will be eligible to receive a 10% reduction of the taxable gain amount invested in Qualified Opportunity Zone Property if the investment is retained for at least 5 years, increasing to a 15% reduction if the investment is held for at least 7 years; and

No Tax on Capital Gains realized on Qualified Opportunity Zone Property – Investors who invest by December 31, 2019 and hold their investment in a Qualified Opportunity Zone Property will pay no tax on any capital gains realized when that investment is sold.

What are the requirements for Qualified Opportunity Zone Property?

There are four primary requirements for a real estate development to achieve the status of “Qualified Opportunity Zone Business Property”: Continue reading →