New York State is participating in the new Opportunity Zone community development program, offered through the Tax Cuts and Job Acts of 2017. The federal program encourages private investment in low-income urban and rural communities. Based on analyses by Empire State Development (ESD), New York State Homes and Community Renewal (HCR), New York State Department of State (DOS) and the state’s Regional Economic Development Councils (REDCs), New York State has recommended 514 census tracts to the U.S. Department of the Treasury for designation as Opportunity Zones. https://esd.ny.gov/opportunity-zones
To get a better understanding of the program, The Bonadio Group partnered with Gross Shuman and CBRE Buffalo to host a panel discussion on Qualified Opportunity Zones. The moderator for the event was Nancy Cox with The Bonadio Group. The panel included Adam Koehn from CBRE, Trevor Torcello from Gross Shuman and Joe Wutz from The Bonadio Group.
The discussion focused on establishing parameters for defining what constitutes an Opportunity Zone (OZ), what is a Qualified Opportunity Fund (QOF), timelines, locations and other trending questions. It appears that that the initiative has broad bipartisan support so initial expectations are that the new regulations will be investor-friendly.
Each panel member brought a unique perspective to the topic. Here are some highlights and key takeaways.
Defining the opportunity
Adam Koehn from CBRE, discussed how to clearly define a Qualified Opportunity Zone Business Property.
- There large portions of Western New York that are attractive to investment that are Opportunity Zones.
- Qualified Opportunity Funds will compete with 1031 tax-deferred exchange rules so participation will depend on investor preference.
- Most QOFs are focusing on real estate due to the uncertainties around OZ businesses.
- Current guidance states that either partnerships or partners can elect to defer gains. This is expected to result in significant capital flowing to OZs.
- Because the 10-year gain exclusion requires that the interest in the opportunity fund must be sold, single asset funds are being formed.
- Sound investment principles always apply; funds will still seek additional incentives through tax credits, state and local incentives, depreciation and interest deductions.
Timeline for Qualified Opportunity Fund
Considering a QOF from a tax perspective
Joe Wutz from The Bonadio Group spoke from a tax perspective and discussed Eligible Gains for Investment in a QOF.
Only capital gains from a transaction with an unrelated party are eligible for deferral treatment when contributed to a QOF within 180 days.
Partners and S corporation shareholders realizing capital gains on Schedule K-1 have 180 days from the last day of their partnership or S corporation’s tax year
Section 1231 gain and unrecaptured Section 1250 gain will qualify.
Gain attributed to recapture of depreciation of business property does not qualify.
Investors must recognize the deferred capital gain at the earlier of the date of disposal of the QOF investment or 12/31/2026
QOF investors will need sources of liquidity in order to pay the tax due.
Character of capital gain you defer will be the character of gain you ultimately recognize (i.e., short-term capital gain, Section 1231 gain, etc.)
Accounting for a QOF Investment:
Careful planning and accounting is critical for all stages of a QOF investment (for both QOFs and investors alike)
Initial basis in a QOF investment made with deferred capital gains is zero.
Further guidance is needed regarding losses and distributions allocated to QOF investors with initial basis of zero during years 1-5 of the investment.
“Other money” contributed to a QOF is treated as a separate partnership interest.
There is no step up in basis after 10 years available on this portion of the investment.
The basis increases in QOF investment between years 5 and 7 (see QOF timeline slide)
After year 10, investors can elect to step up in basis in the QOF investment to fair market value upon disposition of their QOF interest.
There is a question as to recapture of depreciation deductions funded by debt.
Further guidance is needed to allow investors more flexibility in developing their exit strategy.
QOF planning considerations
Trevor Torcello from Gross Shuman discussed what to consider in the planning of a QOF.
Careful consideration is required by promoters and developers in order to comply with the requirements of the proposed QOZ regulations. Initial considerations include:
Whether the QOF will invest in a single property or multiple properties
How many investors the QOF seeks and how much money the QOF intends to raise.
Whether a property or properties targeted by the QOF will require “substantial improvement” under the proposed regulations.
The timing constraints and ramifications to the QOF
Presently, developers that hold property acquired prior to 12/31/17 may find it difficult to benefit from the QOZ program.
Single tenant, triple-net projects appear to be ineligible for QOZ benefits.
What to expect
Final regulations for the Qualified Opportunity Zone program are pending. The Bonadio Group and our panelists are monitoring the progress and will follow up with details when they are available. For more information, visit our website www.bonadio.com.