MidwestLegal The legal loopholes of Opportunity Zones Matt Baker November 28, 2018 Share on Facebook Share on Twitter Share on LinkedIn Share via email Last year’s introduction of Opportunity Zones provides the potential to lift up impoverished areas while simultaneously giving tax benefits to investors. The finer points of how the program will actually work are starting to take shape, though it’s clear that there are several legal implications for participants looking to dive into this new program. The 2017 federal tax reform bill created a new investment vehicle intended to encourage spending in distressed communities. Qualified Opportunity Zones (QOZ) are pre-selected areas around the country where investors can hold capital gains for preferential tax treatment while long-beleaguered residents can benefit from an influx of funding. The Treasury Department promised new clarification and guidelines on the program, and these came in October. While the new information did answer many questions, several new ones developed. Overall, however, the legal ramifications are beginning to take shape. “The new regulations were fairly broad ranging. They covered a number of topics, frankly more than some of us anticipated,” said Jon Giokas of the St. Louis office of law firm Husch Blackwell. “They were very permissive in most instances and appear to evidence some intent to make the program as user-friendly as possible.” Husch Blackwell recently established a multi-disciplinary practice group to provide focused direction to clients with respect to the federal Opportunity Zone program. Led by partners Joseph Bredehoft, Ryan Brunton, Rebecca Mitich and Giokas, the practice group will advise investors, fund managers, real estate developers and emerging businesses, as well as fund recipients such as municipalities. “The guidance is helpful to developers or people on the ground with projects; it is still lacking for fund managers and private equity folks who want to do large, syndicated, securitized funds,” said Mitich, of Husch Blackwell’s Milwaukee office. “I would say there is still additional guidance needed for multi-investor, multi-asset funds to work.” For example, the latest communication from the Treasury indicates who can designate capital as an Opportunity Zone investment. According to the new guidelines, REITs and partnerships can invest in a Qualified Opportunity Fund (QOF) in addition to S corporations, trusts, estates or individuals. The guidelines added new time frames as well. Investor can defer taxes on capital gains that are invested into a QOF within 180 days of the gains being realized and the funds have up to 30 months before they must invest the proceeds. The deferral ends on December 31, 2026 or when the investment is liquidated. We also now know that to significantly improve property, which is a requirement to make it a QOZ, it either has to be an original use or significantly improved. That significant improvement is the doubling of the basis, and for land containing a building, the basis in the building can be doubled, not the basis in the land—a requirement for investment that is lower than previously thought. “The question is, could you just buy five acres of land with an outhouse on it and double the size of the outhouse but not do anything to the land?” Mitich said. “Even with this last set of guidance, there are loopholes that people are identifying as to how investors could take advantage of this in ways that would decrease the impact on the communities that it is intended to serve.” “Only time will tell what the ultimate impact will be,” said Giokas. “It’s a tool and I don’t think it replaces other tools or should be expected to solve or reverse trends that we’ve seen, but hopefully can help in some regard. Previously, there was an asset test every 180 days to gauge whether a QOF still qualified as such, punishable by a fine. This led to speculation that, if the math worked out, some investors might attempt to game the system by blending in non-qualifying funds if the resulting tax break outweighed any financial penalty. The new guidelines don’t clarify this point, but they do mention “decertification,” meaning fines might not ultimately be the only penalty and a QOF could lose its status. “I think the effectiveness of the program is going to continue to rely on how Treasury responds and shapes the program, because the program is still very much in its nascent form,” said Mitich. “Treasury is still seeking guidance and working through how, ultimately, this is going to work in the long term and that additional guidance is really going to shape whether it has a strong impact on these communities or whether it is just a way for investors to get some benefits.” Though the waters may only slowly be getting clearer, that’s not stopping people from getting ready to jump in. For example, Chicago-based private equity real estate firm Origin Investments launched a QOF that amassed $105 million in less than one day. Time will tell how beneficial the program will be, both to investors and residents of the target communities.