Opportunity Zone Fund Update

Posted on March 5th, 2019

The landscape for Qualified Opportunity Zone funds continues to develop and show promise.  While favorable taxation should never trump underlying investment merits, this strikes us at Beacon Hill as one of the most promising arrows in our quiver for maximizing a selling business owner’s after tax returns.

Rigid Requirements Create Potential Pitfalls

The first set of proposed regulations came out last October.  While the IRS will allow investors a “safe harbor” to rely on those proposed regulations, there are some shortcomings that make it difficult for investors and sponsors to fully implement and realize the benefits for themselves and the communities they will operate in.

I’ve created a standalone fund to defer some capital gains harvested in 2018.  This is more straightforward than a multi-investor setup (due to issues mentioned below), yet I’ve noticed a myriad of hoops to jump through that would be quite easy to miss.  In fact, in an abundance of caution, I’ve rewritten several of our operating documents to ensure we’ve complied with the rigid letter of the law. We believe the final regulations will become more forgiving.  

IRS Clarification

The current language creates risk for multi-investor diversified Funds. However, the IRS seems motivated to clarify, and a public hearing was held on February 14 (postponed from January due to the government shutdown) for investor and [tax] practitioner’s questions and comments to be heard. 

While the IRS provided no further comments or clarifications at the time, the hearing brought attention to areas where additional guidance is needed.

The original sponsors of the bill, which include Ohio’s Rob Portman and Steve Stivers, wrote Treasury Secretary Steve Mnuchin a letter stating that Congress “designed this incentive to be broadly applicable to rural and urban communities, flexible…, and scalable….”  As it is currently written, however, there is still a great deal of work to be done for the incentive to truly meet these “flexible” and “scalable” goals. 

Among the concerns listed, the sponsors specifically urged that the following items be clarified and improved:

  • Businesses- limitations make it difficult to be in businesses that aren’t real estate, especially growth oriented (50% of gross income from the active conduct of trade or business in the qualified opportunity zone)
  • Timing of investments restrictive which “fundamentally impact the ability to form and maintain multi asset Funds that spread risks and costs across a portfolio of investments as Congress intended…”
  • Fund level reinvestments impacting underlying Opportunity Fund investors

Risk Exposure

Diversified, multi-investor Funds currently raising capital are exposing their clients to risk.

At Beacon Hill, the majority of our investors who would benefit from investing in a QOZ include those selling their business, or real estate, with capital gains in the range of $500k-$5m.  As such, there are additional constraints that we see the current legislation needs to lift or clarify;

  • To qualify to receive the tax free gains after 10 years, the investor’s entire holdings of the entity needs to be sold. 

From a pragmatic standpoint, such a limitation becomes a “tough sell” for those seeking to sell single Qualified Opportunity Zone Fund holdings that include unique underlying assets.  For example, if the QOZ Fund owned an apartment building and a retail strip mall- simply selling the apartment building or strip mall wouldn’t qualify.  They’d have to find a buyer that would purchase the QOZ Fund that held those.  That strips a lot of buyers out of the market!