From left: Alex Valente (Trammell Crow Company/UCLA REAG president), Phil Jelsma (CGS3), Robert Dupree (CIM Group), Paul Silvern (HR&A Advisors), Stephen Rosetta (Kilroy Realty), and David Alvarado (CGS3). | Images courtesy CGS3

Event Coverage: Investing in Opportunity Zones

Carrie Rossenfeld Event Coverage

The UC Los Angeles Real Estate Alumni Group and Crosbie Gliner Schiffman Southard & Swanson LLP (CGS3) — a commercial real estate law firm with offices in San Diego and Los Angeles — recently hosted an event on “Investing in Opportunity Zones.” Panelists provided a primer on opportunity zones — which offer an opportunity to invest in and rejuvenate low-income, economically struggling neighborhoods — and discussed its tax implications for real estate investment/development.

Held at the UCLA School of Law and moderated by CGS3 Partner David Alvarado, the panelists included Stephen Rosetta, EVP of Kilroy Realty; Robert Dupree, managing director of portfolio oversight for CIM Group; Paul Silvern, a partner with HR & A Advisors; and Phil Jelsma, a partner with CGS3.

The event defined a Qualified Opportunity Zone (QOZ) business as a domestic corporation or partnership or LLC (QOF subsidiary) in which 50 percent or more of gross income arises from the active conduct of a trade or business in the opportunity zone; substantially all of the tangible property is owned or leased by the QOZ business (at least 70 percent of assets must be QOZ business property); substantial portions of the intangible property are used in the active conduct of the QOZ trade or business; less than 5 percent of the aggregate adjusted tax basis of QOZ business is non-qualified financial property, such as stock, debt, partnership interests, options, futures, swaps, and similar property; and for an OZ business, tangible property that ceases to be OZ business property will continue to be treated as such for the lesser of either five years after the date the property ceases to be QOZ business property or the date such property ceases to be held by the OZ business.

Panelists confirmed that there are two possible investment options: QOZ business property or equity interest in QOZ subsidiaries. All panelists agreed that the benefits of investing in OZs are many, with generous tax breaks such as the temporary deferral of capital gains that are reinvested in a Qualified Opportunity Zone Fund (QOF), which can be organized as a corporation or partnership.

The maximum amount of deferred gain is equal to the amount invested in the QOF by the taxpayer during the 180-day period beginning on the date of sale of an asset to which the deferral pertains.

The basis of an investment in a QOF immediately after acquisition is zero. If the investment is held by the taxpayer for at least five years, the basis on the investment is increased by 10 percent of the deferred gain. If the investment is held by the taxpayer for at least seven years, the basis of the investment is increased by another 5 percent of the deferred gain.

From left: CGS3’s Sean Southard, Phil Jelsma, Theresa Cisneros, David Alvarado, Cheryl Brechlin, David Swartz, and Eoin Gubbins.

The second primary tax incentive excludes from gross income the post-acquisition capital gain on an investment in the QOF that is held for at least 10 years. Specifically, in the case of the sale or exchange of the investment in a QOF held for more than 10 years — at the election of the taxpayer — the basis of the investment in the hands of the taxpayers is equal to the fair market value of the investment on the date of the sale or exchange. Taxpayers continue to recognize losses associated with investments in QOFs.

Also discussed were the many steps to becoming a QOF sponsor, which would typically form a partnership, an LLC, or a corporation for the purposes of investing in OZ property. According to Jelsma, the steps to organizing such a fund as a QOF sponsor are complex and include:

• Form a new limited partnership or LLC.
• Elect to be a QOF.
• Open a bank account for the QOF.
• Choose the right structure.
• Purchase property in the OZ (a list of properties located in OZ can be found at https:\\www.cdfifund.gov\pages\opportunity-zones.aspx).
• Identify relevant testing dates.
• Receive equity in QOF.
• Establish a working capital plan.
• Limit non-financial assets.
• Ensure the QOF subsidiary LLC satisfies the 50 percent of gross income test.

The key to success may lie in a sponsor’s ability to receive equity, then deploy that equity in the purchase of OZ property and make sure that the improvements made to the asset can be completed within a 30-month period. This means that property that requires new entitlements, rezoning, or conditional-use permits may not be ideal as QOZ business property.

The proposed OZ regulations include two important provisions dealing with the 90 percent of assets test. Generally, to qualify as a QOF, an entity must hold 90 percent of its assets in QOZ property which can include newly issued stock of a corporation, newly issued partnership interest, and tangible business property in a QOF. When investing through a subsidiary corporation or partnership, only 70 percent of the tangible property of the subsidiary corporation or partnership needs to be held for use in the OZ property. By contrast, if the QOF opted to purchase QOZ business property directly, it would have to satisfy the 90 percent test, thereby encouraging QOFs to invest through subsidiary partnerships and LLCs.

If the 90 percent test is not met, investors have to pay penalty on amount in total that falls below the 90 percent test at the current underpayment rate. This would be approximately 6 percent times the amount of the shortfall.

Part of the Tax Cuts and Jobs Act, OZs are a powerful new economic tool — designed to spur development and bolster job growth in multiple states including California. Now, Southern California neighborhoods such as Compton and South Central Los Angeles, parts of Hollywood and Riverside, San Diego County’s southeast San Diego region, Downtown Escondido, and parts of Vista and National City are listed as OZs – and new investments in these areas can receive financial incentive and preferential tax treatment.

Interest in OZs by opportunistic investors is mounting, with proposed regulations providing significant opportunities for investors throughout the country to identify and acquire real estate investments in a QOF. Property owners located in an OZ should see an increased interest in their property as QOF investors begin searching for developable real estate.