Does Second Round of Opp Zone Rules Clear Up Confusion?

PORTLAND, OR—Created by the Tax Cut and Jobs Act of 2017, opportunity zones seek to spark economic development in distressed areas by encouraging long-term investments through tax breaks. The tax incentive allows investors to defer or minimize taxes on capital gains and, when the investment is remains in play for more than a decade, eliminate capital gains taxes all together.

The Treasury Department recently released a second round of rules clarifying requirements for opportunity zones in a move designed to encourage more development in low-income areas, according to Housing Wire. The new rules are intended to make it easier for developers looking to take advantage of the tax breaks promised by investing in opportunity zones, and clear up some of the confusion that was holding investors back.

More than 8,700 communities housing approximately 35 million Americans have been designated as opportunity zones. While HUD estimates that opportunity zones could spur as much as $100 billion a year in investments, evidence suggests this potential is far from being realized.

The new rules specify that investors can share stakes in opportunity zone funds and are permitted to sell start-ups in these areas as long as they reinvest the funds in other qualifying businesses or assets. And the regulations clarify that real estate investors can lease and refinance those properties. The Treasury’s new guidance also makes it easier for investors looking to fund small business in these low-income areas by approving tax breaks for those exporting goods and services from outside the zone.

One major investor concern revolved around the previous stipulation that in order to qualify, a business must earn 50% of its gross income inside the zone. This left some wondering how tech companies, which might draw customers from outside the zone, fit in. The Treasury has now clarified that a business qualifies if 50% of its employee’s hours or wagers are from inside the zone or if the property and managers needed to produce 50% of the revenue are from inside the zone.

In this exclusive, Adam Hooper, co-founder and CEO of RealCrowd, shared insights on what the new opportunity zone regulations mean for investors.

GlobeSt.com: What are the key takeaways from the newest regulations released regarding opportunity zones?

Hooper: The biggest clarification in this round of regulations involved how operating businesses can comply with the opportunity zone rules. Most applicable to the real estate investment rules are more clarification around multi-asset fund structures, exiting an asset within a fund without penalty, timelines for safe harbors on initial deployment of capital and timing to meet the first 90% test.

The new regulations eased up a bit on multi-asset fund structures, stating that only assets that have been in the fund for at least six months need to be considered as part of the fund’s qualification as a Qualified Opportunity Zone Fund/QOF. They also stipulated that if a QOF holds assets, the sale of individual assets within the fund after the 10-year holding period can be recognized by the individual investors on a tax-free basis. Investors wouldn’t have to sell their interest in the QOF itself, but would be able to realize the gains from the sale of individual investments held by the fund and wouldn’t face a tax consequence. QOF managers are able to sell the assets in the funds and those gains will retain the benefits of the gain exclusion rather than having to sell the fund interests themselves.

Regarding exiting an asset, if an investor has held an investment in a QOF for at least 10 years and the fund sells an asset, the investor pays no tax on the gain from that sale. And, these funds have a year with which to deploy capital into qualified opportunity zone investments without triggering capital gains to its investors.

The guidance also further clarified the 31-month working capital safe harbor. The IRS said investors would not be penalized if they failed to meet the timeline due to delays from the government. This piece of guidance is especially helpful in California, where the permitting process can be long and can significantly tie up the progress of development.

The new regulations loosened the 90% asset test rule too. Previously, each QOF had to certify every six months that it held 90% of its assets in opportunity zone properties. Now, it has 12 months to do so.

The adjusted rules did tighten up on some of the previous regulations. Opportunity zone benefits now apply to the cash investment and not to the carried interest that has been earned for services, triple net lease investments do not apply to opportunity zones and deferred gains may become taxable if an investor transfers opportunity zone interest by gift but not by inheritance or upon death to an estate or revocable trust.

In addition, it seems as though new guidance on reporting requirements may be forthcoming in future rounds, since language about these requirements was not in the new report.

GlobeSt.com: Did this help clarify some of the concerns investors may have previously held regarding investing in this space?

Hooper: Definitely. Each new round of guidance the IRS provides us with helps to allay investors’ concerns about opportunity zones, most of which stem from the uncertainty that comes with a lot of unanswered questions. This round was no exception, especially for those who were looking at investing in operating businesses versus just a pure real estate approach. The timing and multi-asset fund structures are very important and the ability to sell assets within the fund is one we all had hoped would be clarified, as it was.

GlobeSt.com: Can you share more insight about the one-year grace period to sell assets and what this means for investors?

Hooper: The grace period is very important because, as we all know some deals, especially those with a heavier lift that are required to satisfy the opportunity zone regs, can take time to come together. The one-year grace period provides managers with the flexibility to deploy capital responsibly, rather than trying to meet a short fuse and risk non-compliance.

The new provision brings an added level of certainty to the game for investors, who now have more assurance that their investments will be well vetted rather than rushed through in order to remain in compliance with the regulations.

GlobeSt.com: What changes were made to the substantial improvement requirement?

Hooper: The regulations exempted from the substantial improvement requirement are buildings that have been vacant for the five years prior to acquisition. This allows QOFs more time to implement changes to these properties, which likely are either obsolete or have deferred maintenance issues that kept them vacant for that length of time. That said, further review is needed to figure out the specific impacts of the vacant property rule.

Since its inception, real estate equity crowdfunding company RealCrowd has hosted more than $5 billion in real estate offerings through its platform, spanning more than 200 investments across 38 states.

➤➤ Join the GlobeSt.com ADAPT: Opportunity Zones conference September 16-17 in Baltimore, MD The new national conference series is aimed at identifying opportunity zones across all property types and geographic regions. This first-of-its-kind event will educate, connect and celebrate the investors, developers and owners with the people behind the planning and decision-making, such as architects, consultants, academics and most importantly, municipal officials.

Click here to register and view the agenda.