Lease Termination Costs Could Impact Your Opportunity Zone Deal
When do lease termination costs meet the burden of a substantial improvement on an opportunity zone project?
“To qualify for Opportunity Zone tax benefits, existing structures must be substantially improved,” Phil Jelsma, a partner and chair of the tax practice team at Crosbie Gliner Schiffman Southard & Swanson, tells GlobeSt.com. “This means the Qualified Opportunity Zone or its subsidiary must spend an amount equal to the tax cost of the building or improvements improving that property within the first thirty months of ownership. The question is when can lease termination costs be included in the basis or cost of the building can help the QOF meet the substantial improvement test. Generally they can be included if the building’s tax cost or basis if the building is not being demolished and they are paid to get access to the property to make improvements.”
Termination costs aren’t the only leasing concerns on the minds’ of opportunity zone investors. Recently rent control bills leave a big question mark as to how developers can proceed with tenant terminations. “Since the California’s rent control bill, AB 1482, was signed on October 8th and isn’t effective until January 1, 2020, we don’t know yet how these restrictions will impact the California rental market. However, it is likely this will exacerbate the problem,” adds Jelsma.
Jelsma’s advice is to analyze all tenant-related costs before pursuing an opportunity zone deal. “These costs could in fact make or break an Opportunity Zone deal,” he says. “The Tax Rules suggest that if the costs are incurred to be able to get access to the units in order to be able to make improvements under the Opportunity Zone Rules, lease termination costs may be allocated to the cost of the building and help meet the substantial improvement test.”
It is ironic that some of these new regulations intended to help alleviate rent burdens are also problematic for the opportunity zone model, which is also intended to spur economic development in underserved areas. “Clearly there are competing solutions, but the opportunity zone Rules are intended to attract capital into underserved communities and improve property located in qualified opportunity zones,” says Jelsma. “It is difficult to see how additional investment will necessarily decrease rents, but it should increase the supply of quality housing stock within opportunity zones. Importantly, the tax benefits also flow to businesses started or related into qualified opportunity zones and increased employment can definitely benefit these communities.”