Get Ready for Opportunity Zones Lawsuits
Attorneys are expecting a number of lawsuits from fund managers who don’t set up their Opportunity Zones properly.
Mike Krueger, counsel with Newmeyer Dillion, represents investors, developers, fund managers and nationwide brokerage firms in Opportunity Zone Projects. While he sees a lot of potential in the program, his crystal ball says there could also be some legal issues ahead.
“We, as attorneys, are anticipating a substantial number of lawsuits down the road from ‘fund managers’ who don’t do this properly,” Krueger says.
“I think a lot of people are assuming that they can just put money in their own bank account,” Krueger says. “That has to be a completely separate entity.”
If investors keep money in their own account, Krueger says that will face legal risks. That said, each individual investor can set up their own fund, which is a separate entity. They don’t need to invest in another big fund.
“I think that’s one thing that is being missed by a lot of investors, especially people who otherwise would be very savvy investors that understand capital gains,” Krueger says. “The reason they’ve incurred capital gains is because they either sold a bunch of stock or maybe they sold a real estate development project. That person or that entity can set up their own new LLC or corporation, put those funds in and integrate their own fund.”
Problems, according to Krueger, don’t just occur when investors don’t set up a fund. They can also happen when they’ve commingled the assets into a giant fund and they haven’t done the proper paperwork. He sees a lot of lawsuits coming on Qualified Opportunity Zone Businesses (QOZB) level. Whoever owns the building or plot of land in an Opportunity Zone will be a QOZB.
“It’s where either the promoter or the developer or the startup company is saying, ‘Hey, we’re a Qualified Opportunities Zone Business where your qualified opportunity fund can invest and receive these benefits,” Krueger says. “Those on the QOZB level will qualify for opportunities on business level. That’s where they really need to have a professional advising them on how to draft their funding documents because each of these has to be either a corporation or a partnership. A partnership can be an LLC, but they have to set that up. In the conversations that I’m having with investors, they seem to just be glossing over that point.”
QOZB’s need to be careful when drafting proposal documents to investors to contribute their Qualified Opportunity Zone Funds [QOZF].
“It is important for all of those reps and warranties to the accurate,” Krueger says. “They’re relying on that, not just for their investment, but also for tax purposes to qualify. That is why it is so important to have this nexus with the QOZB and QOF. If either of those is out of compliance, not only will you not get the benefit of growing tax free and deferring your taxes, your capital gains tax you anticipated deferring until 2026 could potentially come immediately due.”
Despite legal pitfalls, Krueger thinks the Opportunity Zone still present a lot of promise.
“If you do this properly, it is an amazing program,” he says. “This is a once in a lifetime program to take advantage of these tax savings. But, if you blink for a minute and you mess up [with how you set up your fund], there’s no reset button three years down the road. There is no cure.”