More Clarity Promotes Increased QOZ Investing

SAN FRANCISCO—The Tax Cuts and Jobs Act section 1400Z-2 of the tax code relates to capital gains that may be deferred as a result of an investment in a qualified opportunity fund/QOF that holds property and operates in a qualified opportunity zone/QOZ. At the end of 2019, this legislation had gone through two rounds of regulatory guidance from the government, but still left many unanswered questions. With final regulations released last month, investors finally have clarity on a host of issues, and some of the new rules and expansions will make investment, development and operation of projects in QOZs even more attractive, according to Urban Catalyst.

In fact, Reid Thomas, executive vice president and general manager of NES Financial’s Specialty Financial Administration, believes that December investments alone will equal the cumulative investments into the program since its inception. Opportunity zone investment spiked in December with more than $2 billion of equity raised, according to newly released data. This increase underscores the requirement investors had to place capital gains in a QOZ fund by the end of 2019 to get the maximum 15% discount on those gains.

“The fact that December investment into QOZ funds across NES Financial’s base of 64 funds more than doubled the total amount invested since the inception of the initiative, when final regulations were still emerging, is a strong testimony to the potential of opportunity zones,” Reid says. “The ultimate success of the opportunity zone program will be dependent on funds measuring the social impact to show that these investments are doing the good they’re branded to do.”

Thomas recently shared insights into opportunity zone fund administration as these investments start to take off.

GlobeSt.com: Opportunity zones were slow to catch on but it seems they are picking up steam. To what do you attribute this turnaround?

Thomas: There were a number of factors that contributed to the relatively slow start of opportunity zones. The first factor is that industry was relatively caught off guard. Opportunity zones were launched as part of the Tax Cuts and Jobs Act which was signed into law on Dec. 22, 2017. Reportedly, the opportunity zone component was added late in the process, therefore there was no advanced preparation by the industry. For example, at the time of launch, no opportunity zones had been designated and so no potential investments could be identified until then. The second big issue was that IRS regulations which specify the details of how the program works were not available at the time the program was introduced. In fact, the first version of the regulations was not released until October 2018 with final regulations not being released until December 2019. And finally, the tax deferral and tax reduction benefits are maximized if investments are made prior to the end of 2019. The maximum benefit is achieved when investors invest at least seven years prior to December 21, 2026.

GlobeSt.com: How soon do you anticipate the funds to follow? 

Thomas: The ultimate success of the opportunity zone program will be dependent on funds measuring the social impact to show that these investments are doing the good they’re branded to do.

Across our client base, we saw a massive increase in funds flow leading up to the end of 2019. In fact, December 2019 had higher investments than we saw in the entirety of the program leading up to it.   NES Financial recognized early that the ultimate success of the program will be measured on how funds are invested and the impact that they have in the areas of the country that need it most. From the outset, we built in the necessary reporting and tracking to be able to be a leader in this effort.

As Thomas mentions, the program has undergone some adjustments for clarity and increased participation. This new guidance from the Treasury answers a lot of questions, which opens the door to significantly more equity investment in opportunity zones across the country, says Urban Catalyst.

Specifically, the period a property must be vacant to be considered original use has been reduced. This makes a huge difference when deciding which properties to purchase. Properties vacant for one year before the designation of the QOZ are eligible. Otherwise, a property in a QOZ is only considered original use if it has been vacant for three years, according to Urban Catalyst.

In addition, investors can transfer a qualifying interest by reason of death. It is now clear that interest in a QOF can be transferred to heirs upon death. And, not only that, there is no adjustment to the basis of the inherited qualifying adjustment to its fair market value as of the deceased owner’s death. That means if an investor passes away, their beneficiary can take over the investment without negative repercussions to tax benefits.

Finally, the taxpayer can begin its 180-day investment period on the due date of the entity’s tax return. Not including extensions, the final regulations now provide additional time to invest when capital gains have been received from partnerships, S corporations and non-grantor trusts. This will be a huge benefit to investors who hold interests in pass-through entities that may not get notice of eligible gains until the entities have issued Schedule K-1s, well past the 180-day period, according to Urban Catalyst.