A New Hybrid Opportunity Zone Investment Model Has Emerged

Thanks to the economic challenges catalyzed by the pandemic, a new hybrid opportunity zone investment model has emerged. The new structure combines opportunity zone investment with the exclusion from capital gains for the sale of qualified small business stock after reaching a five-year hold, according to Phil Jelsma, a partner at Crosbie Gliner Schiffman Southard & Swanson.

“This new form of investing is related to the fact that tax planners are beginning to link two disparate sections or areas of the law together and realizing that they can work in conjunction with each other to achieve a different or more favorable result,” Jelsma tells GlobeSt.com.

This new model is a new perspective on the structure of the opportunity zone fund as well as the hold period. “Typically, most opportunity zone investments are structured as LLCs or partnerships so the tax attributes of income or loss are passed through to the investors,” says Jelsma. “Further, most opportunity zone investments have a 10‑year investment horizon, which is often too long for venture capitalists. This new structure goes another direction by having a qualified opportunity zone fund invest in C corporations. These are taxable corporations who pay their own liability and don’t pass tax attributes out to the investors.”

This new structure provides an earlier exit route for investors. “The principal benefit of this structure is that the QOF can sell stock of the opportunity zone businesses before the end of the normal ten year investment period required by the opportunity zone rules and still generate a tax benefit for the investors, provided the stock has been held more than six months,” says Jelsma.

East Coast investors have readily adopted this new structure, but California investors have been reticent. “The outlook is unclear here because California taxes capital gains the same as ordinary income rates and it neither recognizes the benefits of QSBS or opportunity zone investments,” says Jelsma. “As a result, this structure is more impactful outside of California. In the states that conform to federal law, I think the potential tax benefit is greater than it is in California. Over time, I would anticipate this structure will become more commonplace as investors get more comfortable with opportunity zones. Some noticed that recently both Tesla and Amazon announced opportunity zone investments.”

From a regulatory perspective, there is a lot of room for investors to take this route. “In many respects, the opportunity zone investment requirements for businesses like C corporations are fairly generous,” according to Jelsma. “Typically, they must have at least 70% of their assets in an opportunity zone and more than 50% of their gross income from business activities inside an opportunity zone.  Income can be sourced into the OZ if compensation is attributable to services in the opportunity zone or management activity takes place there.  As a result, the opportunity zone guidelines can generally accommodate this type of structure for an operating business.”