Well we knew this was going to happen – that Opportunity Zones would become a political football. Any doubt about that prediction has been laid to rest in recent days and I will not cite the various articles – they are all over the press. Among other things was last week's announcement of the White House Opportunity and Revitalization Council designed to boost the Opportunity Zone program.
We are certainly not going to wade into the political fracas that is probably just starting; however, we are at the forefront of Opportunity Zones nationwide, so our perspective should be useful. We are working on somewhere around $4B of Opportunity Zone deals, funds and related matters, so we are deep in the thick of it.
Here is what is going on, in no special order:
First – We were one of the first to point out a major concern, which is about to hit us all head-on, which is that over-eager parties are going to be raising funds under the theory that “you should give us money and we will find Opportunity Zone deals for you.” If this happens too much it will be a bad thing, as it will become a poster child for the tax tail wagging the deal dog and incentivizing people to invest in deals for the wrong reasons. I don’t know what we at D&S can do about this except sing out vociferously that investors should “only” be investing their money with super-high-quality sponsors who can say, and justify, that the deals are ones they would do irrespective of whether they were in Opportunity Zones.
Second – There is a wall of money coming into the space. Actually it is going to be a tidal wave. This is just starting out, but I have been around for 35 years in real estate and haven’t ever seen anything like it. I will be writing more on this shortly but not taking the space for it here.
Third – Following this train of thought, right now the parties with the money (slightly) hold the upper hand; however, I foresee that within a few months the parties with the good (see above) Opportunity Zone deals will be in the driver’s seat since there will be more opportunity zone capital than a need for it.
Fourth – For many of the parties that have announced that they are raising opportunity zone funds, we expect that they will be kicking their fundraising efforts into gear throughout 2019. This will enable them to capture the wave of investors looking to invest in a QOF before the end of 2019 (in order to capitalize on the 7-year benefit – i.e., the 15% reduction of taxes due on the capital gain in 2026) without being subject to the year-end testing date in 2018.
Fifth – The first round of proposed regulations helped out a lot but additional guidance is still sorely needed. Our Tax Team – points out the following key issues are not resolved:
- Whether (and when) investors can depreciate the investment that they have made in an Opportunity Zone, and whether the exemption from gain on sale would avoid any recapture of those deductions.
- Whether distributions of refinancing proceeds will cut against the investors having made a qualifying “investment” in the fund.
- The so called “hotdog stand” deal, where one buys raw land for $10M improved by a hotdog stand worth, say, $50,000 and satisfies the substantial improvement test with an investment of another $50,000. Too good to be true huh….
- Whether the 31 month safe harbor included in the October proposed regulations limits opportunity zone benefits to projects that are completed within that time, or just requires money to be spent within 31 months after it comes in.
Our team will be writing about each of these issues shortly – including the most up-to-date and cutting edge analysis – but we are not taking the space here.
Sixth – Our well-known real estate department chair Terri Adler has been spearheading a swath of Opportunity Zone deals at our firm. There are many devils in the details and Terri will likely be writing about this in the future as well.
Seventh – Very excitingly, Terri and Jessica attended a very small closed-door meeting with members of the Treasury Department just two weeks ago to discuss the Opportunity Zone program. As an industry leader in the opportunity zone space, we are working with the New York State Bar Association and the American Bar Association to provide comments on the October proposed regulations, as well as additional topics that will be addressed in future rounds of proposed regulations.
Eighth – Our prediction for Opportunity Zones hasn’t changed in the past few months. We still see it as a major game-changer for the real estate world. And we think we are seeing only the tip of the iceberg. Almost every few days someone comes up with a different idea of how Opportunity Zones could be used – and I am not exaggerating about that. The real estate world’s creative juices have truly been unleashed and for a Real Estate Philosopher it is like catnip to a big cat.
Ninth – According to the Treasury’s latest statements, the next set of regulations should be released sometime in January. The next round of regulations apparently will address, at least in part, how the Opportunity Zone rules will apply to operating businesses. According to an excerpt from a recent TaxNotes article, the January regulations will relax the requirement that revenues of a Qualified Opportunity Fund be mostly generated from within the Opportunity Zone. “For example, a corporate headquarters moving to an Opportunity Zone might have businesses all over the United States or abroad and would find it restrictive to have 50 percent of its sales within the Opportunity Zone.” This could be very beneficial for Amazon in LIC.
Tenth – Between the additional expected rounds of proposed regulations, the hopeful finalization of those regulations, the ability of investors to invest “K-1 gains” from 2018 in the first half of 2019, and the 12/31/19 deadline for investors to invest in a QOF to get the maximum tax benefits, we are expecting a tremendously busy 2019 in the Opportunity Zone space.
So that’s what we at D&S are seeing in the Opportunity Zone world. More to come – please stay tuned…