Case Studies in Opportunity Zone Investment

September 30, 2019
Written by: Susan Cumins, CREW Miami member since 1998
Presented at CREW Miami’s Luncheon Meeting, September 17, 2019
 
  Moderator:  
 
  Janis Cheezem, Partner, Akerman LLP
 
  Panelists:       Frank Guerra, Founder, Altis Cardinal LLC
Arthur J. Lieberman, Director of Tax Services, Berkowitz Pollack Brant CPA
Todd Rosenberg, Managing Principal, Pebb Capital

Qualified Opportunity Zones (QOZs) were created by the Tax Cuts and Jobs Act of 2017 to get money and new businesses into distressed areas by allowing investors to realize partial or complete deferral of some federal taxes. Today’s panelists helped illuminate many of the variables that affect commercial real estate investments under the complex new law.
 
“The primary benefit of QOZs is the ability to avoid paying any federal tax on capital gains,” said Todd Rosenberg, Managing Principal, Pebb Capital. Unlike a 1031 exchange, which defers but does not eliminate capital gains tax, the new law has a real upside. “If you hold your QOZ investment for 10 years and a day, it is actually tax free,” he said. “You can grow an asset long term and pay no tax on the capital gains.”
 
Art Lieberman, Director of Tax Services at Berkowitz Pollack Brant and a specialist in structuring complex transactions, pointed out how a 1031 investment property that sells for $10 million with a gain of $1 million requires reinvestment of the initial $10 million to shelter gains. “With a QOZ asset, only the $1 million gain has to be reinvested in a qualified opportunity zone fund,” he said. “You can now use the rest of the $10 million any way you like.”  Frank Guerra, who practiced real estate law at Bilzin Sumberg prior to founding Altis Cardinal LLC, added that QOZ investors can also offset depreciation and earnings on net income by adhering to certain formulas. “OZ benefits can make a good deal better, but can’t make a bad deal work; the viable deal fundamentals still have to be there.”
 
Transactions must be carefully structured.
 
“An opportunity zone deal has to make sense on its own,” Rosenberg said. “The tax benefits are good only if a project succeeds and you make money.” About a project his firm is developing at Delray Beach, he said, “We liked the property even before it fell into an opportunity zone because it was a great area in a strong market.” Its four parcels lie on opposite sides of a street that marks the OZ border, putting half of the retail/office/hotel project outside the opportunity zone. The solution? “We’re doing an OZ fund and a non-OZ fund, because it makes sense to develop the entire property at the same time. The entity in the zone must be held 10 years to realize maximum tax benefits. We put the hotel in the ‘out’ portion so we can monetize that part when the market is right.”
 
Options for legacy owners who are “grandfathered out” 
 
Lieberman described potential work-arounds for those who owned property in QOZs before the legislation was passed, noting that successful transactions require particular care when determining fair market values. One way is to build a structure that represents 80% of the asset’s value, with the land accounting for 20% of value. Another approach is for the legacy property owner to issue a 99-year ground lease to a QOZ fund of which he owns 20% or more. Then a subsidiary fund can start a business, deploy capital, and realize tax benefits. The grandfathered-out property owner can also sell a qualified building and the qualified business in it, if structured properly.
 
Tenants can benefit from qualified opportunity zones
 
A building owner might offer reduced rent to tenants who will pay for their own buildouts. “Any qualified OZ business can sell it tax free in 10 years,” Rosenberg said. “The new law wants to bring capital investment to communities that had been bypassed by investors.” Guerra added that “tech and other businesses meet the QOZ job creation criterion because now you’re moving people into an office building that would not have otherwise existed in that location.”
 
“To qualify for OZ benefits, the tenant has to run the gamut of rules, too,” Lieberman cautioned. “Ninety percent of a tenant’s asset has to meet the ‘original use’ requirement. That means purchasing new computers and furniture, and potentially building out the new space themselves.”
 
Tax professionals have a role 
 
At present, no transactions are simple where qualified opportunity zones are concerned. Lieberman advises investors to “see where the pressure points are, then work your way around the new law.” Rosenberg saidthe clock starts ticking when the last dollar comes in. Partners on a deal must agree to a 10-year hold, and those who want out sooner have to factor in the tax costs of an early exit.”  
 
The expert panelists agreed that the best way for interested parties to assure that their assets are well-protected and positioned to gain maximum tax benefits from the law’s provisions is to consult legal and accounting professionals.