Publications

- February 1, 2019: Vol. 6, Number 2

Roundtable: Understanding investor benefits from opportunity-zone funds

by Daniel Cullen, Jeff Shafer, Sherri Cooke and Sean Morris

Opportunity-zone funds have become the topic of fevered conversations among investors and their investment advisers. But what are the predominant structures for qualified opportunity-zone funds, and what are the benefits to investors? How can financial intermediaries gain greater access to education and training? What was the original intent of the program, and how do these funds fit into the ESG bucket? What are the tax and accounting impacts and considerations that investors need to take into account?

To better understand the program and its opportunities, we turned to some of the experts for their input.

 

Sean Morris, managing director, partner and co-investor relations, CIM Group

What are the predominant structures for qualified opportunity-zone funds, and what are the benefits to investors?

We have seen both closed-end and open-end fund structures being used for qualified opportunity-zone funds (QOZ funds). In order to fully benefit from the QOZ fund program, investors must exit their investment by selling their interest in the fund vehicle. In addition, the QOZ fund statutes do not currently provide tax deferral on gain generated by individual asset sales.

Accordingly, closed-end QOZ funds are generally being structured as a programmatic series of single-asset vehicles, with a separate manager incentive fee calculation for each asset and asymmetric ownership between each single-asset vehicle. Also, since capital is generally called pro rata from investors over the investment period, the investors “clock” for purposes of the tax benefits does not start until the last dollar of an investor’s capital commitment is contributed into the vehicle. In a closed-end vehicle, there is generally no built-in mechanism for either the investor or manager to redeem an interest during the term of the fund, although the manager has more flexibility with respect to the timing of single-asset sales at the end of the term.

In an open-end vehicle, investors are able to own a pro rata interest in a diversified portfolio of assets, which is owned by the QOZ fund. A manager’s incentive-fee calculation is generally determined by performance of the portfolio of assets at the fund level. While the current IRS regulations limit managers’ ability to sell individual assets from an open-end fund structure in order to redeem an investor, an investor has the flexibility to effectively sell its partnership interest/shares to other investors seeking exposure to the fund through the redemption process. Additionally, after the appropriate time period, the manager may choose to sell the entire portfolio of the fund to a buyer or list all of the shares of the fund on the public market.

 

Sherri Cooke, president and CEO, AI Insight

How can financial intermediaries gain greater access to education and training related to qualified opportunity-zone investments?

Given the regulation and structure of opportunity zones, education will be critical for anyone looking to invest assets in these funds. Many OZ funds will fall into the complex product category, requiring a thorough understanding of the fund’s investment structure, risks, objectives, expenses, and manager and performance history.

There are many resources available to financial intermediaries to help understand the nuances, determine available funds and sponsors, and conduct due diligence. AI Insight, in collaboration with Mick Law PC, has released a CE course titled Introduction to Opportunity Zones, and provided an FAQ with additional resources. A comprehensive Opportunity Zone Fund Directory has been created by NCSHA. Intermediaries can look to policy groups as well as third party due-diligence and law firms who are specializing on these arenas. Novogradac & Co., Economic Innovation Group, Baker Mackenzie, DLA Piper, Holland & Knight, and The Brookings Institution are examples of firms with resources in this space in addition to U.S. Department of Treasury resources. Many of the funds themselves provide extensive education and resources. Finally, there are industry events intermediaries can attend. AI Insight is partnering with the Institute for Portfolio Alternatives (IPA) to host an education-focused opportunity-zone forum in Dallas, Feb. 12-13. IMN is also planning a March event on the subject in New York City.

 

Jeff Shafer, co-founder and CEO, CommonGood Capital

What was the original intent of the qualified opportunity-zone program, and how do these funds fit into the ESG bucket?

With strong bipartisan support, Congress established the opportunity-zone program as an innovative way to encourage long-term private sector investments into low-income areas across America. It was created based on what has been learned from previous positive and not-so-positive attempts to help lift-up these communities. Roughly 50 million, one-sixth of U.S. residents, live in economically distressed communities, and research is showing that place (zip code) is a bigger influencer of chronic poverty, health and success then we probably want to admit.

There are no impact measurements or impact reporting requirements around opportunity zones. With this freedom, the onus to ensure positive community outcomes is on all of us. Fortunately, one can look to the rapidly growing impact industry for best practices to follow: Intentionality is at the heart, followed by measurement and reporting on both financial and impact metrics. With these generous tax incentives, it’s time for the financial community to consider each investment’s impact on the common good.

 

Daniel Cullen, partner, Baker McKenzie

What are the tax and accounting impacts and considerations that investors need to take into account when investing in qualified opportunity-zone programs?

Taxpayers who invest in a properly structured qualified opportunity fund (QOF) should accrue a trio of benefits from rolling over their capital gains. First, the taxpayer will earn deferral of otherwise taxable capital gain until the earlier of disposition of the QOF investment, or Dec. 31, 2026. Second, the taxpayer will benefit from a permanent elimination of 10 percent or 15 percent of that deferred capital gain if the taxpayer holds the QOF investment for five or seven years, respectively. Third, the taxpayer will receive a complete elimination of federal, and potentially state, income tax on gains from any appreciation in the QOF investment itself, if the taxpayer holds the QOF investment for at least 10 years. It is essential that the QOF is carefully structured to comply with all of the technical requirements under Internal Revenue Code section 1400Z-2 — including the manner in which the fund is formed and the composition and use of its assets.

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