Opportunity Zone Magazine Volume 1, Issue 3 - Page 63
HOW TO ACHIEVE SYMMETRY WITH OPPORTUNITY ZONE FUNDS AND PRIVATE EQUITY FUNDS
This would ultimately mean the profits interest would be revalued
at the QOF level twice a year, leaving the potential
tests up in the air depending upon the type of profits interest
and whether it has value. Therefore, it will be important the
project is structured properly to avoid any bad implications
of a profits interest that could result from this. This can be
accomplished with diligent planning on the front-end to
ensure the proper investment vehicles are set up.
CHALLENGE THREE: HOLDING PERIOD FOR ASSETS UNDER
One of the other predominant concerns with a QOF
investment relates to the required holding period.
Typically, a PE fund is not tied into a pre-set timeline to
deploy cash or to exit from an investment. But the largest
benefit in investing in QOZs comes from each investor
holding its fund interest for a minimum of 10 years.
That means PE firms need to seriously weigh how long they
are comfortable keeping their capital parked in a QOF.
If they don’t hold QOZP assets for at least 10 years, investors
in a QOF are required to recognize any gain or loss that occurs
upon selling the underlying asset.
For example, let’s say the QOF invests in a business (structured
as a partnership interest) that is going to build and rent an
Around year five, the manager of the QOF believes this
particular investment has hit its peak and it’s an excellent time
to sell the QOZP. The gain that the QOF will realize will be
taxable because it has not met the 10-year hold requirement.
If the fund held real estate, there is a possible way around that
tax. Regulations allow for an opportunity to utilize a §1031
like-kind exchange to defer and potentially eliminate gain at
the fund level. Certain states may not conform to the Federal
deferral rules, and there are also tax basis, depreciation, and
other implications to consider, so it’s important to work with a
tax advisor when considering a §1031 transaction.
PULLING IT ALL TOGETHER
Without a doubt, PE firms likely have the capital, clients,
skillset and education to enter the opportunity zone market.
The inherent risks may not be enough to warrant the
investment for some. However, the law was intended to be
flexible enough to allow for investors with all sorts of different
backgrounds to take advantage of the rules. And the tax
benefits available may be too tempting for some to pass up.
Prior to the COVID-19 outbreak, investments in operating
businesses were significantly lagging behind real estate and
most PE firms have been sitting on the sidelines. While
investments in almost all sectors have slowed significantly
at the moment, investments in QOZs could be an important
part of the recovery effort. Like many components of QOZs,
everyone will have to wait and see how things play out.
Dannielle Lewis and Josh Graham are senior managers in Wipfli’s construction and real estate tax practice. They also serve as the
firm's national resource for Opportunity Zone funds. They have extensive experience in complex tax transactions and specialize in the
taxation of flow-through entities. Both Lewis and Graham are knowledgeable about the ever-changing tax laws and enjoy helping their
clients structure their funds and finding tax saving opportunities.
1 Gottfried, M. (2019, June 18). Private-Equity Firms Are Raising Bigger and Bigger Funds. They Often Don't Deliver. Retrieved October 13, 2019, from https://www.wsj.com/articles/private-equityfirms-are-raising-bigger-and-bigger-funds-they-often-dont-deliver-11560859200
2 Opportunity Zones Facts and Figures. (n.d.). Retrieved October 13, 2018, from https://eig.org/opportunityzones/facts-and-figures.