Opportunity Zone Magazine Volume 1, Issue 3 - Page 63

HOW TO ACHIEVE SYMMETRY WITH OPPORTUNITY ZONE FUNDS AND PRIVATE EQUITY FUNDS 63 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 MANAGEMENT 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 office complex. 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. Sources: 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. OPPORTUNITYZONE.COM