Opportunity Zone Magazine Volume 1, Issue 3 | Page 87

POTENTIAL ISSUES WITH OZ COMPLIANCE FOR REAL ESTATE FOCUSED OPPORTUNITY FUNDS
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One of these “inclusions events” relates to distributions
from an opportunity fund formed as a partnership with
respect to a qualifying investment. Distributions received
by an investor in a QOF formed as a partnership that are
in excess of the investor’s tax basis with respect to their
qualifying investment will trigger an “inclusion event” and
will cause the investor to recognize a portion/all of the
gain that they initially deferred by making an investment
into the opportunity fund. Keep in mind that since the
opportunity fund is formed as a partnership, the investor’s
tax basis will include the investor’s share of the entity’s
debt.
The OZ regulations also has a provision that looks to limit
an investor’s OZ benefits if they receive large distributions
in the earlier years of the opportunity funds existence.
This provision exists to discourage funds from “cashing
out” their investors by returning large amounts of their
initial investments early in the funds life cycle. If an
investor was subject to the provision it would reclassify
a portion of an investors qualifying investment in an
opportunity fund to be a non-qualifying investment. This
would mean that the investor would be losing the 10-year
holding period benefit with respect to this now reclassified
non-qualifying interest. An example of when this provision
may be applicable in a real estate focused QOF would be a
debt financed distribution upon stabilization of a property
that was acquired and substantially improved.
QOF should be mindful of these provisions in the
OZ regulations when deciding when and how much
distributions to make to its investors to insure that the
distribution doesn’t inadvertently cause an investor to have
an inclusion event or a reclassification of their qualified
investment.
Applying the OZ rules to a real estate project can at
times feel like trying to put a square peg through a round
hole. If you are interested in forming a real estate focused
QOF, it is important to consider the complete life-cycle
of the project when forming the structure and deciding
on the economic terms between the fund sponsor and the
fund investors. It is also important that you partner with
advisors who have a deep understanding of the OZ program
and have experience serving the real estate industry.
Frank Lucas has more than 13 years of experience serving
the real estate and hospitality practices for RSM. He provides
tax consulting, business advice and tax compliance services to
various real estate funds, property management companies,
developers, hotels and resorts, and high net worth individuals.
In addition to these services, he has successfully represented
numerous clients before the IRS in audit defense. Lucas is one
of the firm’s specialists in the Tax Cuts and Jobs Act of 2017
and is a member of the national Opportunity Zone team.
Jack S. Clarizio is a member of RSM’s real estate practice
assisting clients with their tax planning, consulting and
compliance needs. He is also a member of the firm’s national
Opportunity Zone team. Clarizio has been involved in the
acquisition, development and disposition of numerous real
estate projects, working with various developers and private
equity funds. His experience in the full spectrum of the
real estate project lifecycle enables him to understand the
objectives and priorities that matter most to his clients and the
issues and challenges confronting their businesses.
Sources:
1 Treas. Reg. section 1.1400Z2(d)-1(d)(3)(iii)(A)
2 I.R.C. section 1400Z-2(d)(3)(A)(ii)
3 Treas. Reg. section 1.1400Z2(d)-1(d)(3)(v)
4 Treas. Reg. section 1.1400Z2(d)-1(d)(3)(v)(B)
5 Treas. Reg. section 1.1400Z2(b)-1(c)
6 Treas. Reg. section 1.1400Z2(b)-1(c)(6)(iii)
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