Opportunity Zone Magazine Volume 1, Issue 3 | Page 87

POTENTIAL ISSUES WITH OZ COMPLIANCE FOR REAL ESTATE FOCUSED OPPORTUNITY FUNDS 87 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) OPPORTUNITYZONE.COM