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Opportunity Fund

OVERVIEW OF THE OPPORTUNITY ZONES PROGRAM

The Tax Cuts and Jobs Acts of 2017 created the Opportunity Zones program, one of the few bipartisan successes in recent years, combining Americans’ love for avoiding tax with their love of country. This Federal program allows holders of capital gains to shelter them from taxes for years by putting them in Qualified Opportunity Funds (QOF), which then buy a property or business equity in designated low-income Qualified Opportunity Zones (QOZ). The program’s incentives are focused on the deferral, reduction, and elimination of capital gains taxes. Opportunity Zones were designed as a fundamental departure from the traditional ways that the Federal Government has incentivized capital to move into communities in the past. Their purpose was to decentralize the process by removing the central intermediary doling out tax credits, grants, or being a gatekeeper and giving communities this tool to attract capital from the marketplace in a permission-less way.

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To qualify for the tax incentives, an investment in an Opportunity Zone must be done throught a Qualified Opportunity Fund (QOF)

OPPORTUNITY ZONES

Opportunity Zones are economically distressed communities, defined by individual census tract, nominated by America’s governors, and certified by the U.S. Secretary of the Treasury via his delegation of that authority to the Internal Revenue Service. Under certain conditions, new investments in Opportunity Zones may be eligible for preferential tax treatment. There are 8,764 Opportunity Zones in the United States, many of which have experienced a lack of investment for decades. The Opportunity Zones initiative is not a top-down government program from Washington but an incentive to spur private and public investment in America’s underserved communities

OPPORTUNITY FUNDS

A qualified Opportunity Fund is any investment vehicle organized as a corporation or partnership with the specific purpose of investing in Opportunity Zone assets. The private sector is responsible for establishing Opportunity Funds. Opportunity Funds must hold at least 90 percent of their assets in qualifying Opportunity Zone Property (defined below), and will be tested at the 6-month and year-end points to ensure compliance (final guidance on the initial timing of this test is forthcoming).

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    DEFERRAL OF CAPITAL GAIN A tax deferral for any capital gains rolled over in an Opportunity Fund. The deferred gain would be recognized on the earlier of December 31, 2026 or the date on which the investment in the Fund sold.

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    REDUCTION OF THE CAPITAL GAINS TAX REALIZED A step-up in basis for capital gains rolled into an Opportunity Fund. The basis of the original investment is increased by 10% if the investment is held by the taxpayer for at least 5 years, and by an additional 5% if held for at least 7 years. For example, if by December 31, 2026 an investor has held an investment in an Opportunity Fund for 7 years, then the tax on the initially deferred gain is expected to be reduced by 15%, or reduced by 10% if by then held for only five years.

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    ELIMINATION OF CAITAL GAINS FROM AN INVESTMENT IN AN OPPORTUNITY FUND In the case of any investment in an Opportunity Fund held by taxpayer for at least 10 years, the basis of such property shall be equal to the fair market value of such investment on the date that the investment is sold or exchanged. In short, after 10 years, thereafter there would be zero federal capital gains tax on profits from the sale of an investment in an Opportunity Fund.

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HOW INVESTING IN AN OPPORTUNITY WORKS

To receive the most favorable tax treatment on their investment, investors are incentivizied to hold their stakes in an Opportunity Fund over the long term period of 10 years, with the program providing the most potential upside to those who hold their investment for 10 or more years.

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The figure above illustrates how an investor’s potential after-tax returns compare assuming a 10-year holding period, annual investment appreciation of 7%, and a long-term capital gains tax rate of 23.8% (federal capital gains tax of 20% and net investment income tax of 3.8). For example, after a period of a 10-year hold, an investor would see an additional $44,000 for every $100,000 of capital gains reinvested into an Opportunity Fund on December 31, 2018 compared to an equivalent investment in a more traditional stock portfolio generating the same annual appreciations. Please note, that the performance assumptions shown are for illustrative purposes only, and are not intended to reflect the actual experience of any individual investor.

Illustrative Scenario: After-Tax Potential Net Returns
$100,000 investment over 10-year hold (assuming 7% annual appreciation)
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A long-term investor could roughly double their potential after-tax return by rolling capital gains into a Qualified Opportunity Fund (QOF) instead of investing them into a traditional stock portfolio.

“The Opportunity Zones program is a once-in-a-lifetime opportunity to economically transform some of the most distressed census tracts in the United States”

TAX INCENTIVES FOR OPPORTUNITY ZONE INVESTMENTS

The QOF program is intended to provide investors in QOFs with three types of potential tax benefits:

(1) Temporary Deferral: If a taxpayer realizes eligible capital gain from the sale or exchange of any property to or with an unrelated person, the taxpayer, generally, has 180 days from the sale or exchange to elect to defer all or part of the eligible capital gain from the sale or exchange by investing the gain in a QOF. Eligible capital gain does not include (i) certain gains from “section 1256 contracts” and (ii) any capital gain from a position that is or has been part of an “offsetting-positions transaction.”

The amount of the eligible capital gain that has been invested in a QOF by the taxpayer is referred to as the “Deferred Gain Amount.” The taxpayer’s equity interest in a QOF that is attributable to the Deferred Gain Amount is referred to as the “QOF investment.” The taxpayer is required to include the Deferred Gain Amount (subject to certain adjustments described below) in its taxable income on the earlier of (i) the date the taxpayer sells or exchanges its QOF investment and (ii) December 31, 2026 (the applicable date, the “Inclusion Date”).

(2) Step-up in Basis: The initial tax basis of the QOF investment will be zero. If the taxpayer holds the QOF investment for at least five years, the tax basis of the QOF investment will be increased by an amount that equals 10% of the Deferred Gain Amount. If the taxpayer holds the QOF investment for an additional two years (or seven years in total), the tax basis of the QOF investment will be increased by an additional amount that equals 5% of the Deferred Gain Amount (or 15% in total). Upon the Inclusion Date, the taxpayer will be required to include as capital gain on its tax return an amount equal to the excess of (i) the lesser of (x) the Deferred Gain Amount or (y) the fair market value of the QOF investment, in each case as of the Inclusion Date, over (ii) the taxpayer’s basis in the QOF investment as of the Inclusion Date; immediately upon this tax event, the tax basis of the taxpayer’s QOF investment will be increased by the amount of gain so included. The deferred gain that is included by the taxpayer on the Inclusion Date will have the same tax character as such gain would have had if it had not been invested in a QOF.

(3) Permanent Exclusion: If the taxpayer holds the QOF investment for at least 10 years, the taxpayer can make an election whereby the taxpayer’s basis in the QOF investment will be made equal to the fair market value of the QOF investment on the day the QOF investment is sold or exchanged. Generally speaking, this means that no U.S. federal income tax will be owed with respect to appreciation in the value of a QOF investment (i.e., a qualifying equity interest in the QOF) that is held for at least 10 years.

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    Temporary Deferral

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    Step-up in Basis

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    Permanent Exclusion

THE OPPORTUNITY ZONE PROGRAM

On December 22, 2017, Congress enacted H.R. 1, also known as the “Tax Cuts and Jobs Act” (the “TCJA”). Among many other provisions, the TCJA established a new tax regime for investments in vehicles established for the purpose of acquiring “qualified opportunity zone property.” These vehicles are referred to as “qualified opportunity funds” or “QOFs.” The tax regime is referred to as the “QOF program.”

In order to qualify as a QOF, an investment fund will need to hold at least 90% of its assets in qualified opportunity zone property in each of its taxable years, determined by calculating the average of the percentage of qualified opportunity zone property held by such investment fund (i) on the last day of the first six-month period of the taxable year of such investment fund, and (ii) on the last day of each taxable year of such investment fund.
Qualified opportunity zone property generally includes direct and certain indirect interests in businesses or property located in a population census tract that is (i) a low-income community (or contiguous with a low-income community) located in a state or possession of the United States and (ii) designated as a qualified opportunity zone by the applicable state or possession and approved by the U.S. government.

It is estimated that there are more than $6.1 trillion of potential unrealized capital gains that could be invested in QOFs, representing a significant untapped resource for economic development. In addition to the potential tax benefits to investor, investing in qualified opportunity zones can benefit these underserved areas, as substantial real estate investment in qualified opportunity zones can assist in creating the infrastructure and economic growth necessary for attracting new business and investments to these areas, thereby, creating a cycle of economic growth.

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California is home to ten of the least affordable major markets and six of the fifteen most expensive large metropolitan rental markets in the country. Rising costs continue to strain homeowners and renters statewide and negatively impact the state’s quality of life and long-term economic prosperity.

Recently released population estimates from the California Department of Finance show the state added only a net 77,000 completed housing units in 2018. This is down from 85,297 units in 2017, which was down from 89,457 units in 2016. The underproduction of supply continues to define the housing crisis the state is currently facing.

The Governor’s Budget introduced a comprehensive $1.75 billion proposal to spur housing production, including planning and production grants to local governments, expansion of the state’s housing tax credit program and loan program for mixed-income housing, and opportunities for innovative housing projects on excess state property

Across the United States, a total of 8764 census tracts have been designated as Qualified Opportunity zones. The state of California has been granted the most census tracts with 879 (10%) in total. More specifically, Los Angeles county alone has a total of 274 census tracts.

The State of California’s goals are aligned with the Federal Opportunity Zone Program in hopes of being able to eliminate the housing deficit that is haunting the state.

For more information, please contact [email protected]

ABOUT BLUESTONE CAPITAL

30%

AVERAGE GROSS IRR

$100M

VALUE OF GLOBAL REAL ESTATE PORTFOLIO

100+

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