Qualified Opportunity Zones By Rob Howard and Matt Olhausen Pillsbury Winthrop Shaw Pittman LLP

Benefits of the Qualified Opportunity Zone (“QOZ”) Program 1. Deferral 2. Reduction 3. Elimination

Benefits of the Qualified Opportunity Zone (“QOZ”) Program “As laudable as the goals of the QOZ program might be, the statutory provisions enacted by Congress setting forth the program benefits and requirements were written in such haste that they suffer from a mix of poor drafting, incorrect and/or ambiguous cross references, and a general failure to think through a real world implementation of the program.” -Thomas D. Morton For more information please refer to Tom Morton’s excellent white paper: https://www.pillsburylaw.com/images/content/1/2/120543.pdf

Brief History 1. Passage of the Tax Cuts and Jobs Act of 2017 2. Designation of QOZs (2018) Governor of each state selected QOZs from a pool of eligible census tracts 879 QOZs designated in California California Map 3. Investment in QOZs (ongoing) Investment period closes on Dec. 31, 2026 Pending Treasury Regulations . . .

Deferral and Reduction of Capital Gains Existing capital gains are eligible if invested in QOZs within 180 days of realization event / disposition of existing asset Reduction 5 years = 10% 7 years = 15% Mandatory recognition of deferred gain by Dec. 31, 2026

Elimination of Capital Gains on QOZ Investment Holding Period 10 years Applicable to investments made by Dec. 31, 2026 Elimination Applies to additional capital gain from QOZ investment, not original deferred capital gains Accomplished by basis step-up to FMV upon disposition Applies only to the extent investment is attributable to original capital gains

Dec. 31. 2026: Mandatory deferred gain recognition date Jan. 1, 2019: Gain triggered May 1, 2019: Fund Investment May 1, 2024: 10% basis increase May 1, 2026: 5% basis increase Dec. 31. 2026: Mandatory deferred gain recognition date May 2, 2029+: Tax-free gain on sale of QOF interest 5 years 2 years 3 years

Qualified Opportunity Fund A partnership or a corporation organized for the purpose of investing in “Qualified Opportunity Zone Property” 90% of the assets of a QOF must be QOZ Property If the fund fails to meet the 90% test, it must pay a monthly penalty for each month out of compliance [90% of fund’s aggregate assets / aggregate amount of QOZ Property held by fund] x [penalty (aka short-term federal interest rate plus 3%)]

Qualified Opportunity Zone Property Equity – in a “QOZ Business” Stock Partnership Interests (includes LLCs) Property – “QOZ Business Property” E.g. land, buildings located in a QOZ Direct investment can be problematic—ineligible for working capital safe harbor

Qualified Opportunity Zone Business Gross Income Test 50% percent of gross income must be derived from the active conduct of trade or business (residential leases permitted) Substantially All Test “Substantially all” of the tangible property of QOZ Business is QOZ Business Property Proposed Regulations: “substantially all” means 70% Hot Tub Rule / Sin Restriction

Qualified Opportunity Zone Business Property Requirements Purchased after Dec. 31, 2017 (20% related party limitation) Substantially all used during the holding period in the QOZ Substantial Improvement Test (for used property) – 30 Months

Substantial Improvement Test Property is treated as “substantially improved” if, during the 30- month period beginning upon the acquisition of the property, additions to basis of such property in the hands of the QOF exceed its adjusted basis as of the start of the period Renovation costs greater than acquisition costs

Safe Harbor 31 month grace period for cash placed in “working capital reserve” Need written plan and schedule for use of working capital funds No more than 5% of the assets of QOZ Business may be “nonqualified financial property” (e.g. cash)

Opportunity Zones and Housing in California How can we make this work? Challenges: 31 months to utilize capital reserve Regulatory uncertainty Potential solutions: Targeting fully-entitled projects / Single project funds SB 35 Streamlining? SB 50? Municipal buy in

Rob Howard, Associate Real Estate San Francisco Matt Olhausen, Associate Real Estate San Francisco