1. Qualified Opportunity Zones
What Are They and What Are the Opportunities
Glenn Graff
Ben Swartzendruber
2019 Applegate & Thorne-Thomsen Developer Boot Camp, April 1, 2019

2. Qualified Opportunity Zones (“QOZs”)
Overview
Deal Structures
Application to LIHTC
Frequently Asked Questions

3. Opportunity Zone (“OZ”) Basics
Tax benefits for investments in businesses or property located in QOZ census tracts
Investor must have capital gain from a recent sale or exchange of property
Benefits increase the longer the investment is held. There are 3 distinct benefits available.

4. OZ Overview Investor Requirements & Benefits QOF Requirements
QOZ Property and QOZ Business Property

5. Introduction to OZ Concepts
Investor: taxpayer with capital gain from sale or exchange of any property from an unrelated purchaser Opportunity Fund (QOF): corporation or partnership that has purpose of investing in QOZ Property and holds 90% of Assets in QOZ Property QOZ Property: Stock or Partnership Interest in an QOZ Business or tangible property used in a QOZ trade or business by the QOF
Investor
Qualified Opportunity Fund
Qualified Opportunity Zone Property

6. Deferral of gain from sale Partial Avoidance of gain from sale
Three Tax Benefits to Investor 2. 3. 1.
Deferral of gain from sale
Partial Avoidance of gain from sale
Avoidance of new gain on investment in QOF
(Immediate)
(5 & 7 Year Hold)
(10-Year Hold)

7. Sale or Exchange Results in Gain
Sale Proceeds $150
Taxed on Gain, calculated as Sales Proceeds received minus Tax Basis in Property
Basis is usually original cost as adjusted down for depreciation or amortization
Gain is usually recognized and taxed in year of sale
Gain
$100
Basis
$50

8. Benefit 1. Deferral of Gain from Sale
Sale Proceeds $150
Elect to defer recognition of gain by investing the amount of such gain in a QOF within 180 days of sale (note special rules for partnerships that have capital gains)
Gain* can be deferred until December 31, 2026 or investment in QOF is sold, whichever is earlier
Investor’s basis in QOF is initially $0
Invest
$100
Gain
$100
QOF
Basis
$50
Basis $0
* If QOF investment has lost value, then gain computation starts with lesser of Deferred Gain or FMV or QOF Investment

9. Benefit 2. Avoidance of Gain from Sale
Invest $100 on 1/1/18
5 Years
7 Years
Gain if sold:
$100
Gain if sold:
$90
Gain if sold:
$85
Basis = 10% of gain deferred after 5 years
Basis = 15% of gain deferred after 7 years
Basis
$15
Basis
$10
2018
2019
2020
2021
2022
2023
2024
2025

10. Maximum Deferral of Gain from Sale
Practice Note: Compassion for Bad Investments
If QOF Investment has lost value, then gain is computed using fair market value of QOF investment.
This is a concession by Congress not to force gain recognition on OZ Investors whose investment has lost value
Example –
Fair Market Value is $70.
Gain Computation - lesser of (i) $100 Deferred Gain, or (ii)$70 FMV minus $ basis.
Gain = $70 - $15 - $55
Maximum Deferral of Gain from Sale
Gain from Original Sale deferred only until December 31, 2026
Gain
Recognized
$85
Invest $100 on 1/1/18
5 Years
7 Years
Basis
$100
Basis
$15
Basis
$10
2018
2019
2020
2021
2022
2023
2024
2025
2026
2027

11. Benefit 3. Avoidance of Future Gain
After 10 years, sale of QOF investment results in basis adjustment to FMV, eliminating tax on gain from that sale
Basis
$200
FMV
$200
Original
Investment
$100
FMV
Basis
$100
Basis
$15
Basis
$10
2018
2019
2020
2021
2022
2023
2024
2025
2026
2027
2028

12. QOF Requirements
Investor: taxpayer with capital gain from sale or exchange of any property from an unrelated purchaser
Opportunity Fund (QOF): corporation or partnership that has purpose of investing in QOZ Property and holds 90% of Assets in QOZ Property (“90% Test”)
QOZ Property: Stock or Partnership Interest in an QOZ Business or tangible property used in a QOZ trade or business by the QOF
Investor
Qualified Opportunity Fund
Qualified Opportunity Zone Property

13. QOZ Property QOF Must hold at least 90% of its assets as QOZ Property.
QOZ Property includes:
Stock or a partnership interest in a QOZ Business
QOZ Business Property
QOF
Stock or Partnership Interest
Owns Property Directly
QOZ Business
QOZ Business Property

14. QOZ Business 70% of tangible property is QOZ Business Property
Actively Conducts business in QOZ
Not a “Sin Business”
Does not hold excess nonqualified financial property (including cash)
QOF
Stock or Partnership Interest
Owns Property Directly
QOZ Business
QOZ Business Property

15. QOZ Business Property Tangible Property
Acquired by purchase from unrelated party (after 2017)
New or Substantially Improved (rehab exceeds acquisition cost)
Used in a trade or business in a QOZ
QOF
Stock or Partnership Interest
Owns Property Directly
QOZ Business
QOZ Business Property

16. QOZ Geography Designated by governors and approved by Treasury.
Eligible census tracts qualified as “Low- Income Community” under NMTC rules (poverty 20%, income 80% AMI)
Designation in effect for 10 years

17. QOZ Maps

19. Direct Model 90% of QOF’s assets must be QOZ Business Property
Leaves only 10% for cash, reserves, intangibles
Avoid limits on Sin Businesses and Nonqualified Financial Property
Timing issues (for construction)
QOF
Owns Property Directly
QOZ Business Property

20. Indirect Model 90% of QOF’s assets must be invested in QOZ Business
QOZ Business subject to 70% test of tangible property (not all assets)
Timing safe harbor for tangible property, primarily real estate – 31 months to expend assets to acquire QOZ Business Property that is tangible property
Limits on NQFP and business types
QOF
Stock or Partnership Interest
QOZ Business
70% of Tangible Property
QOZ Business Property

21. Comparison Chart Requirement Direct Indirect Notes
Maximum Fund Assets Held in Cash (or other forms of non-qualified financial property)
10%
10% at Fund; 5% at Business level (excluding reasonable working capital)
Minimum Fund Assets that must be stock or partnership interests
N/A
90%
Minimum Project Entity Assets that must be in Qualified Opportunity Zone Business Property
Substantially all of tangible property must be such property
Penalty for Failure: monthly penalty equal to amount of property that Fund is short multiplied by Federal Short-Term Rate + 3% (i.e. IRS Underpayment Rate).
Minimum Assets that must be Invested in Tangible Property located in QOZ
No Minimum
Gross Income / Active Business Test
None
50% of gross income must come from “active” conduct of trade or business
Substantial portion of intangible property must be used in the active conduct of such trade or business
Ineligible Businesses
Sin Businesses

22. Comparison Chart (cont’d)
Requirement
Direct
Indirect
Notes
Qualification of Leased Property
No requirement stated
Substantially all of leased property must be QOZBP
Not sure how leased property should be treated
Safe Harbor for property that ceases to be QOZBP
None
Deemed QOZBP for the lessor of: 5 years from the date property ceases to be QOZBP or no longer held by business
Grace Period to invest cash in QOZBP
Have up to date of first 6-month measuring test. IRS might provide more flexibility and has been requested
May benefit from grace period at QOF level plus 31 month safe harbor at QOZB level for tangible property.
Exit Strategy for 10-year hold benefit
Sale of QOF interested is eligible for 10-year basis step-up election
Sale of lower-tier partnership or corporation is not eligible for 10-year basis step-up
Preference for single asset investments. QOF invests in a single QOZBP or holds singe project directly by QOF. IRS might provide more flexibility and has been requested.

23. QOF Timing Issues
180 Days to Invest Gain- Gain Investor must invest in QOF within 180 days of gain
QOF Timing- QOF must have 90% of its assets invested in QOZP or there is a tax penalty. The test is measured by the average taken at 6 months from start of the taxable year and end of the taxable year.
Special rule for 1st Year - Can select year and month when start being a QOF. For the first year only, the first 6-month testing date will be from the month selected.
Example Select March 1, 2019, then 90% is the average of computed based on assets owned on August 31, 2019 and December 31, 2019.
Late Election Date - If first QOF month is July or later, then for the first year there will be only one testing date--the end of the year.
QOF can invest in Qualified Opportunity Zone Business Property or in corporate or partnership stock of QOZBs.
Cliff Nature of QOZB Investments- If funds invested in a QOZB, then it either all counts or none of it counts. Failure to qualify as a QOZB, e.g. failing 5% NQFP limit, can result in substantial penalty.

24. QOZB Timing Issues
QOZB Timing- timing requirements are less explicit for QOZBs.
70% of all of tangible property owned or leased must be QOZBP.
Does property qualify as QOZBP while it is being constructed?
31 month safe harbor for cash held during construction and whether treated as NQFP
Investor Timing Issues – What if the investor does not have gains available when funds are needed by the QOF or QOZB?
Conflicting Goals- QOZ rules incentivize quick investments. However, LIHTC structures encourage delayed equity to increase yield.

25. LIHTC Syndicator Bridge Issues
Syndicator wants to invest in lower-tier LIHTC Partnership that is also a QOZB and close with upper-tier LIHTC/QOZ Investor. How to structure this?
Temporary Syndicator Affiliate GP
GP Affiliate
Syndicator
Upper Tier Investor
GPQOF
Syndication QOF
Lower Tier
QOZB

26. LIHTC Syndicator Bridge Issues (cont’d)
Option 1 – Syndicator or its affiliate invests equity that is invested in the Lower-Tier QOZB. When Upper-Tier has its gain and is ready to invest, cash is contributed to Syndicator QOF and funds are used to redeem equity invested and pay syndicator fees.
Can Upper-Tier cash be used to just redeem equity
Does payment of syndicator fees create intangible assets that could violate the 90% rule? For example, if the syndicator fees are 11% of funds invested, does that mean only 89% of cash can be invested in QOZB?
Option 2- Syndicator or its affiliate loans QOF funds that are then invested in the Lower-Tier QOZB. When Upper-Tier has its gain and is ready to invest, cash is contributed to Syndicator QOF and funds are used to pay off the syndicator debt.
Can Upper-Tier Cash be used to pay off QOF debt?
Option 3- Syndicator or its affiliate loans funds to Lower-Tier QOZB. When Upper-Tier has its gain and is ready to invest, cash is contributed to Syndicator QOF and funds are used contributed to the Lower-Tier QOZB and those funds are used to pay off the syndicator debt.
Variation- what if the Syndicator is a direct QOZ Investor but doesn’t have gain when Lower- Tier needs funds. Can it put money into QOF as a non-QOZ investment and then when it has gain put new $$$ and pay off its old equity? Or can it loan funds in and then later put in equity to pay off its own loan

27. Developer Commercial/Workforce Housing Structure
Developer has plans for a workforce housing project in QOZ, possibly including commercial space.
Developer creates a Qualified Opportunity Fund and looks for Investors.
Project needs an economic engine. Unlikely to find investors just for deferred taxation and possible tax-free gains in 10 years. Investors likely will need some current return and share of upside.
If the Developer has gain, then it can invest funds and also get some or all of its back-end tax free.
Developer
Investor
Developer QOF
QOZB OR
BLDG
BLDG

28. LIHTC Considerations Structure is mostly the same as normal LIHTC deal
Developer
Syndicator
QOZ-LIHTC Investors with Capital Gains
Structure is mostly the same as normal LIHTC deal
Syndicators cannot have multiple levels of funds.
General Partner
Investor QOF
QOZ Business (Operating Partneship)

29. LIHTC Considerations
Pick the right deal! New construction or very substantial rehab.
Rehab must exceed cost of acquiring building
Pick the right deal (2)! Deals with significant debt
Because of initial zero basis in QOF, Investor needs project to have debt to allow investor to take losses
Treatment of significant related party fees is unclear
Related party developer fee, architects, general contractors, etc.
Could be issues if related party fees exceed 20% of tangible property cost or perhaps 30% of such cost.

30. LIHTC Considerations Single Asset funds preserve flexibility and value
Only sales of QOF investments get tax free basis step-up. Easier to sell interest in QOF that only own one project.
LIHTC projects may recognize less gain in 2026 if fair market value has decreased due to using up substantial LIHTC. This can offset limited or no long-term upside for investor

31. LIHTC Considerations
Developer
Developer Affiliate
Syndicator
QOZ-LIHTC Investors with Capital Gains
Developers and general partners can also benefit from QOZ investments if they have capital gain to invest
Developer forms GP as a QOF. Developer invests cash into GP QOF which then invests cash into the lower-tier Qualified Opportunity Zone Business
If done correctly, can get 90% back-end tax free or mostly tax free
Unclear how much GP has to contribute. Perhaps present value a reasonable estimate of value in 15 years.
GP QOF
Investor QOF
QOZ Business (Operating Business)

32. Frequently Asked Questions (by Developers, Investors and other Clients)
Upper Tier- Fund of Funds
Partnership with Gain
Construction Projects
Basis in Leasehold
Property Owned Prior to 2018
Intangibles

33. 1. Fund of Funds
“I’m a syndicator and want to create a nested structure with mid-tier funds to manage the unique terms negotiated with each investor. This is especially important in light of the differing times my investors recognize gain.”

34. 1. Fund of Funds Prohibited
Opportunity Fund can’t invest in another Opp Fund (1400Z-2(d)(1))
Precludes multi-tier structures, nested funds, planning for multi-investor vehicles difficult
Look at bridge equity, debt with QOZ investors as take out

35. 2. Gains generated by Partnership
“I’m the general partner of a LIHTC partnership that just sold an apartment complex at a gain that could take advantage of the QOZ incentive. Can the partnership invest in an Opportunity Fund?”

36. 2. Gains generated by Partnership
Partnership may defer gain by making a QOZ investment.
Partners may defer gain allocated by partnership (not deferred by partnership)
A partner’s 180 day investment deadline starts at end of partnership tax year or on the date the gain was generated.

37. 3. Construction Projects
“I am starting a construction project that is going to take about two years from start to finish. I sold another property 5 months ago and would like to invest the proceeds in the project before the 180 day deadline. What QOZ tests do I need to consider?

38. 3. Construction Projects
Indirect model (invest in a QOZB) has a limit on NQFP:
Indirect Model: Safe Harbor - Cash held for construction within 31 months considered reasonable working capital
Direct Model: No safe harbor – need to meet 90% test (invest in QOZBP) by 6 month testing dates.

39. 4. Basis in Leasehold
“To meet the substantial rehab test I need to invest at least as much as my original basis in property owned. I am leasing space in an existing building for 10 years and will be building out interior offices. How does substantial rehabilitation test work for leased property?”

40. 4. Basis in Leasehold
Tenant wouldn’t commonly have basis in leased property (other than intangible created with prepaid rent).
If basis is $0, perhaps $1 of improvements is sufficient. Open Door to Abuse?
Must tenant QOZB own tenant improvements to add to basis?

41. 4. Basis in Leasehold Note definitional oddity
QOZB: Substantially all owned or leased tangible property must
be QOZBP
QOZBP: Must be acquired by purchase per 179(d)(2) (from unrelated seller). But leased property isn’t purchased.

42. 5. Property Acquired Prior to 2018
“I bought land in 2016 and am about to break ground on a new factory. It’s in a QOZ. Do I qualify as a QOZB?”

43. 5. Property Acquired Prior to 2018
QOZB: Substantially all tangible property must be QOZBP
QOZBP: Must be acquired by purchase after December 31, 2017
Relative importance of pre-owned property (by basis, value?) vs. newly acquired improvements
Sell into new project entity majority (80% plus) owned by unrelated QOZ investors

44. 6. Is Land QOZ Business Property?
“How does land fit into the requirement that QOZ Business Property be Newly Used in a QOZ or Substantially Improved?”

45. 6. Heavy Intangible Use
Land is carved out of the calculation of whether a building located thereon is substantially improved (Rev Rul )
The requirement that the original use of tangible property in a QOZ commence with the QOF or QOZB is not applicable to the land on which a building is located.

46. Questions?