Insight Center: News

Julia D. Corelli and Stephanie Pindyck Costantino Quoted in The Deal Pipeline, 'Qualified Opportunity Zones: How and When to Invest'


This article was posted on The Deal Pipeline on February 11, 2019 (a subscription is needed). It is printed here with permission.

In December 2017, the Tax Cuts and Jobs Act was signed into law, cutting corporations taxes and launching several new tax-driven initiatives, including Qualified Opportunity Zones.

Qualified Opportunity Zones are economically distressed communities where new investments may be eligible for preferential tax treatment under certain conditions. To qualify as an Opportunity Zone, a locality must be nominated for the designation by its state and certified as such by the Secretary of the U.S. Treasury.

There are about 8700 Opportunity Zones in the United States, the Virgin Islands and Washington D.C., according to Pepper Hamilton LLP partner Stephanie Pindyck-Costantino.

"The potential advantages of being designated as an opportunity zone is substantial investment and capital improvement in the zone," Pindyck-Costantino said in a recent web panel with The Deal. "Typically, these areas are low to moderate income. The substantial tax benefits available from investment in an "opportunity zone" designation will attract a fair amount of increased capital investment in that area. The effect is to bring real and permanent improvements to the LMI area."

But what is particularly interesting about these zones, Pepper Hamilton partner Julie Corelli pointed out on the panel, is the funds set up for investors. Both Corelli and Pindyck-Costantino are members of the firm’s Funds Services and Family Office practices.

"These are special vehicles that draw in capital to be invested in the Qualified Opportunity Zone," Corelli explained. "There are several criteria that have to be satisfied in order to be a Qualified Opportunity Zone Fund. The entity has to be tested periodically. To invest in a Qualified Opportunity Zone – that is, how people take advantage of the benefits – they use capital gain proceeds to fund the investment in the Qualified Opportunity Zone Fund."

From there, there are three primary benefits for investors if they hold the interest in the fund long enough, according to Corelli. The benefits include deferral of the rolled in gain until Dec. 31, 2026; elimination of tax on 10 percent of the rolled-in gain if the fund interest is held for at least five years; elimination of tax on 15 percent of the gain that is rolled-in gain if the fund interest is held for seven years; and zero taxes on any appreciation in the investment if the interest is held for 10 years.

"So there are substantial tax benefits for doing this," Corelli said. "There are also the social benefits … you really are revitalizing a LMI area that has been designated as an area that needs investment."

As a new kind of opportunity, Qualified Opportunity Zone Funds may be a very attractive option for family offices in particular, the Pepper Hamilton partners noted.

"The fact that you could either defer tax for an extended period of time or actually relieve some of the tax burden, is going to be a preliminary and primary driver for a number of family offices," Pindyck-Costantino opined. "Also, there are a number of very socially minded family offices."

And unlike some other asset managers, the lengthy time horizon for Qualified Opportunity Zone Funds is not a deterrent for family offices.

"Family offices typically have at least one investment bucket for very patient capital," Pindyck-Costantino said. "The fact that they can potentially put money to work for an extended period of time, potentially 10 years or more, and have it be tax advantaged is also a great driver. The fact that there’s a social improvement niche for patient capital can also be a very important factor for the family office."

To be sure, anyone considering investing in a Qualified Opportunity Zone Fund needs to understand it is a long-term play.

"If you want to experience the full panoply of benefits coming out of this, from a tax standpoint, you need to be prepared to be a long-term investor," Corelli said.

Moreover, the Qualified Opportunity Zone Fund is essentially brand new, and as such, guidance is still trickling out.

"There’s a lot still to come in terms of interpreting some of the provisions associated with the Tax Cuts and Jobs Act adopted in December 2017," Corelli added. "There will be open-ended questions. That’s a big cautionary piece for people investing in Qualified Opportunity Zones."

And while Qualified Opportunity Zone Funds can be set up to invest in a business or a property, not all funds geared toward these ends meet the proper criteria.

At least 90 percent of the assets in a Qualified Opportunity Zone Fund must be invested in Qualified Opportunity Zone property. This property comes in three varieties, according to Corelli.

"Either it’s a business itself, and you own the business itself, or you own a partnership interest, or you own stock in a corporation," she explained. "If it’s stock or a partnership interest, then it has to be in an entity that is itself invested in one or more qualified businesses."

The biggest hurdle people have in understanding what is a qualified business, according to Corelli, is the fact that investments need to be made in property acquired after Dec. 31, 2017.

"The whole purpose of the statute was to revitalize low and moderate income areas," she continued. "That means putting new investment capital to work. You have to put the money to work in a business or property acquired after Dec. 31, 2017."

That means you must invest in it as an original use of the property, or you must acquire it and invest an additional amount equal to at least two times the acquisition price of it, and with these criteria come several nuances that are hard to apply in reality.

"We have several situations where people want to take vacant land and build on it, or they want to take a parking lot and put condominiums on top of the old parking lot," Corelli said. "Then there’s always environmental issues, such as does cleaning up the environment of the land count as the investment that qualifies for the two times investment in the asset? There are a lot of little questions like that, which are very detailed and very fact specific and which the rules don’t yet answer."

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