Episode One: The Wizards of OZs (Opportunity Zones)

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There’s no place like zones—Opportunity Zones, that is.

Since 2017, opportunity has been knocking specifically in the form of Opportunity Zones—a piece of the Tax Cuts and Jobs Act that provides new tax benefits for investors. The Opportunity Zone program was designed to foster economic development in lower-income areas by incentivizing investments within these zones.

What are Opportunity Zones? Why do we have them? What should investors know? How can you know if you’re in compliance with the constantly-evolving regulations? And what are the tax benefits?

Join Paul and Kim, along with Opportunity Zone experts, Chris Branch, CPA and Grant Cardwell, CPA, for a crash course about Opportunity Zones for investors.

Congress and taxes and gains! Oh my!

At the end of this podcast episode, you’ll be able to:

  • Have a basic understanding of what Opportunity Zones are and how they work
  • Locate Opportunity Zones in your specific areas of interest
  • Know how to evaluate a potential Opportunity Zone investment before you make it
  • Understand the tax benefits that this program offers to investors

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  1. What is an Opportunity Zone?
  2. How were Opportunity Zones created?
  3. How do Opportunity Zones spur economic development?
  4. How were the communities or areas designated as an Opportunity Zones?
  5. What are the tax benefits of the Opportunity Zone Program?
  6. How can I take advantage of the Opportunity Zone Program?
  7. What is a Qualified Opportunity Fund? Opportunity Zone Business?
  8. What should I know before investing?
  9. Do you have an example of how you’ve advised a client on OZ?
  10. It seems like there is still clarifications and changes happening in Congress about the OZ program? What are we waiting on?
  11. How can listeners keep up with changes or updates on OZ? warrenaverett.com/opportunityzones
  12. As we are wrapping up, what is one piece of advice you would give to a business owner as they consider Opportunity Zones?

Intro (00:00): Welcome to The Wrap, a Warren Averett podcast for business leaders designed to help you access vital business information and trends when you need it so you can listen, learn, and then get on with your day. Time is tight, that’s why our advisors have wrapped up today’s most timely topics into a podcast with actionable advice. Now let’s get down to business.

Paul (00:22): Hey Kim.

Kim (00:23): Hey Paul.

Paul (00:24): How are you today?

Kim (00:25): Great, how are you?

Paul (00:26): I’m doing wonderful.

Kim (00:27): I’m excited about this episode.

Paul (00:28): This is going to be a really good podcast with some folks from our tax department.

Kim (00:33): It is, and I had the opportunity to sit in on some of the presentations that they did over this past year and it’s very informative and something that I think a lot of people are still learning about. Today we’re talking about Opportunity Zones.

Paul (00:47): Yeah, it’s going to be a good conversation. With us today is Chris Branch and Grant Cardwell. Welcome guys.

Grant (00:52): Thanks for having us.

Chris (00:53): Yep – thanks for having us here today.

Kim (00:55): Yeah, we’re excited to have you.

Paul (00:56): So Opportunity Zones. Can you kind of start us off with, you know, what is it and kind of, you know, why were they created?

Grant (01:04): Yep, absolutely. I’m going to read actually the definition off of Wikipedia and then we’ll talk about it from there. We’re not going to get all of our information from Wikipedia, but we’ll start with this. So, an Opportunity Zone is a designation created by the Tax Cuts and Jobs Act of 2017 allowing for certain investments in lower-income areas to have tax advantages. The purpose of this program is to put capital to work that would otherwise be locked up due to an asset holder’s unwillingness to trigger a capital gains tax. These are specifically government identified lower income areas where the government is really trying to drive investment. It’s a bipartisan deal where you had Republicans and Democrats both wanting to find ways to drive investment in these lower income areas. And this was their solution.

Kim (03:25): And you mentioned it in the definition where it talked about unlocking capital that owners would be unwilling to let go of because they’re afraid that they would then be taxed on that. So that’s kind of the, the, you know, incentive behind that for someone to let go of that capital. And you mentioned that it is meant to create economic development. So how exactly does an Opportunity Zone spur economic development in those areas?

Grant (03:53): Yeah. So one thing I want to point out the freeing up the capital gains. They estimate that there were somewhere around $6 trillion of unrealized capital gains that were out there.

Kim (04:06): That’s pretty significant.

Grant (4:07): And that was the target of this was to try and say we were trying to look at ways to encourage investment. This is one of those ways that they figured would help if we could get some of that undeployed capital deployed into these kind of suppressed areas.

Chris (04:23): So when you look at the Opportunity Zones program, and I’m going to make sure I don’t nerd out too much here.

Paul (04:29): You’re in good company, don’t worry about it.

Chris (04:32): It’s an opportunity to set up an investment structure where investors, taxpayers have these capital gain tax liabilities, whether they’re expecting to realize those in the near future or they’re locked up and have an opportunity to go ahead and realize those, is to drop those into what you call an Opportunity Fund. And what these Funds are, is it’s a corporation or a partnership. Basically it’s a taxable entity. The IRS wanted a taxable entity that had to file a tax return so that they could follow to make sure that the intent of the law is being followed by these investors. So taking your capital gain, you drop it into an Opportunity Fund, and then these Opportunity Funds go out into these low income areas like Grant was talking about, these Opportunity Zones and deploy this capital into real estate, into businesses – it’s just an opportunity to take some areas that otherwise were not being economically developed, that didn’t have a lot of jobs, that didn’t have a lot of people living there, an opportunity to kind of get these areas flourishing where the government either wasn’t able to do it themselves or it was so low income that investors needed some tax benefits to kind of push them in that direction.

Kim (05:44): And so you mentioned, you know, that there is a tax benefit. What exactly is the tax benefit?

Chris (05:51): So there’s a three kind of pronged tax benefit to it. It was right off the bat you get a temporary deferral of your capital gain. It’s that there is a mandatory recognition date is December 31st of 2026, if you sell your investment in the Fund before then that’s when you would realize the gain. But that’s something we’ve talked to a lot of people about. There’s a lot of people that think this is a permanent exclusion, a permanent deferral of their capital gain. It’s not that original gain is always going to come due with that. The second step of it is if you hold your investment for at least five years, you get a 10% step up in that original gain.

Grant (06:29): That’s your new Opportunity Fund investment.

Chris (06:33): Right. And then if you hold it for an additional two years, a full seven year holding period, you get a 15% step up. It’s why, and I know we’re kind of here at the end of 2019, it’s why it’s very important if you’ve got a capital gain, if you’ve got a project that is aiming for one of these Opportunity Zones to go ahead and kind of get moving on it because of the need to get the full seven year holding period you’d have to put in your gain into the Opportunity Zone Fund by the end of the year or you’re going to miss out on that December 31st, 2026 recognition date. And then finally the, the big kicker, the main reason that people are really excited about this that are looking into it, is if you hold your investment in an Opportunity Zone Fund for at least 10 years, you’re going to exclude the gain on the appreciation of that Opportunity Zone investment. So, as you see that December 31st, 2026 date, it’s going to come between the start of your Fund, the start of your holding period on the deferred capital gain and that 10-year window. So, you’ve got to kind of keep in mind that you’re going to have some cash locked up for at least 10 years, but you’re going to have tax due on the gain during kind of the middle of that holding period.

Intermission (07:46): Like what you hear so far? Make sure you never miss a show by clicking the subscribe button now. This podcast is made possible by listeners like you. Thank you for your support. Now back to the show.

Kim (08:00): And so how were those communities and areas designated and how do we find out, I know you guys sit in Birmingham, we have listeners all across the country, how can they find out where those areas are and where, you know, where there is opportunity for them to create this economic development?

Grant (08:22): Yeah, so they were created on a state by state basis. Each state was responsible for creating their own or nominating their own areas for Opportunity Zones. And they were approved by the governor of each state. They had kind of a specific task force put together in order to identify those. You can find them on our website, go there and, and we have a link to a map that is interactive, you can zoom in, zoom out, look all across the country and find where those Opportunity Zones are located.

Paul (08:58): And that’s at warrenaverett.com/opportunityzones.

Chris (09:01): That’s correct.

Paul (09:02): Okay. So for the business owners and executives that are out there listening to this right now, what’s the sort of thing they need to know before investing? What are the top couple things that that need to be on their radar?

Grant (09:12): Yeah, so first thing that we’ve talked to, whether it’s an investor or someone that’s putting together a Fund is making sure that the investment is a good investment and that you would do the investment without regards to the Opportunity Zone benefit. That one thing that we’ve cautioned people is getting too far ahead of their skis, thinking just investing in it because of the tax benefits and not really paying attention to the underlying investment. And being so focused on the five, seven-year deferral, the haircut, the 10-year appreciation exclusion – all of those things. So that’s really kind of first and foremost what we’re kind of warning against, but you know, outside of that, it’s making sure you have a reputable group that’s putting together these Funds. Our Firm has worked closely with a lot of Funds with a lot of people in it are putting together Funds that are investing in Funds, doing a lot of the vetting. There’s a lot of compliance that goes along with it and trying to make sure that different tests are met with your assets and your income. So, trying to keep track of all of that. It can be a big deal. And if you end up messing one of those up, you end up in a bad situation.

Chris (10:32): Right. I mean we’ve definitely already kind of had to talk to people throughout just 2019 and where they jumped a little bit too far ahead at the certain requirements and the certain test. And we’re sitting here trying to kind of reel everything back and find some opportunity to make it work. But in the end, I mean what this being so brand new with the IRS struggling a little bit, writing the rules is everything is kind of a bright line test of what needs to be done, when it needs to be done. So it’s extremely important to make sure that you’ve got a trusted advisor working along with you to kind of help you navigate the different hoops that you’ve got to jump through to make sure that if you’re going to do this investment, that you’re doing it the right way.

Paul (11:10): And Chris, you talked about the changes and I assume there’s always changes going on to Opportunity Zones. Does the actual Zone itself change or is it just the law and how it’s applied?

Chris (11:22): So as of right now, the Zones in place are going to have a 10-year designation. I know a lot of people are probably thinking, well, if I invest in a Zone and after 10 years they say it’s not a Zone, what happens to my investment? Well right now they say that even though the designation may drop, if you invest in a Zone when it’s an Opportunity Zone, your investment is going to qualify. But that kind of brings up the next question of the Opportunity Zones are designated now – we’ve had a lot of people ask, “well, how do I get the area that I’m living in working in designate as an Opportunity Zone?” I think right now it’s pretty tough. The only real thing I’ve seen kind of in that area is there was a rep, I think out of Florida that was trying to get Mexico Beach designated as an Opportunity Zone because the devastation by the hurricane, but even then with Congress and the Senate kind of going at each other, there’s not a whole lot moving from a legislative standpoint. I would expect that at least through the upcoming election, it’ll probably be tough to get anything additionally designated, but we’ll kind of have to see how it works out.

Paul (12:23): But there may be some in the future is what they said?

Chris (12:26): Right. There may be some additional Zones depending on what kind of census data they look at. I know we talked a little bit about the changes of Opportunity Zones, but there’s even probably some changes in the requirements when it comes to reporting. There may be even some changes with the Opportunity Zones. Now from a standpoint of, I know Grant mentioned that this is a bipartisan bill that both Republicans and Democrats wanted, probably for different reasons, but now that the regulations have come out, the Zones have been laid out, their members on both sides of the aisle that are looking at the rules, the requirements that have been laid out and trying to decide are these following the intents of the laws written? Are these really going out and developing these low-income areas or to states, localities, municipalities take advantage of the testing rules on designating Zones based off that 2010 census data, when in 2018, probably wouldn’t qualify. So, it’s something to keep in mind over the next couple of months, the next year and a half as we get through the next election is what’s going to happen. Depending on who’s in the White House, who’s got the majority in the House and the Senate to where this really is going to end up going.

Kim (13:42): So do you have an example of how you’ve advised someone on either setting up an Opportunity Zone or maybe they’ve already set it up and you’re advising them on what they need to do now? Something that would maybe help the listener figure this out a little bit more in a real time scenario?

Chris (13:58): Absolutely. So a lot of these investments so far have been real estate plays. It’s really straight forward when it comes to real estate. As you go into a low income area, purchase a, an older building, put enough into it to meet the requirements of the law. Um, we’ve had a bunch of people reach out to us that we’ve started to work with. We’ve worked with them to set up the correct structure when it comes to the Opportunity Fund and the Opportunity Zone business that actually does the development. We’ve worked with a couple of lawyers who have a lot of OZ experience. We found that the way that they go about it and the way that we go about it are very similar that it’s worked for I guess our clients now of making sure that the structure is correct, the operating agreements, correct. That we’ve got the support together to follow all these different compliance tests from a tax return standpoint, making sure that all our forms get filed correctly. So, it’s a, it’s a lot of paperwork. If you get with the right people, it’s probably a lot easier than trying to do it yourself because Grant and I’ve kind of been involved in this from when the tax reform bill came out, when Opportunity Zones really starting to catch fire. And we’ve really kind of dug into the weeds to make sure that we understand the rules because there are so many out there and it’s so important that you make sure that you’re meeting all these tests.

Paul (15:15): So, the clients that you’ve advised, have there been common pitfalls that they’ve all that you’ve seen with all of them that, that you’ve corrected for them?

Grant (15:21): So, I think one of the hardest things is the fact that there’s not full complete regulations on this yet. So, there’s still some items to be clarified and to be kind of played out. I’ve had a couple of situations where one of them was a new business that wanted to start. Chris mentioned the real estate play and that’s probably the easiest to understand, but you can also start a new business in an Opportunity Zone and it’s a little bit different of how that works and some of the requirements equally is advantageous if you could make it work though. This person really couldn’t get over the uncertainty and the unknown and the lack of clarity really around how that would play out. I think how it’s going to go, is there going to end up not designating themselves as an Opportunity Fund basically because they just don’t feel comfortable with it. And not because they think they’re going to go to jail or anything, but they can’t get comfortable enough with how they’re set up, how it’s going to work, how they’re going to do the reporting, all of that that goes along with it. And so it was almost just a miss too much trouble to deal with.

Kim (16:26): Chris you mentioned that there are going to be changes and Grant you just mentioned that not all the decisions have been made and so it sounds like this is an ever evolving process. So how do people keep up with things that are changing in the legislation and updates that are, that are happening?

Chris (16:45): Right. I mean you’re dead on. This is going to change even though we’re expecting finalized regs before the end of the year, which you can find those at warrenaverett.com/opportunityzones. You’ll be able to find our thoughts on those regulations, how they’ve changed from the proposed regulations that came out this past April and then even as far back as last October. We’re going to try to put as much information out there as possible to make it as clear and concise from if you were to sit down with a cup of coffee and read through it instead of having to read through all the tax law and you can just read our thoughts of how the regulations are going to impact investors, developers, and business owners.

Kim (17:27): That sounds a lot easier to do than read the taxes.

Paul (17:30): I’ll give, I’ll give Chris a plug. He got voted a top 25 Opportunity Zone influencer for his work that he’s done. Chris has really, really put a lot of time and effort into knowing the kind of, the nitty gritty details of how these things work. And you know, we’re not getting into that in, in this forum, but there’s a lot of information that we’ve put out there that they can be beneficial.

Chris (17:55): Right. And it’s not just us, it’s, it’s we’re reaching out to professionals across the country and our own market. We’re talking to business owners and real estate developers. This is not just something where we’re just going to give our thoughts and opinions on the law. We’re going to come up with opportunities for our clients, for other people out there, to take advantage of the program. Cause that’s the reason it was written, is for taxpayers to be able to take advantage of the program, to follow its intent, hopefully, to build some socio-economic value in these low-income areas, but at the same time to create some tax value for wealthy individuals. Anybody who’s basically got a capital gain.

Kim (18:35): That’s great. So, on Ohe Wrap, we like to wrap this up in, you know, a short statement. What do you hope that people listening to this podcast will take away in terms of Opportunity Zones?

Chris (18:49): So, I’d hope that they take away that there are opportunities out there. I think a lot of people were struggling with the Opportunity Zones program because they saw it as another new market’s tax credit, another empowerment zone program where the zones weren’t going to be worth investing in. There are some opportunities out there with the Opportunity Zones program. There are some census tracks out there that already were being developed that that there is going to be some opportunities to deploy some capital gain there and really get a rate of return, um, that you possibly would get from a normal investment. But even on top of that, I mean, the tax benefits are going to add a percentage on top of your normal return that you’re going to be happy that you got into it.

Paul (19:31): Grant, Chris, thank y’all very much for your time. This has been a good conversation.

Kim (19:35): Thank you both.

Chris (19:36): Thank you.

Close (19:38): And that’s a wrap. If you’re enjoying the podcast, please leave a review on your streaming platform. To check out more episodes, subscribe to our podcast series, or make a suggestion for other topics to cover. Visit us at warremaverett.com/thewrap.

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