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Grandfathered Out Of An Opportunity Zone? Be Wary Of Doing This.

Get ready for urgency in opportunity zone investing in the coming months. Timing provisions of the federal opportunity zone program require investors to harvest capital gains in 2019 and reinvest them within 180 days to qualify for the full benefit of the program — a 15% tax break. 

Berkowitz Pollack Brant Director of Tax Services Arthur Lieberman, KPMG Tax Managing Director Katherine Breaks, former state Rep. Jose Felix Diaz, Urban Street Development founder Alan Hooper and Bilzin Sumberg partner Joshua Kaplan

KPMG Tax Managing Director Katherine Breaks and other panelists at Bisnow's South Florida Opportunity Zones Regulations Update event in Fort Lauderdale June 20 cautioned that each fund and underlying deal should be evaluated on its own particular merits and quirks.

They recommended entering into deals only if they would make sense independent of the program, and hiring legal and accounting experts to carefully assess and structure all agreements. 

As the director of tax services at Berkowitz Pollack Brant, Arthur Lieberman spends much of his day on such matters.

"The questions are all over the map," he said. "In a way, it's all the same question: What about my property?" 

A common question is from people who have long owned some land or a building, then found out that it was designated as being inside an opportunity zone, and have been wondering how they can profit off the program. But rules say that to qualify for qualified opportunity zone investment, property must have been acquired from an unrelated party after 2017. 

Lieberman said he calls these cases where the owner has been "grandfathered out." He has seen developers try to set up leasing structures to work around the technicality, but warned against it.

"Be careful when you get into these leasing structures," Lieberman said. "If you are going to lease to a related party or alter ego, you need [to] make sure it's a fair market value land lease, which I think is difficult to structure ... You have to be mindful that on the exit, a portion of the gain will be allocated to the fee interest in the land and a portion of the gain will be allocable to the leasehold interest, plus the improvements on the property. That's going to be a very tricky exit, because if you get the valuation incorrect, there are substantial penalties in the Internal Revenue code for valuation misstatements."

BH3 co-founder Daniel Lebensohn at Bisnow's event on opportunity zones June 20, 2019.

Most of the panelists already owned property or had deals brewing when they discovered their parcels were in opportunity zones.

Alan Hooper has been investing in Fort Lauderdale for decades because the bigger demographic trends make sense.

"It's a boutique downtown," he said. "Broward County is bordered by the Everglades and ocean so downtown is going to grow rapidly as time goes on. If you can get a deal in an opportunity zone, in a location that pencils, then it's great, it's a bonus, it's a 3% bonus on your IRR post-tax."

BH3 co-founder Daniel Lebensohn said the opportunity zone designation inspired him to put together a $100M mixed-use project on West Atlantic Avenue in Delray Beach, which he thinks will eventually converge with already-bustling East Atlantic Avenue.  

"The density generally in Delray is not significant enough to draw our attention," he said. "The fact that this was in an opportunity zone contributed ultimately to knowing we can draw capital that has an appetite for that, despite density being low. Our preference would be to do high-rise — similar brain damage, more sellable net and leasable square footage. So in this case, it really did matter, but in other cases we were organically in the areas already." 

Driftwood Acquisition & Development General Counsel Jorge Gomez-Moller, Merrimac Ventures Senior Vice President Dale Reed and Affiliated Development co-founder Nick Rojo

Merrimac Ventures Senior Vice President Dale Reed and Affiliated Development co-founder Nick Rojo both said that while they benefited from their projects falling within opportunity zones, Community Redevelopment Agency incentives had been drivers of their deals, not the zones.

Rojo said that because he was building workforce housing, the CRA kicked in $7M. "We tied up the site in 2017, realized it was in an opportunity zone. So we switched and raised equity as a QOZ [fund]," he said.

In his case, it was relatively easy because "investors were very sophisticated family offices," but even so, "we spent way too much on legal."

Reed advised that any potential investors with hesitations wait to get into QOZ funds, as people can still realize benefits from the program — just a lower percentage — if they invest after 2019.