Opportunity Zone Funds

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cdaddio23
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Opportunity Zone Funds

Post by cdaddio23 »

[2019 thread bumped in 2021 -- admin LadyGeek]

Has anyone had experience with Opportunity Zone Funds? In a sentence, they are investments that are mainly invested in areas defined as qualified opportunity zones (QOZ) and allow some short term capital gain deferment with some elimination of tax on long term gains (if fund held for ten years).

The crowdfunding sites I've looked at (eg Origin Investments) still charge pretty hefty fees including 15% performance fee and 1.25% annual fee.

Any experience or thoughts?

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quantAndHold
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Re: Opportunity Zone Funds

Post by quantAndHold »

Opportunity zones have only been a thing for just over a year, so nobody is going to have much of a track record.

I discovered that I live in an opportunity zone. From what I’ve seen, I would strongly suspect that the tax advantages are priced in already.
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Re: Opportunity Zone Funds

Post by bsteiner »

We looked at this for a real estate developer some of whose projects are in an opportunity zone, but it didn't seem practical to take advantage of it.
Wyodoc
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Re: Opportunity Zone Funds

Post by Wyodoc »

I have looked into OZ. I believe they could make financial sense for someone with large capital gains from the sale of a business or funds and they want to avoid some LTCG taxes and defer the rest. This will come at a price of illiquidity and higher risk investment areas.
riverguy
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Re: Opportunity Zone Funds

Post by riverguy »

Looked at them extensively and decided to pass. Cap gains rates are low now. Enormous exposure to the laws changing between now and ten years from now. The trend is going to be to eat the rich. Hard to see how cap gains rates get lower but super easy to see them going up.

The basis increase is rather minimal. You have no liquidity. You are entirely dependent on cap gains being realized from your OZ fund on an exit. Waterfalls and incentives to the sponsor taking a big chunk of the cap gains kills it as well. If you don’t have monster cap gains on exit, you basically wasted ten years.
Spencer
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Re: Opportunity Zone Funds

Post by Spencer »

I have quite a bit of experience underwriting OZ funds (30+), and have committed to numerous funds from the sale of a business. It's an interesting tax play for certain investors in certain circumstances, but it's not for everyone.

If you are concerned about fees, this is not the space for you. 1.25/15 is par for the course, if not lower than average, for fund fees. On top of this, I suspect this is a ground-up development play (as 95+% of OZ projects are), you've got developer level fees that can double or triple total fees. The key is having a fee waterfall that rewards performance, and not just base management fees. Personally, I'm happy to pay incentive fees for good performance but not egregious management, or transaction based fees.

If you are serious about the space, you need to network with the sponsors directly. Generally speaking, the heavily marketed projects/funds online are garbage. Additionally, most require being an accredited investor, if not qualified purchaser, and require minimums of $250k-1m, so there are some hurdles to having decent diversification in the space.
riverguy wrote: Sun Jun 16, 2019 5:26 pm Looked at them extensively and decided to pass. Cap gains rates are low now. Enormous exposure to the laws changing between now and ten years from now. The trend is going to be to eat the rich. Hard to see how cap gains rates get lower but super easy to see them going up.

The basis increase is rather minimal. You have no liquidity. You are entirely dependent on cap gains being realized from your OZ fund on an exit. Waterfalls and incentives to the sponsor taking a big chunk of the cap gains kills it as well. If you don’t have monster cap gains on exit, you basically wasted ten years.
The biggest cap gain rate risk is through 2026 when the deferral is due. I would tend to agree with your assessment of rates going up but the risk is hedged by the 15% gain reduction and TVM of the 7 year deferral.

As you noted, the biggest incentive is the back end, but it is a step up in basis, and not just cap gain forgiveness. This means (but is not 100% set in stone due to regs not being 100% final), that you don't have to recapture depreciation on the back end either, which is another huge bonus, and for most projects, means you've got tax free income over the project life, plus many throw off more depreciation expense than distributions, so you can shield other sources of passive income as well.

As far as the 10 year horizon, personally, I like it. Too many private RE deals tend to be 2-5 year horizons that incentivize huge IRRs with mediocre multiples that benefit the sponsors and not long term equity investors. As far as wasting 10 years, that can happen in any market if you have a long horizon, but the cash flows in these deals are not all after 10 years. Most have a large liquidity event around year 4-5 when the projects are stabilized, which returns a large sum of capital, plus you've got tax-advantaged distributions over the life of the project.

There are pros/cons to the program, but again, I think it works well for certain investors in certain circumstances. I would not be selling gains in an index fund to invest in QOF's.
renue74
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Re: Opportunity Zone Funds

Post by renue74 »

bsteiner wrote: Sun Jun 16, 2019 1:26 pm We looked at this for a real estate developer some of whose projects are in an opportunity zone, but it didn't seem practical to take advantage of it.
+1 . We looked at it in real estate as well. I'm not remembering the exact details, but basically if you bought properties for rehab, you had to match the purchase price with updates. Buy a $75K property, you had to put in $75K in upgrades/rehabs to participate.

Not an option for small time folks like me.

I would also be interested in hearing success stories.
Spencer
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Re: Opportunity Zone Funds

Post by Spencer »

renue74 wrote: Sun Jun 16, 2019 8:14 pm
bsteiner wrote: Sun Jun 16, 2019 1:26 pm We looked at this for a real estate developer some of whose projects are in an opportunity zone, but it didn't seem practical to take advantage of it.
+1 . We looked at it in real estate as well. I'm not remembering the exact details, but basically if you bought properties for rehab, you had to match the purchase price with updates. Buy a $75K property, you had to put in $75K in upgrades/rehabs to participate.

Not an option for small time folks like me.

I would also be interested in hearing success stories.
You have to double the improvement value, so for that $75k property, if the split between land/improvements is 50/50, then you'd need to invest another $32.5k into the property to qualify.

For value add deals, the OZ qualification works best in markets (and properties) with a high land value ratio (ie, land value is 75%+ of acquisition price), which tends to be older buildings in HCOL markets.
renue74
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Re: Opportunity Zone Funds

Post by renue74 »

Spencer wrote: Sun Jun 16, 2019 8:22 pm
renue74 wrote: Sun Jun 16, 2019 8:14 pm
bsteiner wrote: Sun Jun 16, 2019 1:26 pm We looked at this for a real estate developer some of whose projects are in an opportunity zone, but it didn't seem practical to take advantage of it.
+1 . We looked at it in real estate as well. I'm not remembering the exact details, but basically if you bought properties for rehab, you had to match the purchase price with updates. Buy a $75K property, you had to put in $75K in upgrades/rehabs to participate.

Not an option for small time folks like me.

I would also be interested in hearing success stories.
You have to double the improvement value, so for that $75k property, if the split between land/improvements is 50/50, then you'd need to invest another $32.5k into the property to qualify.

For value add deals, the OZ qualification works best in markets (and properties) with a high land value ratio (ie, land value is 75%+ of acquisition price), which tends to be older buildings in HCOL markets.
Thanks for clarifying! I think it's been about a year since I looked at it. Large parts of my town are OZ areas, but not HCOL. I don't think I've seen any deals made here.
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cdaddio23
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Re: Opportunity Zone Funds

Post by cdaddio23 »

Spencer wrote: Sun Jun 16, 2019 7:37 pm.

If you are concerned about fees, this is not the space for you. 1.25/15 is par for the course, if not lower than average, for fund fees. On top of this, I suspect this is a ground-up development play (as 95+% of OZ projects are), you've got developer level fees that can double or triple total fees.
Good to know, because much as there is a 0.5% acquisition fee of asset purchase price, it is hard to quantify what that means.
Spencer wrote: Sun Jun 16, 2019 7:37 pm Additionally, most require being an accredited investor, if not qualified purchaser, and require minimums of $250k-1m
This particular fund has an entry level of 50k, hence my interest. I'm not sure I would want to risk a larger amount at this time.
Spencer wrote: Sun Jun 16, 2019 7:37 pm I would not be selling gains in an index fund to invest in QOF's.
Another good point, but I am a Boglehead, so all of my free capital goes rapidly into index funds. Now what?

Thanks for the advice, I will likely hold off.
lcsma
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Re: Opportunity Zone Funds

Post by lcsma »

How do one go about finding a list of good OZ funds? Is there any resources you can recommend? Or if you can recommend some specific funds, that would also be really helpful. Thanks!
Spencer wrote: Sun Jun 16, 2019 7:37 pm If you are serious about the space, you need to network with the sponsors directly. Generally speaking, the heavily marketed projects/funds online are garbage. Additionally, most require being an accredited investor, if not qualified purchaser, and require minimums of $250k-1m, so there are some hurdles to having decent diversification in the space.
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Re: Opportunity Zone Funds

Post by LadyGeek »

This thread is now in the Investing - Theory, News & General forum (general discussion).

lcsma, Welcome!
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Spencer
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Re: Opportunity Zone Funds

Post by Spencer »

lcsma wrote: Tue Jul 23, 2019 2:40 pm How do one go about finding a list of good OZ funds? Is there any resources you can recommend? Or if you can recommend some specific funds, that would also be really helpful. Thanks!
Spencer wrote: Sun Jun 16, 2019 7:37 pm If you are serious about the space, you need to network with the sponsors directly. Generally speaking, the heavily marketed projects/funds online are garbage. Additionally, most require being an accredited investor, if not qualified purchaser, and require minimums of $250k-1m, so there are some hurdles to having decent diversification in the space.
Here are a few databases to start with,

https://www.ncsha.org/resource/opportun ... directory/
https://opportunitydb.com/funds/
https://www.novoco.com/resource-centers ... ds-listing

I can't recommend anything publically since "it depends" on individual circumstances, just like ETF/Mutual Fund/Bond recommendations.
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Re: Opportunity Zone Funds

Post by lcsma »

Thanks for the pointers. I also found those lists independently by googling, but it is hard to tell good funds from bad funds, especially given all QOZ funds are pretty much new with no track record to speak of. Some of those sponsors have done other projects before, but finding reviews in the private equity world seems next to impossible for people outside the industry.

The reason I am researching this is that I have about 100k of realized capital gain that I'd like to defer on, and this seems like one way of doing it (plus I also want to increase my real estate exposure). Doing a QOZ project on my own is out of the question due to the original use requirement. I've never invested in private equity fund before, I would qualify as accredited investor, but not qualified purchaser. And I don't want to put in much more than 100k in this. Is this something worth pursuing at all or should I just pay the capital gain tax and put the money in a total stock fund?

Thanks

Spencer wrote: Tue Jul 23, 2019 3:50 pm
lcsma wrote: Tue Jul 23, 2019 2:40 pm How do one go about finding a list of good OZ funds? Is there any resources you can recommend? Or if you can recommend some specific funds, that would also be really helpful. Thanks!
Spencer wrote: Sun Jun 16, 2019 7:37 pm If you are serious about the space, you need to network with the sponsors directly. Generally speaking, the heavily marketed projects/funds online are garbage. Additionally, most require being an accredited investor, if not qualified purchaser, and require minimums of $250k-1m, so there are some hurdles to having decent diversification in the space.
Here are a few databases to start with,

https://www.ncsha.org/resource/opportun ... directory/
https://opportunitydb.com/funds/
https://www.novoco.com/resource-centers ... ds-listing

I can't recommend anything publically since "it depends" on individual circumstances, just like ETF/Mutual Fund/Bond recommendations.
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Re: Opportunity Zone Funds

Post by MikeG62 »

cdaddio23 wrote: Sun Jun 16, 2019 11:08 am Has anyone had experience with Opportunity Zone Funds? In a sentence, they are investments that are mainly invested in areas defined as qualified opportunity zones (QOZ) and allow some short term capital gain deferment with some elimination of tax on long term gains (if fund held for ten years).

The crowdfunding sites I've looked at (eg Origin Investments) still charge pretty hefty fees including 15% performance fee and 1.25% annual fee.

Any experience or thoughts?

Cdaddio23
My broker (where I source my muni bonds) sent me an e-mail on this several months ago. If I were inclined to invest in something like this, I would be very comfortable buying into anything he recommends (he almost always is personally investing in anything like this he sends my way - which is not all that often, by the way). However, these are (at least his was) a very long term investment. Ideally the money should remain in the investment for 10 years or more. One upside is ability to defer tax on capital gain (for up to 7 years) on investment sold to free up cash for investment in these opportunity funds. Second, is ability to shield some of the capital gain from ever being taxed (10% shield if held for 5 years and 15% shield if held for 7 years or more). Third, you get basis step up on opportunity fund investment if you hold for I think it was 10 years. I'm not looking to tie up funds that long and I prefer simple over complex. This felt complex. So I passed.

That's all I know about them.
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Spencer
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Re: Opportunity Zone Funds

Post by Spencer »

lcsma wrote: Thu Jul 25, 2019 1:15 pm Thanks for the pointers. I also found those lists independently by googling, but it is hard to tell good funds from bad funds, especially given all QOZ funds are pretty much new with no track record to speak of. Some of those sponsors have done other projects before, but finding reviews in the private equity world seems next to impossible for people outside the industry.

The reason I am researching this is that I have about 100k of realized capital gain that I'd like to defer on, and this seems like one way of doing it (plus I also want to increase my real estate exposure). Doing a QOZ project on my own is out of the question due to the original use requirement. I've never invested in private equity fund before, I would qualify as accredited investor, but not qualified purchaser. And I don't want to put in much more than 100k in this. Is this something worth pursuing at all or should I just pay the capital gain tax and put the money in a total stock fund?

Thanks

Spencer wrote: Tue Jul 23, 2019 3:50 pm
lcsma wrote: Tue Jul 23, 2019 2:40 pm How do one go about finding a list of good OZ funds? Is there any resources you can recommend? Or if you can recommend some specific funds, that would also be really helpful. Thanks!
Spencer wrote: Sun Jun 16, 2019 7:37 pm If you are serious about the space, you need to network with the sponsors directly. Generally speaking, the heavily marketed projects/funds online are garbage. Additionally, most require being an accredited investor, if not qualified purchaser, and require minimums of $250k-1m, so there are some hurdles to having decent diversification in the space.
Here are a few databases to start with,

https://www.ncsha.org/resource/opportun ... directory/
https://opportunitydb.com/funds/
https://www.novoco.com/resource-centers ... ds-listing

I can't recommend anything publically since "it depends" on individual circumstances, just like ETF/Mutual Fund/Bond recommendations.
As you noted, the OZ regs are new, so there is not going to be any direct QOF track records available, but there are plenty of RE sponsors that have played in OZ markets previously, so at the end of the day, you're investing in the Sponsor and their overall track record. Personally, I was looking for reputable sponsors where the OZ program fit into their existing investment model.

For $100k of gains, I'd probably just pay the tax, especially if you're in the 15% cap gain bracket with no/low state taxes. The potential benefit is probably not worth the amount of work it takes to underwrite these funds, plus you won't have enough capital to commit to most of the funds, or obtain much diversification across sponsors. I'd probably want $750k-1m in gains at a minimum, which would get 3-4 $250k commitments (generally the minimum for larger/experienced multi-asset OZ funds), with exposure to 20-30+ underlying assets. This is enough Sponsor/Asset diversification to get a broader OZ/RE exposure, which tends to be the idea, unless you've got an edge, in which case, you're probably running your own OZ deal rather than investing in a fund as an LP.

It would be nice if there was a low cost "fund of funds" for QOF's to get broad exposure in a single vehicle but unfortunately, it's not allowed by the regulations.
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Re: Opportunity Zone Funds

Post by Vladimir »

I found a publicly traded OZF, ticker symbol BELP (soon to be changed to OZ), https://belpointereit.com. It is much cheaper than most other OZFs: 0.75% expense ratio and 5% carried interest. They specialize in class A apartments.

Here is some information about the fund coming from the answers to the questions I asked their rep:

"We are trading as a quasi open-ended structure, similar to an open-ended mutual fund but instead of being priced daily, we are priced quarterly. Our NAV is determined by our independent board who obtains third-party appraisals of our real estate + cash (other assets) / number of shares outstanding. We then issue shares to our market makers at that price and they execute orders on the market for a small spread. So currently our NAV is $100 and our market makers are executing between $100.05 and $100.20. Going forward, as an example, let's say the NAV increases to $105 next quarter. We would then issue shares to our MM's at $105 and they would execute for between $105.05 and $105.20. This strategy enables us to stay in line with NAV where closed-end structures (all publicly traded REITS) fluctuate around NAV. This whole strategy allows us to continually raise capital for many years as well as add 4-5 new projects per year. Unlike our closed-end competitors who open up the capital raising period, take all of the capital in, and close it. This means those investors are only diversified in a set number of projects, they all have the same 10-year clock, and they are all beholden to the fund manager's decisions on when to liquidate. We do not plan on ever not raising new capital."

I have a couple of questions about OZF/QAF taxability:

1) Depreciation recapture is not taxed for OZF investments held > 10 years. What about the properties sold to acquire an OZF? If I sell my four-plex for $200k in 2021 that had cost me $110k and has accumulated depr-n of $38k, the gain due to appreciation is $90k and the unrecaptured depreciation is $38k. If I invest the entire $128k gain (90k + 38k) into an OZF, is the entire $128k deferred to 2026 or is only the $90k appreciation deferred? I asked two different people and got opposite answers.

(2) After 2026, the tax on the gain is due. I read the basis is stepped up 10%. Is “basis” that is stepped up the total gain invested into an OZF ($128k) or the basis of the original property sold to buy an OZF ($72k)?

(3) If my capital gains rate is 15% and depreciation recapture rate is 25% in 2026, how much do I pay in taxes on that total gain after the end of 2026?

Thanks
Spencer
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Re: Opportunity Zone Funds

Post by Spencer »

I don't have any answers for your tax-specific questions, but I wouldn't touch the Belpointe REIT with a 10ft pole. They've had extremely limited traction, and IMO, there is no upside to having the share trade publically.
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Re: Opportunity Zone Funds

Post by Vladimir »

I don't care if it's publicly traded as much as the lower fees.
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Re: Opportunity Zone Funds

Post by HootingSloth »

EDIT: These answers were not right. I have corrected the answers below after SubPar's comment.
Vladimir wrote: Thu Jun 24, 2021 12:51 pm 1) Depreciation recapture is not taxed for OZF investments held > 10 years. What about the properties sold to acquire an OZF? If I sell my four-plex for $200k in 2021 that had cost me $110k and has accumulated depr-n of $38k, the gain due to appreciation is $90k and the unrecaptured depreciation is $38k. If I invest the entire $128k gain (90k + 38k) into an OZF, is the entire $128k deferred to 2026 or is only the $90k appreciation deferred? I asked two different people and got opposite answers.
The depreciation recapture is not an eligible gain. In order to be eligible for deferral under the Opportunity Zone rules, a gain must either be a capital gain or qualified 1231 gain. Depending on your facts, your gain from the sale of the four-plex potentially could be 1231 gain, but, in any event, the portion of any 1231 gain that is treated as ordinary income under the depreciation recapture rules is excluded from qualified 1231 gain under the Opportunity Zone rules and so is not eligible gain.
(2) After 2026, the tax on the gain is due. I read the basis is stepped up 10%. Is “basis” that is stepped up the total gain invested into an OZF ($128k) or the basis of the original property sold to buy an OZF ($72k)?
The 10% that is stepped up if you hold your interest in the qualified opportunity fund for 5 years prior to the end of 2026 is 10% of the deferred gain (i.e., 10% of $90k).
(3) If my capital gains rate is 15% and depreciation recapture rate is 25% in 2026, how much do I pay in taxes on that total gain after the end of 2026?
At the end of 2026 you will pay your then-current capital gains rate on any remaining deferred gain. Because the depreciation recapture will not figure into deferred gain, it will not have any impact in 2026.
Last edited by HootingSloth on Thu Jun 24, 2021 4:37 pm, edited 2 times in total.
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Re: Opportunity Zone Funds

Post by Spencer »

Vladimir wrote: Thu Jun 24, 2021 2:36 pm I don't care if it's publicly traded as much as the lower fees.
You'll care if you buy shares at 100% NAV now, and then they trade at a 30-40% discount when you try to sell them after your 10yr horizon, and the sponsor has no plans to sell assets. Micro-cap security with esoteric tax treatment is ripe for limited secondary interest.

In my opinion, you're getting what you're paying for in this situation. I've met the principals at an OZ event, and heard their pitch, and again, wouldn't recommend them compared with some of the other offerings, and sponsors in the OZ world.
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Re: Opportunity Zone Funds

Post by Vladimir »

What sponsors or OZFs would you recommend, Spencer?
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Re: Opportunity Zone Funds

Post by Spencer »

Big OZ players that I'd start off research with are Bridge, Cresset, Argosy, Grubb and Origin. All reputable, and have successfully raised and deployed 9-10 figures each.

With that being said, it sounds like you have gains from an RE transaction, in which case, I'd personally consider a 1031 exchange strategy as well. Better tax deferral, and you aren't forced into ground-up development, which most OZ deals are.
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Re: Opportunity Zone Funds

Post by SubPar »

Unrecaptured 1250 Gains are capital in nature and deferrable into a QOF.
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Re: Opportunity Zone Funds

Post by HootingSloth »

SubPar wrote: Thu Jun 24, 2021 4:21 pm Unrecaptured 1250 Gains are capital in nature and deferrable into a QOF.
This is correct, and I misunderstood the questions above. Recaptured depreciation, treated as ordinary income under section 1245 or section 1250, would not be eligible, but unrecaptured 1250 gain is eligible.

If you bought before the end of this year, held until the end of 2026, and there was no inclusion event for the QOF, you would be able to defer $128k, would get a $12.8k step-up in basis after the 5-year hold, and would then recognize $115.2k of gain at the end of 2026 ($81k of capital gain and $34.2k of unrecaptured 1250 gain).
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Re: Opportunity Zone Funds

Post by SubPar »

HootingSloth wrote: Thu Jun 24, 2021 4:35 pm
SubPar wrote: Thu Jun 24, 2021 4:21 pm Unrecaptured 1250 Gains are capital in nature and deferrable into a QOF.
This is correct, and I misunderstood the questions above. Recaptured depreciation, treated as ordinary income under section 1245 or section 1250, would not be eligible, but unrecaptured 1250 gain is eligible.

If you bought before the end of this year, held until the end of 2026, and there was no inclusion event for the QOF, you would be able to defer $128k, would get a $12.8k step-up in basis after the 5-year hold, and would then recognize $115.2k of gain at the end of 2026 ($81k of capital gain and $34.2k of unrecaptured 1250 gain).
I mean, nothing that you said in your first response was wrong. The question referred to both depreciation recapture and unrecaptured depreciation as if they were synonymous. A 25% tax rate was mentioned, so I assumed it was the latter. A lot of people get confused between those two concepts (as I'm sure you know), so I just wanted to clarify -- they are, in fact, different.

Generally, unless you've carved out 5/7/15 year property via cost seg or made capital improvements following acquisition, there usually won't be much in the way of ordinary recapture upon disposition of 27.5 year property.

Spencer gave a ton of great detail surrounding the program already, so not a ton to add. My company has developed/sponsored a number of multi-family/mixed use ground-up OZ developments, albeit on a much smaller scale than the national players. I agree that QOF investments make sense for some, don't make sense for others, and not all projects/funds/developers are created equal.
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Re: Opportunity Zone Funds

Post by HootingSloth »

SubPar wrote: Fri Jun 25, 2021 8:51 am
HootingSloth wrote: Thu Jun 24, 2021 4:35 pm
SubPar wrote: Thu Jun 24, 2021 4:21 pm Unrecaptured 1250 Gains are capital in nature and deferrable into a QOF.
This is correct, and I misunderstood the questions above. Recaptured depreciation, treated as ordinary income under section 1245 or section 1250, would not be eligible, but unrecaptured 1250 gain is eligible.

If you bought before the end of this year, held until the end of 2026, and there was no inclusion event for the QOF, you would be able to defer $128k, would get a $12.8k step-up in basis after the 5-year hold, and would then recognize $115.2k of gain at the end of 2026 ($81k of capital gain and $34.2k of unrecaptured 1250 gain).
I mean, nothing that you said in your first response was wrong. The question referred to both depreciation recapture and unrecaptured depreciation as if they were synonymous. A 25% tax rate was mentioned, so I assumed it was the latter. A lot of people get confused between those two concepts (as I'm sure you know), so I just wanted to clarify -- they are, in fact, different.

Generally, unless you've carved out 5/7/15 year property via cost seg or made capital improvements following acquisition, there usually won't be much in the way of ordinary recapture upon disposition of 27.5 year property.

Spencer gave a ton of great detail surrounding the program already, so not a ton to add. My company has developed/sponsored a number of multi-family/mixed use ground-up OZ developments, albeit on a much smaller scale than the national players. I agree that QOF investments make sense for some, don't make sense for others, and not all projects/funds/developers are created equal.
Yes, I read the initial reference to depreciation recapture and then just assumed that is what the poster was talking about. After rereading it, it seemed much more likely he was talking about unrecaptured gain.
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Re: Opportunity Zone Funds

Post by Vladimir »

Thank you all for for all the answers/clarifications! Looks like I got confused by "recaptured" vs. "unrecaptured". I only used straight-line depr-n, so it should all be a qualified gain.

I have two investment properties and am tired of direct ownership. I got offers from the same buyer for both (have not accepted yet, going back-and-forth on the nuances). The net proceeds would be around $295k ($200k - $40k mortgage on one property + 135k on another that has no debt). The price appreciation & accumulated depreciation are roughly $90k & $38k on one of them (my example) and $60k & $17k on the other.

My goals are:
- Get out of direct RE ownership and reduce net exposure to RE by 20-25% (from the current net of about $295k to $240k). I would get out of illiquid RE investments altogether if I could without tax consequences, but it does not appear realistic.
- Have about $10-12k annual income from indirectly-owned RE or other investments. This would partially replace my net cash flow from the directly owned properties ($12-18k, depending on the year).

Seriously considering both 1031s (into DSTs) and OZFs.

Using the expected net proceeds of $295k, the paths I am considering are:

1) Reinvesting all the gains incl. accumulated depreciation (90 + 38 + 60 + 17 = $205k) into an OZF. Investing the remaining $90k into liquid assets (stocks, index funds, etc. - I am way more comfortable managing them than RE).

Downsides: May not see sufficient current income (distributions) for a while in OZFs. (Low liquidity and a holding period > 10 years do not bother me). I can invest the remaining $90k in high-dividend stocks and hedge the price exposure with futures or inverse ETFs to partially replace the current income. But the hedges would not be perfect, still leaving some exposure. Besides, investing $205k may be too much if the downside is significant.

Based on an earlier post in the thread, I need $250k to get into a reputable OZF, which I would not have. This is why I am considering BELP. Clearly, I need to study their business model deeper. If they don't get traction and sell fewer shares than hoped for, but all it does is cause them to operate on a smaller scale (have fewer properties), that's not a huge problem. If, however, they employ significant leverage and have great downside risk, that's a totally different story.

2) Reinvesting the gains from the bigger property ($128k gains) into an OZF, its remaining undepreciated basis less the mortgage ($72k - $40k = $32k or so) into liquid assets, and the total proceeds from the smaller property ($135k, no leverage) into a zero-leverage DST with a low downside and modest upside. At around a 5% distribution yield, that would replace only $6-7k of the current income. However, DSTs tend to overpay for properties.

3) Reinvesting $160k of the net proceeds from the bigger property sale ($200k less the $40k mortgage) into a levered DST via a 1031 exchange; the gains from the smaller property ($77k) into an OZF, and its remaining basis ($58k) into liquid assets. This is similar to #2, but the properties are switched around (in terms how the proceeds are reinvested).

The problem here is I have to use a levered DST in a 1031 exchange. IMO, chances of the RE market peaking and then turning down within a couple of years are significant. This can get many leveraged DSTs in trouble. I have a 20% leverage in my bigger property, but levered DSTs tend to start at 40%+ (higher than my preference).

4) Reinvesting all of the proceeds ($295k) into a combination of levered and unlevered DSTs via a 1031. May replace my current income, but does not reduce RE exposure, and the overall DST leverage will likely end up being higher than I prefer. I can try to hedge with liquid instruments, but no RE hedge would be great.

5) Recognizing gains and paying taxes ($40-42k in federal plus state) in early 2022, reinvesting the net proceeds into liquid assets. With a net worth just over $1m and with most of it in retirement accounts (can start withdrawing from some of them in 15 years but prefer to delay more), $40k is a significant chunk of money for me, so I would like to avoid this scenario.

I realize, of course, that I would have to pay capital gain tax in early 2027 if I reinvest in an OZF. Here the hope is that by then my OZF investment(s) would appreciate enough to justify it, and that the fund would either plan to have a large payout to investors in 2026 or (if it is publicly traded like BELP) there will be enough liquidity to sell some of the fund's shares to cover the tax obligation.

P.S. I don't mean to get a free ride and hope this discussion is useful to other members.
Spencer
Posts: 172
Joined: Wed Mar 19, 2014 10:20 am

Re: Opportunity Zone Funds

Post by Spencer »

Another option might be to sell the properties on an installment sale to spread your gain recognition over a number of years, which could help your tax liability depending on your tax bracket.

DST option - As you noted, they are generally a rat's nest of overpriced deals and heavy placement fees. I'd beware of this route.

Some of the better OZ funds have lowered their minimums since my post in 2019. I personally know that Grubb and Origin have accepted $100k commitments.
HootingSloth
Posts: 1050
Joined: Mon Jan 28, 2019 2:38 pm

Re: Opportunity Zone Funds

Post by HootingSloth »

I think, first and foremost, you should be making sure that you actually want the investment, ignoring the tax benefits. It sounds like you know that and are looking before you leap on whether the investment is the kind of investment you want to make. If I were in your shoes, I would not do either a QOF investment or a 1031 exchange, but only because I am not someone who invests in real estate deals.

My impression is that it is still pretty difficult to find attractive, diversified QOFs. Most of the activity I am seeing in this space is still "single project"/"single business" investments that might be driven by a single investor or by a friends-and-family group of investors. I don't know that I have a comprehensive view of the market, though, because I only see what my own clients are doing.

Assuming you are deciding between a QOF and a 1031 exchange that are equally compelling on a pre-tax basis, I think the main tradeoff you are looking at is needing to recognize most of the deferred gain in 2026 vs. the benefit of the 10-year step up. The 10-year step up can be significantly more valuable than the deferral benefit, but obviously depends on how the investment actually does.
Global Market Portfolio + modest tilt towards volatility (80/20->60/40 as approach FI) + modest tilt away from exchange rate risk (80% global+20% U.S. stocks; currency-hedge bonds) + tax optimization
Dowade
Posts: 1
Joined: Sat Oct 30, 2021 8:56 pm

Re: Opportunity Zone Funds

Post by Dowade »

Belpointe OZ is now trading on the NYSE at $100 and the NAV is set quarterly. It seems to solve the liquidity issue of Opportunity Zone Funds.

I have $100K capital gains from stocks in 2021 that I wish to defer. What if I were to buy $100K of OZ now to defer 2021 capital gains.

…. and sell it in June 2022.

If I wish to defer capital gains again in 2022, I can repurchase within 180 days of the “inclusion event” which is my sale in June 2022.

As a short term tactic, is it feasible to sell and rebuy within 150 days of the sale?

I’m assuming the stock price stays at $100 or even goes up a bit next year.
3feetpete
Posts: 613
Joined: Sun Dec 14, 2014 6:30 pm

Re: Opportunity Zone Funds

Post by 3feetpete »

I think this would be a very risky investment. I like the concept of opportunity zones to help disadvantaged areas but would bet there will be plenty of schemers moving in and out of it with shell companies and other fraudulent activities. All anyone has to do is rent an office with a telephone and they've got a business in an opportunity zone. Working in the construction industry, I saw that kind of activity frequently with the minority business programs that exist in most cities.
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