MODERATOR: Welcome, thank you all for being here. I’m looking forward to an interesting discussion on a topic that probably isn’t discussed a lot, but may be beneficial for folks, and that is opportunity zones. And I figure we probably ought to start with a definition. What is an opportunity zone or a qualified opportunity zone?
MR. SULLIVAN: I can jump in and talk a little bit about that. Essentially, through the Tax Reform Act that got passed back in December of 2017, this incentive was put in place, and it’s really geared around identification of distressed areas, economically distressed, very low-income areas, communities that, through the act, gave each of the governors of their states the ability to go in and designate up to 25 percent of what they call distressed areas through the census process, and they can designate up to 25 percent of those as these opportunity zones. So it’s based on census data from some period of time, and then each of the governors were given the ability to say, OK, we want to put forth to you as treasury these specific areas that we would like to have designated as qualified opportunity zones. And so they went through that process of submitting it to treasury, and then, I believe it was in June, treasury came out and said these are all the areas we’ve certified as qualified opportunity zones. So that’s kind of the process, and the purpose was to provide an incentive for there to be economic development brought into these particular areas.
MODERATOR: These are distressed areas
that may not otherwise get a lot of
attention and by determining them as
opportunity zones may invite some more
MR. SULLIVAN: Right.
MR. POHL: Yes.
MR. NELSON: I believe there’s 74 in the State of Kansas that have been approved?
MR. SULLIVAN: There’s, like, 8,700 across the U.S., so there’s quite a few of those areas. But I think it’s pretty interesting if you really drill down and look at those areas that could have been picked, there was a lot of ability for the states to really focus on where it is they want that to take place. Where do they want to provide the incentive, hoping it would take place, because it’s not only in core downtown, what we normally think of maybe as a little bit economically depressed areas, but there’s also some opportunities to say, well, if we really want to incent economic development, bringing in jobs and that sort of thing, we could look at maybe where we want to have industrial parks be developed, because a lot of times the census data is based on what’s the average income of the individuals that live in those areas, and they particularly are fairly low population areas.
So different states, I think, took different approaches, if you really get to looking around the country and what areas have been designated and what ones weren’t.
MODERATOR: Do we know about how many are in Kansas, how many in the Wichita area?
MR. SULLIVAN: There’s nine total. Now, some of them are contiguous, so when you look at it it looks like there aren’t that many, but there really are nine and, again, some of them are butting up against each other so they look like one.
MR. NELSON: Which most of downtown —
MR. SULLIVAN: Yeah, it really is.
MR. NELSON: — is in the opportunity zone.
MR. SULLIVAN: For the most part it’s bordered on the north by 21st Street, down south to about Pawnee, from about Seneca over to roughly Hillside or Oliver in some cases. And it’s not that whole area, it’s pockets within there.
MODERATOR: But nine generally within that geographic area?
MR. SULLIVAN: Yeah.
MODERATOR: So now that they have been designated as opportunity zones, what’s next?
MR. POHL: Well, the next step is to invest in those zones or find companies that will invest in those zones, whether it be on a developer side, a manufacturer side, any type of business that’s willing to defer or wants to defer their gains and take those gains and put them into either a fund or an investment, a real estate investment inside those zones and take advantage of what the tax provisions allow for. And that’s essentially a step-up in basis for a period of time or different steps-up in basis plus a deferral of the tax for a period of time. So we now need to essentially look at those zones and see what’s available and also look at different businesses that would like to be in those zones.
MODERATOR: So let’s say a developer or a business or a company is taking a look at the discussion and talking about opportunity zones and may be interested. What steps should they take? Maybe a deeper dive into what’s exactly the benefit to the investor in that opportunity zone?
MR. POHL: I view it as there’s probably two different benefits: one is the step-up in basis from the five- and the seven-year period; in other words, if you hold in that area five years, you get 10 percent, and another two years after that, you get another 5 percent on top of that, so you’re at a 15 percent step-up.
I view that as kind of a small incentive compared to what I consider the larger incentive, which is that if you hold in that area for a period of longer than ten years, when you go to sell, you get a step-up to fair market value of the property or the asset that you’re selling from that zone. And to me, the long-term play of this is much better than the short-term play of the statute.
MR. NELSON: And incentives to get in and stay in versus in and out, just to take a short-term advantage. The ten-year is a big upside, an incentive to the investor to hold in that area.
MR. SULLIVAN: Maybe a simple example would be helpful. If an individual has a capital gain, and we’ll get into the specifics of how you qualify or what qualifies, but if an individual sells something and has a capital gain, they would normally have to pay tax on that, let’s say it’s a million dollars.
Well, if you invest that in one of these qualified opportunity zone arrangements and you hold it at least five years, where you would have paid tax on a million dollars, now you’re only going to pay tax on $900,000 because you’re getting the 10 percent step-up in basis as discussed.
And if you hold it out seven years, you actually get another 5 percent, so 15 off, so you’re only paying tax on $850,000. And then going to the ten-year example, let’s say it’s doubled in value now and it’s really worth $2 million, well, you’re only ever going to have paid tax on $850,000 because you’ve got the 10 percent, the 5 percent, and then everything over and above the gain that you originally invested.
So for that long-term play it’s a huge benefit. For the short-term, it’s a deferral of the tax for a while and somewhat of a haircut on the tax, but certainly if the gain’s big enough that could be a huge deal.
MODERATOR: And obviously there’s a community benefit to this whole thing, that’s why the opportunity zones were created in the first place, right?
MR. SULLIVAN: Exactly.
MR. POHL: Yeah.
MODERATOR: Talk about that a little bit.
MR. SULLIVAN: Well, anytime somebody has a very significant transaction where they’re going to pay a lot of tax — I sold my business for $50 million or I’ve got some significant real estate I sold or I’ve got a large stock portfolio with a lot of gains, appreciation built up, I feel like it’s the time to roll out of that market but I really don’t want to pay Uncle Sam his big piece right now — so the opportunity here is to defer that off and let your money work from a tax advantage for a period of time. And those are who are going to be the players are those individuals with the larger situations where they can get that deferral.
MR. NELSON: You mentioned real estate, do you think real estate’s going to play into this? I mean, to me if you have a real estate gain, the 1031 is probably a better vehicle, have you —
MR. SULLIVAN: Well, the only differential on a 1031 is, with the qualified opportunity zone you only have to invest your gain. So if my gain is a million dollars, that’s all I have to invest. If my real estate deal is really — they paid me $2 million for the property, I’ve got to effectively invest $2 million in the 1031 exchange. In other words, I don’t have any opportunity to take out cash that exceeds my gain because then it triggers on a 1031 some tax at that point.
MR. NELSON: OK.
MR. SULLIVAN: So it’s more flexible in regard to the ability to maybe put in just your gain money and not your total proceeds like you would have to on a real estate deal, where you’ve probably got some financing and you’ve had to pay off debt, well, you’d have to have that same level of debt in a 1031 that you don’t have to have in one of these.
MR. POHL: Yeah, I agree with you in that concept, and the concern I have a little bit is that you’re taking that gain and you’re putting it back into real estate but you also then have to look at a substantial improvement of that real estate. So while you’re pulling off your basis, so to speak, from that land transaction and I guess putting it in your own pocket, the reality is you’re going to have to find a way to come back into that land that you just bought, whether it’s a warehouse that you’re going to renovate, an old building that you want to convert to apartments, you have to substantially improve it, and you got a period of time to substantially improve it. And so you pulled that basis out, but you are going to have to find a way, either through the banking transaction or through other investors, to put more money back into that project to build it back up.
MR. SULLIVAN: And I do think that’s exactly right, it is going to require, typically, some leverage in most transactions, and I think that’s why Tim’s at the table because there are a lot of opportunities there. A lot of these are going to be real estate plays that people are not going to come in with cash to do the whole deal, you’re exactly right.
MODERATOR: What do you see in here, Tim, from the banker’s point of view?
MR. NELSON: Well, I think there’s opportunity. Again, there should be significant equity coming into the transaction. They are in low-income census, CRA credit, Community Reinvestment Act, I think the banks will all see that as a benefit and opportunity to loan in these areas.
MODERATOR: Do you think you’ll see folks that you don’t normally see? Will it create that type of an opportunity that there may be some investors coming into the opportunity zones that you haven’t seen in the past?
MR. NELSON: I think it’s early to tell. This is fairly complicated. You have to get your funds set up and then — it’s not something you just wake up in the morning and decide you’re going to do. One, you’ve got to have significant gain, then you have to have your fund established, and then you have to understand the rules. So I think the small investor … it would be not worth their time or energy or their understanding of it; you might have some large players that come in.
MR. SULLIVAN: Yeah, I think there’s been some discussion about are there going to be some large, more regional or national funds put together, that if I got $100,000 gain and I want to put it into one of these, I’m probably not going to do a local deal because it’s just not enough dollars to make it work, but maybe there’ll be opportunity for somebody syndicating these kind of deals and say, “look, come put your $100,000 into our fund, we’re going out across the country and finding these projects that qualify that you can get into.” I think we’ll probably see some of that. That’s my understanding, is some of those big groups are coming together, these big funds. I haven’t really delved into that, maybe you’ve seen that.
MR. POHL: Yes, I’ve seen a lot of discussion about these types of funds being created. They do cause me some concern from a standpoint of view of, it’s almost a marketing play, they want you to take your capital gains and put it with them.
The problem is you can’t make a bad investment a good investment just because you’re trying to defer capital gains tax or take the step-up basis of 10 percent, plus another 5 percent, plus the long-term deferral. If it’s a bad investment going in, it’s a bad investment no matter what.
And what concerns me is, when these funds come in and start touting this as being a way for the $100,000 issue, put your capital gain with us and we’ll take care of you, by the time you pay fees, costs, expenses, and everything else and look at the underlying documentation that’s been established, it may not be what it professes to be to you. It could be a very bad investment for you. Plus, when you have multiple investors — and this has been a very hot topic going around in the legal community — is that when you have multiple investors in these type of projects, I may be investing in year one and somebody else may be investing in year two and year three. On a real estate play, timing is everything on the sale, and so … it may be year seven and I’ve got my 15 percent in but may be year six for somebody else who came into this type of fund and he doesn’t get the benefit that I’m going to gain from a sale after that point in time, or a sale at year ten for me is different from a sale at year ten for somebody else.
So it’s just kind of a word of caution that these are unique investment vehicles but they need to be studied and reviewed in detail before you invest in them. That’s my caveat to the whole situation.
MR. SULLIVAN: And there is a trigger point at which you have to pay your tax. I mean, it’s — we talk about the five-year and seven-year, but the reality is that 12/31/2026, whatever you haven’t paid tax on, you have to pay tax on that date. Even if you stay in the investment, to move forward into the ten-year play, on that date you have to pay that tax, which maybe it’s 85 percent of what it would have been otherwise, but you’re going to have to fund that somehow. So you’re either going to have to go borrow some money or you’re going to have to get out of the investment or partly out of the investment. So it’s — there is a trigger point there where people are going to have to understand that they’re going to have a cash need to make Uncle Sam happy.
MR. POHL: Unless your investment’s gone down in value … then you made the bad investment and so you’re paying less tax because you made a bad investment going into the situation.
MR. SULLIVAN: Sure.
MODERATOR: Let’s hope there aren’t a lot of those situations.
MR. POHL: Yeah.
MODERATOR: You talked about the 12/31/2026, is that a floating deadline?
MR. SULLIVAN: No, it’s a hard deadline.
MR. SULLIVAN: This law came into effect in December of 2017 and really didn’t start getting much attention, I think, until mid year almost. I mean, there was a few players early on that were saying, “Huh, this is interesting, I wonder how this is going to play out.” We didn’t know where the zones were; we were already six months into it before we found out, OK, where are these zones located.
That data is not set, so, in 2024, if I’ve got a transaction with a big gain, I can put it in one of these investments, but I’m going to have to pay the bulk of that or all of that tax two years later. Now, I can stay in it and get my ultimate ten-year payoff where we talked about all the appreciation over the original amount, so you can stay in, it’s just you’re going to have a trigger to pay your original tax much sooner on that type.
So the closer we get to 2026, which is a hard, fixed date, people are going to have to look at these deals a little bit differently and understand they may not be getting any of that 10 or 15 percent reduction.
MODERATOR: So there is, to a certain extent, some sense of urgency; if you’re going to get in —
MR. SULLIVAN: Right.
MR. SULLIVAN: Yeah, unless you really feel like it’s a long-term, great investment that’s going to have a lot of upside potential.
MODERATOR: How did the opportunity zones get chosen?
MR. SULLIVAN: Well, my understanding is — and it’s really strange how they wrote the law — the chief executive officer of each state, the governor, was the one granted the power to do that. Now, presumably they handed it off to someone in their administration.
It would make sense if they went through the department of commerce. I don’t know if that’s how Kansas handled it, but I suspect then they pushed that down into, certainly, the larger metropolitan areas.
I would anticipate they went to them and said, OK, where do you guys think you want to see these zones, because there were a lot of zones to pick from but a limited number that they could, in fact, pick. So I don’t have any knowledge of how in Kansas exactly that worked.
MR. NELSON: But there are large portions or entire counties in the western part of the state that are zones.
MR. SULLIVAN: There are.
MR. POHL: Yes. Which makes for an interesting question of what do you do? And that’s been the struggle that I’ve had, is, you have entire counties in western Kansas that are a zone. And obviously the intent is to bring business and opportunity to those counties, but the question is what can you do within the time parameters allowed by the statute, and, again, knowing that the endgame here is an appreciation — to have a value appreciate in time, not lose investment money. So it’s going to be an interesting play as to whether this concept can be utilized for ranchers, farmers, oil and gas business, those type of businesses that have interests and plays in western Kansas and how that’s going to impact them.
MODERATOR: You talked a little bit about some of the potholes in the road as we go forward. Are there other potholes that you can tell our readers “You may want to navigate this carefully and watch out for this,” any examples of some more of those potholes in the road?
MR. SULLIVAN: It’s probably more of the timing issues. If we get into kind of the mechanics of this, first step is you have to have a capital gain transaction where you have a gain, and then you’ve got 180 days to decide if you want to reinvest that capital gain into one of these opportunity zones.
So, again, there’s a window of time you have to deal with, which requires that you put your capital gain into a qualified opportunity fund, which is an entity — can be a corporation or a partnership — and then that entity has some tests and requirements that at least 90 percent of its assets are invested in qualified opportunity zone property or businesses.
Those tests take place in kind of the first year of the opportunity zone fund. So it has some testing requirements the first six months and then the last day of the year. And if you don’t meet the 90 percent test, there’s penalties, fairly substantial actually. So if you’re going to get into it, you need to move forward and do it or understand you’re going to back off and pay your tax immediately.
So then, once you have your money in the fund, then the fund has to invest it in a qualified opportunity zone property or qualified property, and as we’ve talked, a lot of people think of it in terms of real estate, normally you’re probably going to go out and either find an existing situation where you want to invest in it or maybe it’s just you go and buy a piece of land with — an example was a warehouse that needs to be renovated or improved. Well, that’s fine but you have to, as it was mentioned earlier, invest as much in the renovation as you did — what you paid for it. Not in the land piece, the land you don’t have to do that, but if half-a-million dollars was the value on the warehouse that you acquired, you’re going to spend at least another half-a-million dollars improving it. And you’ve got, I think it’s 30 or 31 months to make that happen then to qualify.
So there’s all these time frames, there’s a lot of traps in there if things don’t work out … it could fail. But I think it’s fairly straightforward what those are, and as long as you’ve got somebody that’s used to developing real estate or innovating real estate, you’ve got the right players at the table, certainly very doable without a lot of risk in that regard. But, again, things can change on you unexpectedly. It’s a fairly long period of time to get your deal done and truly qualify.
MODERATOR: You talked about setting up that fund with your capital gain, you can do it on your own or you can join one of these funding groups?
MR. SULLIVAN: Right.
MR. NELSON: It would have to be fairly substantial to do it on your own just from the cost to organize and start.
MR. SULLIVAN: Yeah, I think — and it depends on what you’re looking at as far as the project. Like I said, if you’ve got a $1 or $2 million gain, the setup of the entity itself is not that expensive, it’s pretty straightforward, it’s just a basic entity, a corporation or a partnership LLC, that type of structure, so the formation’s very straightforward, people do it every day.
If you’re going to have some other folks bring their money into it, that’s where the complexity starts coming in, and I do think, then, you have to really look at it as, is this worth it given all the administrative costs? Yeah, you’re going to have subsequent tax returns on your fund entity, you’re going to have them probably on the underlying entity that actually holds the property depending on how you structure it, so there certainly are administrative, legal, accounting, tax services, those kind of things that come into play. So it has to be a pretty good amount or it becomes a little more administratively, economically maybe doesn’t make as much sense.
MODERATOR: We have an accounting and consulting firm, we have a law firm, and a bank, and so if investors come to you or somebody’s interested in an opportunity zone type of a situation, what do each of you advise them or what is your role and your advice to them about the opportunity zones and about how that happens?
MR. POHL: So my initial advice is obviously, if you have a gain, let’s set it aside. That’s the first step of the process, is making sure that we’re not mixing it up with everything else you’ve done in your life business-wise, so to speak.
I think after that it becomes a question of finding the fund to invest in or finding the investment, if that makes sense. And that’s where I think it’s important for all of us to kind of drill down into these deals, as I’ve discussed earlier, to make sure that what’s going on is above board and will work for your customer client, whoever it may be.
We do have a period of time, as discussed earlier too, to substantially improve the property, but that’s — I’ve had projects on the development side that can take 30 months to get past —
MR. SULLIVAN: Right.
MR. POHL: — entitlements, which we consider are just zoning issues or getting plan permits from the city or building permits, depends on where you’re located.
Each city has its different standards and different structures. And so you’re going to have to work with the client to help him understand that putting money in the fund is great but let’s find where the investment — can we get it all invested within that period of time? Can it be built? Is it in a good location? You can’t fix bad locations, so to speak. Hopefully the city grows to you or the whole area starts developing and the value goes up.
So I think the first advice, though, is do you have a gain? (You’ve) got to have a gain, and is this the right avenue for dealing with that gain? You hope to catch people before they sell and have the gain. There’s avenues to deal with it. We’ve talked about a 1031, here is another possibility of handling a transaction in that way. There’s probably estate planning devices that come into play for people that you can utilize to help deal with the gains.
So this is one avenue, but it’s not the only avenue, and I think what we can all bring to the table as accountants, bankers, and lawyers is to get in at the beginning of the process when somebody’s coming to you wanting to talk about selling their business or selling their real estate or just looking down the road and saying, what can we do for you first there? And then if we end up with a gain, what can we do, what’s the best way to handle that gain after the fact?
MODERATOR: How about on the banking side? What are you looking for, or at what point in the process does it come into your area?
MR. NELSON: I think these guys will lay the groundwork before it gets to the bank, and, again, we’re going to look at a good property in a good location, a good asset. So I think a lot of heavy lifting would be done by the time that person has made the decision.
I’d want to make sure they knew the rules, they knew the upside and downside to them because, again, there needs to be some sophistication to this transaction that will weed a lot of small players out. And then putting your money in a commingled fund, that’s a little uneasy to me right now. And the rules are still evolving; they just past passed, what, two weeks ago?
MR. SULLIVAN: Yeah, two weeks ago we got, what, 74 pages of proposed regulations where they tell you there’s still a lot of things we haven’t decided about; and, oh, by the way, what we’re telling you is proposed, we might change our mind and change that rule that we told you we think what the rule is.
MR. SULLIVAN: So there is a tremendous amount of uncertainty, and the clock’s ticking, as we said. Every day we’re one day closer to that December 2026 date, and some people are going to say, well, gee, I’m not comfortable yet, but yet maybe their 180-day clock is running. So it’s a challenge from just a rules and regulations standpoint.
MR. NELSON: And my hope is it does what it’s designed to, but the government is at work here, let’s make it difficult.
MR. POHL: I do think some of the guidance that the treasury did provide to us is good —
MR. SULLIVAN: Oh, absolutely.
MR. POHL: — in some respects. I mean, they gave us some latitude, I felt, on some things. I felt on other aspects of it, I thought they — the statute says gains, but they’re saying capital gains as opposed to ordinary gains, so they kind of shut that door a little bit, or how far it’s been shut, I don’t know.
This is a moving project, and so I get articles daily from people writing different theories or analysis or different concepts to use, so I think we’re going to see a lot of that play out over the next … now that we have some guidance, we’ll see a lot more articles, a lot more information being disbursed, and maybe some people starting to put these funds truly together and start to put these investments together.
MR. SULLIVAN: And the underlying message in these proposed rules is, look, as long as you’re trying to follow the intent and what we think we’re going to do, you’re going to be OK, because even if we change our mind, we’re probably going to give you an out in most cases.
So they’re trying to be understanding. Look, this was an incentive, not just taxing somebody, so, therefore, (we) don’t want to be punitive but we have to have some core rules everybody needs to be operating under.
You say what’s the role of the attorneys and the accountants and the bankers, and from the accounting side, it’s very similar to the attorneys on the front end. There’s clients come to us, they may come to us as the CPAs, they may go to their attorneys as their advisers, a lot of the same questions. And from our role we’re much deeper into typically the taxpayer’s tax situation, their overall financial picture, so I think from that standpoint we have some knowledge and ability to advise them on some different aspects just because we are intimate with their particular situations.
And really it’s to guide them and remind them along the way that this is how this works, don’t forget, because sometimes people … it was a great deal, I got into it but when the day comes up and they have to start writing some checks, they’re kind of, “Well, but I don’t want to do it.” Well, no, this is the way this deal works.
So it’s not a one-off consultation; it’s kind of over the life of the project we’re there to hold the hand and be somewhat of a gatekeeper on making sure things go the way they should go. As is the legal team and the bank as well, certainly.
MODERATOR: There may be folks you’re talking to about opportunity zones who did not know anything about them. But it may be something that you say, OK, this is a vehicle you might want to take a look at. They may not have ever heard of an opportunity zone, right?
MR. SULLIVAN: No, that’s exactly right. Because this, until recently, hasn’t gotten a lot of play in the press, certainly. And I’m even surprised … we’ve reached out over the last several months to talk to what I would call some significant real estate players, and some of them weren’t really tuned into it at all, which was kind of surprising. You’ve kind of got the ones that every new deal that comes they’re all over it real quick.
MR. SULLIVAN: They never use it, but they understand it and what the opportunity is. So it’s been kind of a mixed bag of who it’s on their radar and who it isn’t.
MR. POHL: Yeah, it’s gaining steam, but until the zones were designated, everybody kind of sat back and just was floating around trying to figure this thing out. Now that the zones have been designated, the amount of seminars being presented, the number of articles being written, that stuff, more analysis, that’s really starting to ramp up tremendously.
MODERATOR: Hearing you describe the guidance from back east and Washingon sort of reminds me of ACA. “Here are the rules, but now we’ve got more guidance for you during the process…”
MR. SULLIVAN: Right.
MODERATOR: It’s obviously a smaller scale than ACA but may be some of the same things. Any other concerns that rules or guidance may change soon or in the near future?
MR. POHL: Obviously those are always concerns. We’ve got to consult and talk with our clients about that — this is what we know now and it may change later. I’ve heard rumor that these zones may actually change, too, over a period of time, that they might recreate different zones, so while you have an opportunity now in X zone, it may be a better fit for Y. If the zones get redesignated or the law gets changed slightly, it may be a better bet to hold for a little bit of time before you do something and look at a different opportunity, if that makes sense.
And I think that can happen, I think this is all in flux still, not all of it but a substantial portion of it is, and being the first one in the game is not always maybe the right game to be in, if that makes sense.
MR. SULLIVAN: And these proposed rules, and even the original law said, “Look, this initial go around, once we designate it, you don’t have to worry about that changing.” You’re good for, I think, out to 2048.
MR. POHL: Yeah, ‘47, ‘48, something like that.
MR. SULLIVAN: So as Scott said, even though they might come in and designate some more or change something, all indications are in the law and these rules is, “Look, anything we’ve designated so far, you’re golden, don’t worry about it, it will not change.” So that’s not really a risk from that standpoint, it’s kind of, is there a better opportunity coming.
MR. POHL: Right.
MR. SULLIVAN: Well, I don’t have a crystal ball, I can’t tell you that, but maybe if you lobby hard enough, it’ll happen.
MR. POHL: The interesting thing that I think I’ve had happen to me is several people come to me and say, I’ve got property in the zone. And that’s great but it’s not really doing you much good because you already own the asset in the zone. And so somebody may be looking to buy your property because it’s in the zone but you really can’t do much with it because you already own that asset in the zone and it’s not a thing that you go in with a new investment and say, we’ve invested in this property.
I have heard, though, that properties within the zone — and this is kind of a catch that comes up that always happens when some tax incentive is passed or something benefits a certain area — is the property values tend to start creeping up, or the sale prices tend to start creeping up. So if you own a property in the zone and you know people are looking to buy property or assets in the zone, your value may go up and you may be able to get a better sale price, which then, again, if you’re the one doing the investing, you think you’re doing a better job by getting your 15 percent step-up in basis, but, no offense, the property already stepped up 15 percent on you between the time the tax provision passed and the time the sale closes. You’ve paid 15 percent more for the property, so you’ve really lost that step-up in basis issue.
So then again, you fall back on is this a long-term play, and, again … I love the 15 percent step-up, but the long-term play is what I think is the game of this deal and where you really can see a lot of windfall if you invest in the right project.
MR. SULLIVAN: Kind of playing off of the concept of somebody that owns something currently in a zone … if you’re a business, let’s say you’ve got a manufacturing business and you’d really like to increase your footprint and your facility and you’ve got the ability for the land there but the financing piece is tough because I need some more equity in my business, there is an opportunity there to bring in some new equity players in your business that could qualify them. So there’s different ways to look at that. There could be a benefit to that owner, but it’s not his benefit, it’s somebody else’s.
His benefit is I got some equity in my business I needed; there’s not a tax benefit for them, per se.
MR. NELSON: But that could expand his business, it could create jobs.
MR. SULLIVAN: Oh, absolutely, yeah, could be huge for him.
MR. NELSON: Right.
MODERATOR: As an investor, I’m choosing the area in which I want to invest rather than I say, OK, I’ve got this pool of money, nobody else tells me you’re in this zone. So that’s how that works?
MR. SULLIVAN: Yeah, it’s purely your decision which zone you want to invest in, assuming there’s an opportunity there to do that.
MR. NELSON: My understanding, if you establish a fund, you can invest in multiple zones in different states.
MR. SULLIVAN: All around, in any state. You’re not confined to where you live, it’s any zone in the country.
MODERATOR: Tim, as these proposals start coming to you, do you look at these vehicles different from other vehicles?
MR. NELSON: I wouldn’t say so, not necessarily. It’s still got to make sense, it needs to be a good investment and make sense for the bank.
MODERATOR: Right. And this is just starting, so you wouldn’t have had anybody coming to you at this point, right?
MR. SULLIVAN: I haven’t been involved with anybody that’s actually done one of these. I’ve talked to some people that are kicking it around pretty hard. I think we’ll start seeing something over the next few months, especially now we’ve got a little more guidance. But, again, it’s all about somebody has to have a transaction.
MR. POHL: I think the working capital guides that we received was probably a big plus in the sense that, if you are one of these funds and you’re taking in a lot of cash, if you’re doing a renovation project on a building, you can’t get rid of the cash that quick, and the bank doesn’t want you to get rid of the cash; they want you to have cash and you spend your money to take your share of the development and then they’ll loan you the next piece to take you past that.
The problem is with the 31-month requirement issue, if you have taken in a lot of cash, trying to get it out of your pocket and still meet the six-month testing period and those type of periods, it’s very difficult to do, 90 percent in at six months. So allowing you to keep that as a working capital as long as you have plans for development and you’re going forward with that development and being able to keep that as working capital, I think helps out a lot. I think there was a lot of people wondering how they were going to invest that kind of cash that quickly within the 180 days, if that makes sense.
MODERATOR: There are really several clocks that you have to watch during this process, right?
MR. POHL: Absolutely.
MODERATOR: From the beginning to 12/31 of ‘26, right?
MR. SULLIVAN: That’s right.
MR. POHL: And that’s the clock inside the statute. You’ve got clocks outside the statute that are running on you, too, in a sense that if you’re developing things, you’re pushing harder on your city officials to get your plans permitted … normally, on a real estate acquisition, you can look at a three-, six-month window to close on the transaction. Well, that’s a day — every one of those days that ticks off creates a problem for you going forward on the fund investing and how it’s going to invest and whether it’s going to get the full tax advantage here. So you’re monitoring both inside and outside the tax code what deadlines need to be met.
MODERATOR: The process is dependenent, too, on outside forces. Like you say, is there a zoning change, are there permits associated, those types of things. How do you advise them through that process?
MR. POHL: I think you pretty much just let them know that obviously the driving force of this will be the tax deadlines, you’ve got to meet the tax deadlines.
And so it’s one of those deals where you hate to say it, you push your city officials harder, you push your architects harder, your attorneys harder, your accountants harder, everybody, to try to make sure that everybody understands that this is a tax-driven investment and every day that passes is not a benefit to you, so to speak, so let’s try to move a project that may normally take six to eight months to a year to bring from contract to acquisition — that may not even be developed — let’s try and compress that time period and move it at a lot quicker pace.
MR. SULLIVAN: And I think one point I really want to make sure we make here on all these time frames … We all deal with two general categories of people. We have the planners that say, “I’m looking at selling my business” or having some big transaction, they come to us well in advance, we talk about that. Then there’s the guys that show up, “Hey, a couple months ago I sold my business, I got a $50 million gain, what do I do now?” And so you’re way down the road on the clock.
MR. SULLIVAN: So there’s kind of those two extremes, but that’s the reality, I think, we deal with every day.
MODERATOR: That’s the 180-day clock, right?
MR. SULLIVAN: Yeah, because, again, this is going back really on these other time frame issues, if you have somebody that thinks they’re going to have that transaction happen, they’ve kind of already started looking around at potential projects so that when they hit that transaction date, then they really have another 180 days before they have to put the money in the fund, OK, so they could wait up until the 179th day and then put their money in the fund. And then the fund, depending on the time of year they do it, it can have up to another 6 to 12 months before it actually has to make the investment. So you can stretch that quite a ways if you’re planning and things are working out the way you intend them to.
MODERATOR: I’m picturing you all with clocks on your computer monitors attached to each client saying, OK, this clock’s running here and this is — it’s different for each client, right?
MR. SULLIVAN: It is, absolutely.
MR. POHL: Even if they’re in the same investment fund, it’s different for each client.
MODERATOR: Right. How do you monitor that, how do you guys keep hold of that process? That’s pretty complicated.
MR. POHL: Same way we do with any other transaction we have and that we’re involved in, we calendar — our calendars are full of deadlines and two-week notices before a deadline arrives, those types of things. And we’re trying to give the clients plenty of heads-up notice to say, you’ve only got two weeks left or a month left or this is proverbially the day you’ve got to get this invested or dealt with. I think that’s what we routinely do, it’s just a matter of, this is just another piece of it that will have to fit within the calendaring system that all of us maintain.
MR. NELSON: And ours is probably the easiest. They come with the date. We’ve got to do it by this date.
MR. POHL: I would say that’s the easiest other than when I come to the bank, I’m going to say, please make it quicker, please let’s not spend a lot of time negotiating, I need to make these documents work, let’s get it done.
MR. SULLIVAN: It’s that category B situation where it’s last minute for everything they do in their life, I mean …
MODERATOR: Are there any hard-and-fast deadlines coming up? For example, here we are in November, do you have to do something by the end of the year, or those clocks start at some point when you decide you want to use this capital gain that way?
MR. SULLIVAN: I don’t know if there’s an actual definite 12/31 trigger; every situation is totally different on its timing.
MR. NELSON: I think first clock starts when you have the gain.
MR. SULLIVAN: Have the gain.
MR. POHL: And I think that may be your 12/31 trigger, depending on whether your gain is going to be at the partnership level or at the individual level. If the partnership doesn’t elect to go through a qualified opportunity fund investment when they sell, that’s the gain. I think at the end of the year, and I’m not the tax guy here, but my understanding is when 12/31 rolls around, that’s when they would recognize the gain, the partner would at that level, and they would have 180 days after that period of time in order to get their investment in if the partnership didn’t decide to do it.
MR. SULLIVAN: Right, and that was one of the clarifications to come out of these rules here a couple weeks ago that was very welcomed, because we didn’t know what happens if the gain occurs within the S corporation or the partnership LLC entity, when does the clock start running, and is that purely an individual owner decision or is that an entity level decision? And the clarification was, well, no, the partnership or the S corp can decide if they’re going to take that gain and reinvest it, and if they do, then the clock starts ticking based on what they do and when that transaction happens. So if it was a May 31st sale that created the gain, then the 180 days starts right then. If the partnership says, no, we’re not going to do that, you individual partners get to decide what you want to do, well, then what happens is you roll up to 12/31 of that year of the transaction, and for the partner, the transaction was deemed to have occurred 12/31 and not back in May when it really did happen. Now —
MR. POHL: Unless they got the cash for some reason, unless there was a distribution at the time maybe?
MR. SULLIVAN: Yeah, they have the opportunity to back — if they choose, they could back up and say, hey, you know what, the transaction happened in May, in June the partnership distributed everything out to everybody so I got the cash, well, an argument is that’s when your clock started ticking maybe, and you may want it to start right then and there. So, again, there’s a little clarification needed, but in general, it can work a couple of different ways, whether the entity chooses to do the reinvestment or the partner gets to choose to do the reinvestment.
MODERATOR: Are there decisions that could also affect their taxes, their investments outside the confines of an opportunity zone? Keep in mind if you do this here, it may change something over here?
MR. SULLIVAN: Maybe an example situation would be: I had this transaction with a big gain, but a few years ago I had a big transaction, I had a huge loss, it was a horrible deal I was in, lost a lot of money, and because of the limits on how I can deduct that, I’ve still got this big loss carry-over I’ve never used. Well, in that case, you look at it and go, hey, maybe you just take the loss against that, net it out, if you have any tax due, pay it. I mean, those are the kind of situations — it’s not a definitive, “I’ve got a big transaction, I should reinvest it.”
MR. SULLIVAN: You have to look at your entire situation. That’s an easy example of where maybe you say, oh, maybe I don’t do that deal.
MR. NELSON: And you will have to pay tax in 2026, and you have to have those funds set aside.
MR. SULLIVAN: Well, you do and for some people it’s, I don’t want that hanging over my head, I’ll just pay my tax today and move down the road and not mess with all the complexities of this. It just depends on the appetite of the individual. Are they kind of that entrepreneurial investor that looks at those opportunities and says, yeah, I’m all about that? Other people run away from it, they’ll say, oh, no, just write the check and let’s go down the road, I’ll do whatever I want to do.
MODERATOR: Tim, in the ramp-up to this being passed, was this something that was really being discussed a lot in banking circles and how you would handle it?
MR. NELSON: To be honest, it was so up in the air until recently. And, again, there’s so much information flying around, until we can get our arms around it, I don’t think — we didn’t talk about it much. It comes to us after it’s been cooked, and these guys are more involved in getting it to our area because, really, we’re going to look more at it as a traditional loan opportunity we’ve always looked at.
MODERATOR: Does it pose a bigger opportunity for you?
MR. NELSON: Well, hopefully it does what it’s designed for, in areas of the city or the state or country that need investment, that makes it a good, viable plan, hopefully with more equity into it.
MODERATOR: We had talked a lot about real estate … are there other qualifying opportunities within the context of the opportunity zones?
MR. POHL: Well, we’ve talked a lot about, obviously, the real estate aspect of it, but there are other opportunities. And I think we kind of talked about this as a fund investment, so to speak, but there’s what I call three different ways — and probably would be better broken down into two different ways — through what we normally consider a fund company or do a direct type of investment type deal through your own LLC, and I treat those two as separate.
What we’ve really been talking about here is going into a fund, going into an LLC, a partnership or an S corp, that type of entity, and going into these types of investments, … but we also have business opportunities where you’re going in and looking at it from a business perspective.
There are some what we call sin businesses that you’re not allowed to invest in. I don’t know that most people would call a golf course a sin business, but that’s one example, so to speak.
MODERATOR: The way I play, it’s a sin.
MR. POHL: Yeah. So you do have to monitor what are the sin businesses and make sure that if you are investing in that type of acquisition that that may be prohibited.
Now, the interesting thing — again, there’s been articles written, there’s so much information floating around, and I’m assuming everybody even at the table here, has been looking for where the loopholes are in this law and where things match up. And you get into questions of … you can’t directly invest in a sin business, but can you indirectly invest in a sin business and will that be prohibited? Or what will the new guidance be on that, because things I’m seeing, articles I’m reading, indicate that maybe you can indirectly do a sin business but not directly do the sin business type of investment.
So I think we’ll see … as one of my partners once said, Scott, you’re trying to do what the statute is not designed to do. And I think that’s why we get paid what we get paid, is to figure out — we know what the IRS wants and what they were thinking, but the question is, is there an avenue by the way they worded it that I can find a mechanism to get through to a different type of business structure or different type of asset that would either be a sin business or would be something that would be partially in the zone and maybe partially out of the zone? What can we do with this type of mechanism?
And that’s what I’ve been looking at in detail, trying to study those, primarily from an oil and gas perspective. I do a lot of real estate, so I look at it on the real estate side, but I also do a lot of oil and gas work so I’m looking at it from that perspective too. And there’s just — people are picking away at the law trying to find the loopholes or the holes that they can fit different types of businesses through.
MR. NELSON: But in the sin business, any place that sells alcohol is in there, right?
MR. POHL: There’s seven sins, I can’t remember what they —
MR. SULLIVAN: The casinos, liquor stores, I think massage parlors are in there.
MR. POHL: Yeah, spas, I thought.
MR. SULLIVAN: Something along those lines.
MODERATOR: And those are all non-qualifying?
MR. SULLIVAN: Non-qualified businesses.
MR. NELSON: But, like, most of Delano’s in there, if you wanted to buy a warehouse and open a bar, is that permitted, is that not because you’re selling alcohol?
MR. POHL: The interesting question would be: Can you buy the bar and sublease it out, buy the building and turn it into a lease type transaction where your business is? You own the building and your tangible asset, so to speak, is the building itself and the equipment in the building and you’re going to lease it to another entity for a bar operation or something to that effect? Can you get around those types of situations? And that’s what, I think, we’re going to all be paid money to try and figure out, is what we can’t do directly, can we do indirectly, if that make sense.
MR. SULLIVAN: Yeah. And I don’t know that, in your example of the restaurant that happens to also serve alcohol in that prohibits it from being a qualified business, but it’s certainly something you’d want to be careful and really look at the rules and say, OK, it appears the intent was a liquor store, or that’s your business, you’re selling alcohol, period, and it’s really more of a retail, take it out the door and take it home, do whatever you want. But in all these cases, you really need to make sure you understand the rule and don’t get into a deal that at the end of the day, oops, doesn’t qualify.
MR. POHL: Or structure it correctly.
MR. SULLIVAN: Yes.
MR. POHL: In other words, I think our job is when clients come in and say, this is what we would like to do, it’s our job to find potentially an avenue to make that work for them, if it can work. It may not work. At the end of the day, that’s the advice you got to give your client and say, you just can’t do what you’re asking to be done here, but the hope is, whether it be a lease, a license, or some other type of document structure, some other type of entity relationship that you can get it done, at least assist the client … you may not be able to get rid of all the capital gains that they’ve invested but maybe you can help them get rid of a significant portion of it if they’re trying to defer that significant portion through a different mechanism, if that makes sense.
MR. SULLIVAN: I do think just playing a little bit more off of the concept of, investing in a business itself, we may see some of the private equity groups — they have portfolio companies, they may have 10, 15 different companies, and their plan is they roll out of those quite frequently, they turn them over, they’re probably going to have some level of interest in saying we just rolled out of this one and had a winner, made a lot of money, some good gains, gee, there’s a really nice little manufacturing business down here in one of these zones, let’s roll our gain into that deal and not carve off and pay Uncle Sam right now, because they typically operate on a three- to five-year window when they want to roll out of something and that might fit in perfectly to this time frame right now that we’re in where, OK, we just had our big gain on selling company A, let’s take that over and buy this company over here in Wichita in that zone and have Uncle Sam help with some of the equity investment, that deferral of tax.
MODERATOR: Keeping in mind that if they buy that business for $750,000 —
MR. SULLIVAN: Right.
MODERATOR: — that’s the investment they also have to make in it?
MR. SULLIVAN: It’s a little different if you’re buying into a business entity.
MR. SULLIVAN: But if you’re buying a piece of property, real estate, you do have to improve it.
MR. SULLIVAN: It’s a different requirement.
MODERATOR: Are there factors that the Community Reinvestment Act may impact?
MR. NELSON: Well, most of these are qualifying census tracts from CRA, so anything you would do should benefit your CRA status. So I think it would be looked at on every deal you do.
MR. SULLIVAN: One of the questions is, if somebody has a significant opportunity that they’re looking at in one of these zones, are they going to be going to the city and the state and say what’s going to be your participation in this deal? Are you going to help with the financing?Are you going to help with some incentives? So it doesn’t stop with this.
It’s no different than any other development deal. Who are all the players? And, again, it goes back to: “Well, I’ve got to get them all rounded up and on board to make this deal happen too,” and that could be its own challenge. But certainly don’t want to lose track of … there are even more pieces of this that come into play.
MODERATOR: You talk about STAR bonds, you talk about IRBs and different things, there may be a completely new vehicle that’s created from it?
MR. SULLIVAN: Right, right. Because there’s certainly nothing to indicate in here that there’s any limitation on any of those more typical arrangements that get made on a development deal.
MR. POHL: Correct, yeah. I think you can pair up incentives and benefits and work through the same process. Again, it’s a timing issue.
MR. NELSON: Yeah, the timing is going to be the biggest factor.
MODERATOR: What else do we need to tell folks about opportunity zones and how it may benefit them? So I’m an investor, I’m interested, I guess the first thing I need to do is figure out where these zones are around Wichita. How do I find that information?
MR. SULLIVAN: There is a central site that many resources will reference you to. I think Kansas has a particular site for their opportunity zones, but they will provide you the link too, which I believe is the cdi.gov site.
Certainly you can drill down into every state and see every zone that’s been designated out there, so it’s pretty easy to get an idea of where those are at and it drills down into street levels. The information is there, you can outline exactly what blocks in a particular zone are qualified.
MODERATOR: Or even a Google search?
MR. SULLIVAN: Oh, absolutely, it’ll come up. There’s enough out there on these qualified opportunity zones that it’s not difficult at all to find the link to that information.
MODERATOR: OK. This is complicated stuff, this is what you guys do on a daily basis, but investors, it may be over their head or it may be a challenge for them to really figure out what they can do in an opportunity zone. I would assume your advice is get with somebody who understands what’s going on, get an adviser who can help you through the process, right?
MR. SULLIVAN: Yeah, absolutely. We had somebody early on come to us and say, “Well, my buddy told me all I had to do was take my gain from my rental property I sold and put it in one of these.” And first question we said, “When did you sell it?” “Well, I think it was in January of 2017.” We said “No, you’re a little too late, sorry.”
MR. POHL: Yeah, I think if you even foresee this happening to you, you’re thinking about selling your business in the future, that would be the optimum time to go see your adviser. If you’ve got real estate for sale or something where you’re going to have a gain, go consult with your tax counsel, your accountants, your bank, all of us will have enough information at least to say that’s an interesting question, we need to dig deeper into it. And that’s where you’ve got to start, you’ve got to find somebody that understands these concepts and at least can say “I understand where you’re going, let’s plan to get there but give me time to make that plan, if possible.”
MR. SULLIVAN: And we’ve certainly seen a very high level of interest from the banks. Certainly Tim’s here representing Fidelity Bank, which is a big player in the real estate market, certainly from a financing standpoint, but in general it’s high on the radar of a lot of lenders, so certainly the resources are out there.
MODERATOR: Any final thoughts for our readers as they consider this as a vehicle for them?
MR. POHL: My only final thought is going back to something I’ve really stated: These can’t make a bad investment good. Be careful who you’re investing with, make sure they’ve got a track record. If you’re going out and investing with somebody else, they better have a track record on what they can do, how they’ve done it in the past. The benefit of this process or this tax provision can be completely wiped out if you make a bad investment, and so don’t just … as somebody would say, you’re better off going to Vegas with your money, so to speak.
Get in and talk with your advisers. There’s a lot of people that are — again, more guidance is coming out — there’s a lot of people that already understand these concepts in enough detail to help you out, but, again, you need to look at the structure behind it. We need to see who else is involved in those type of deals. Our goal is to save you money, not to lose your money.
MR. NELSON: I think what we’ve heard is preplanning is better than being reactive at the end. Be aware of the deadlines, be aware that you are going to have to pay most of the tax anyway. So to me it’s got to have some sort of economies of scale to do this with all the effort it’s going to take to pull it off, so I don’t think the little guy is going to benefit from this.
MR. SULLIVAN: I don’t disagree. I think it goes back to just a basic comment I like to make to people, similar to what the guys are talking about, and that is don’t do something just because of taxes. That’s the absolute worst reason to do something in the vast majority of cases, the deal has to make sense.
MODERATOR: All right. Thank you, great discussion. Thanks for helping us understand a little bit more about opportunity zones.
Originally Published on November 16, 2018 at 06:54AM
Article published originally via opportunity zones – Google News https://www.bizjournals.com/wichita/news/2018/11/16/table-of-experts-opportunity-zones.html