Private Equity: Seizing the Land of Opportunity Zones
Typically, most traditional private equity funds and investment firms have not focused on owning real estate as a component of their acquired portfolio companies. With that underlying consideration, you may dismiss the notion of private equity benefiting from the recently enacted Opportunity Zones (“OZ”) incentives. However, the OZ incentives not only encompass the more traditional real estate and related required improvement of such real estate, they also extend to businesses that operate within an OZ.
A summary of the tax benefits/incentives available from OZ are as follows:
- Temporary deferral for recognition of realized gain until as late as December 31, 2026
- To the extent gain portion of proceeds is reinvested in a Qualified Opportunity Fund (“QOF”) within 180 days of the sale or exchange of any asset, gain is not required to be recognized in the year of sale.
- The deferred gain is recognized upon the earlier of the date the investment in the QOF is sold, or December 31, 2026.
- Permanent reduction of deferred gain depending on how long the investment in a QOF is held
- 10% of original deferred gain if the QOF is held at least five years before gain is recognized.
- Additional 5% of original deferred gain if the QOF is held at least seven years before being recognized.
- Exemption from realized gain on QOF investment held at least 10 years
- Gain on subsequent appreciation is eligible for permanent exclusion if the QOF investment is held at least 10 years.
On April 17, 2019, proposed regulations were issued that provided much needed clarity to a number of areas. Of particular interest to private equity is the guidance related to timing of investing cash in the fund in qualifying property or businesses and the calculation of the gross receipts test. Prior to the issuance of the proposed regulations, the 31-month safe harbor for investing cash in the fund applied only to investing in real property. The safe harbor has now been extended to the investment in a qualifying business.
The other confusion was focused on Qualified Opportunity Zone Businesses (“QOZBs”), specifically from the initial regulations requirement that stated, “50% of gross income be derived from the active conduct of the trade of business in the opportunity zone.” Private equity investors and future owners were unclear if the new QOZB needed to be a Starbucks-type operation serving customers locally only to the QOZB, or whether the QOZB could be the next Amazon and have revenue outside the OZ. The OZ newly issued proposed regulations gave three safe harbors that allow the QOZB to have revenue outside the QOZ if any one of the following apply:
- At least 50% of the hours necessary to produce the revenue for the QOZB were conducted by employees and independent contractors located within the Qualified Opportunity Zone (“QOZ”).
- At least 50% of the amount paid for services necessary to produce the revenue for the QOZB was paid to employees and independent contractors located within the QOZ.
- Management is located in the QOZ and the QOZB meets the tangible property rules necessary to generate at least 50% of the gross income of the QOZB.
In addition to the rollout of the proposed regulations, the president’s December Executive Order (“EO”) was issued, establishing the White House Opportunity and Revitalization Council. The Council is aimed at cutting the red tape among federal agencies, as well as state and local governments. The EO imposed a short-term timeline to identify potential bottlenecks as well as to identify potential solutions barriers. The plan is broken down into work streams, or subcommittees, including economic development, entrepreneurship, safe neighborhoods, education and workforce, and measurement and analysis (i.e., social impact). The Council’s solutions could be beneficial for the future for OZ.
The new provisions and proposed regulations are highly complex and require careful analysis. The Cherry Bekaert National OZ Team can help analyze how private equity can best take advantage of the changes within the Tax Cuts and Jobs Act.