East Tennessee Preservation Conference May 17, 2019 G. Mark Mamantov Bass, Berry & Sims PLC 900 South Gay Street, Suite 1700 Knoxville, TN 37902 865-521-0368 mmamantov@bassberry.com
Federal Tax Incentives • Opportunity Zones • Historic Rehabilitation Tax Credit • New Market Tax Credits • Low-Income Housing Tax Credits
Opportunity Zones in a Nutshell • A tax incentive • For wealthy investors • To fund new business and development • In “Qualified Opportunity Zones” (QOZs)
Qualified Opportunity Zones (“QOZs”) • Tracts of land nominated by governors (and D.C.’s mayor), certified by U.S. Treasury Dep’t • Had to meet certain “low-income community” standards • Ship has sailed. • All QOZs have been set. • It’d take an act of Congress to change them. • Literally.
QOZs – Tennessee
O-Funds • Opportunity Funds (“O-Funds”) are the heart of the entire program • To get the tax benefits, investors just have to buy shares in an “O- Fund” Yep, that’s it • • O-Funds then identify and invest in qualifying projects within QOZs • O-Funds must invest 90% of their assets in “qualified opportunity zone property” (“QOZ property”) or pay a penalty This is tested, more or less, every six months. • So O-Funds have relatively little time to find and invest in QOZ property •
Qualifying Opportunity Zone Property (“QOZ property”) • Since O-Funds must invest 90% of their assets in “QOZ property”, it’s important to know what qualifies. • QOZ Property, generally, is a trade or business that meets the following requirements: “Substantially all” of its tangible personal property must be • • Purchased after 2017 from an unrelated party; • Purchased new or “substantially improved” within 30 months of purchase; and • Used in the QOZ during “substantially all” of O-Fund’s investment A “substantial portion” of its intangible property is used in the active conduct of business in the QOZ • Less than 5% of its assets are “nonqualified financial property” (e.g., long-term financial • investments or interests in other companies/partnerships) Business cannot be a country club, massage parlor, hot tub facility, racetrack, health club, • wine/liquor store, or another O-Fund • Two ways to Invest O-Fund can buy newly created stock or partnership interest in a QOZ business; and/or • O-Fund can buy new or substantially improved property to be used in the QOZ business. • • Bottom Line, O-Funds are just like the rest of us: they want stuff, not old stuff, but fancy new and improved stuff They just want their stuff to be used to conduct a trade or business substantially within the • boundaries of a qualified opportunity zone.
Questions Abound • Additional proposed regulations were just issued on May 1, 2019, and lawyers (including me) and accountants are still digesting what they mean. • But some O-Funds are already up and running, soliciting investors and looking to invest in QOZs
The only tax stuff you really need to know: • The U.S. “Income Tax” generally taxes all forms of profit • But not all forms of profit are taxed the same. • Two broad categories: “Ordinary Income” – profit from running a business, working, etc. • “Capital Gains” – profit from selling an asset (e.g., real estate or • stock) • “Capital Gains” are taxed very favorably (for most taxpayers) Taxed at lower rates – maxed out at 20% (versus 37% for • “Ordinary Income”) Delayed taxation – no tax is owed until you sell your asset and • “realize” your gain
Capital Gains in Action You own stock in a I run a successful business successful business • I invest $10M in my • You buy $10M worth of stock business • Each year you don’t sell, you • I didn’t talk to my tax don’t pay taxes accountant, and take all my income as ordinary income • In 10 years, you sell for $15M • Each year I make ~ $500k, • You’ve got $5M in “capital taxed at 30% gains”, taxed at 20% • In 10 years, I’ll have • You pay ~ $1M in taxes, ~ $3.5M in total profit leaving you $4M in total profit
The Tax Benefits of Opportunity Zones • Taxpayers facing a capital gains tax bill can, instead of paying the IRS, choose to invest their money in an O-Fund • O-Funds confer three big benefits • Deferred tax – any gains reinvested and kept in O-Funds aren’t taxed until 2027 • Discount – if you hold your O-Fund investment for at least 5 years, your tax bill is discounted (10% for 5 years, 15% for 7 years) • No tax on O-Fund gain – if you hold onto your O- Fund investment for at least 10 years, none of your gains from the O-Fund are taxed
Opportunity Zones in Action Have I got an Opportunity Our Prior Example for you! • You take your $5M in capital gains, and • You bought $10M in stock you invest it in an O-Fund 10 years ago • In 10 years you sell your O-Fund stock for $8M • O-Fund benefits: • You sell today for $15M (1) You owe nothing today • (2) Your original $1M tax bill is reduced to • $850k (3) You owe nothing on the O-Fund gains • • You’ve got $5M in capital • So you’ve just turned a $1M tax bill into gains, so you’re facing a $2.15M more cash in your pocket! $1M tax bill • In fact, your O-Fund could lose up to 20% of its value ($1M here) and you’d be no worse off than if you’d paid the IRS
Investors • Everyone! (maybe) One possibility is that anyone could buy O-Funds and • benefit from paying no tax on the O-Fund’s gains Also possible that Treasury would limit that benefit to only • investors rolling over prior capital gains Securities laws may further restrict who really has an • opportunity to invest in O-Funds • But benefits scale exponentially with wealth Only investors with prior “capital gains” can use the • deferral and discount benefits No clear caps on deferral and discount, so the more • capital gains you have, the more you can benefit
Capital Gains as Share of Income $1,600,000.00 36% $1,400,000.00 $1,200,000.00 $1,000,000.00 $800,000.00 Other Income $600,000.00 Capital Gains $400,000.00 15% $200,000.00 3% 2% 1% 1% $- Lowest Second Third Fourth Fifth Top 1% Quintile Source: CBO, The Distribution of Household Income and Federal Taxes, 2011, at 10 (2014).
Property Owners • Real estate values will likely be inflated in QOZs Benefits are tied to specific parcels of real estate • These benefits will likely allow businesses and investors to pay more for • land in QOZs than comparable property elsewhere • Prior Owners vs. Real Estate Speculators Hard to guess when and by how much prices will rise • Many current property owners may not know that they are in an • Opportunity Zone, let alone how that could affect their property value Speculators have incentive to buy now, quietly, before market reacts •
New Businesses? • The whole point is to get O-Funds investing more in QOZ businesses, right? • That demand could encourage O-Funds to invest more favorably in QOZ businesses • But that benefit could be offset by • Property owners demanding higher rent, sales prices • Investors demanding higher returns on O-Fund investments • Competing QOZ businesses willing to take investment on more standard terms • Net effect likely depends on • Number of attractive O-Zone businesses competing for investment • Balance of power between O-Funds, Property Owners, Investors, and Businesses
Existing Businesses? • O-Funds generally must make new investments Larger businesses likely can structure deals to at least partially take advantage of O- • Fund investment Smaller businesses already located in QOZ may have difficulty finding realistic ways to • qualify and attract O-Fund investment • Potential downside O-Fund investments could give new QOZ businesses competitive edge over existing • businesses Rising real estate prices, discussed earlier, could lead to higher rents • Current or potential investors may look instead to new QOZ businesses • • Potential upside Increased economic activity in area could be good for business – depends on the • business and the nature of the economic changes Existing businesses might also benefit indirectly from access to new goods/services • offered by new QOZ businesses
New Market Tax Credits • Investor receives tax credits equal to 39% of investment over a 7-year period • Investment must be made through an approved community development entity (CDE) that has NMTC allocation • CDE usually makes a loan (QLICI) to a qualified active low-income community business (QALICB) • Very complex and expensive transaction to undertake; cost prohibitive for smaller deals
Historic Rehabilitation Tax Credit • Tax credit for 20% of the qualified rehabilitation expenditures (QRE) for certified historic structure and 10% for other nonresidential building placed in service before 1936 • Certified historic structure generally must be on national register or in historic district and certified by NPS • Project must be substantially rehabilitated • 5-year recapture period • Historic Boardwalk case really hurt the market for these credits
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