Today’s guest is self-described “codehead” Tony Nitti, real estate tax law expert, CPA, and partner at WithumSmith+Brown. He also serves on the editorial advisory board for The Tax Adviser. And he’s a contributor at Forbes.com, where he recently published a thorough primer on the opportunity zones tax incentive.

Click the play button below to listen as Tony and I dissect the basics of the opportunity zones tax code, explore some unintended consequences and loopholes introduced by the proposed IRS regulations, and discuss who the actual drivers behind most opportunity zone investments will be.

Episode Highlights

• Who the drivers behind most opportunity zone investments will be. (Hint: it probably won’t be the investors themselves.)
• Why 2019 is a very important year for opportunity zone investors seeking capital gains deferral.
• Biggest surprises from the proposed IRS regulations that were published last month, including friendly rules regarding partnerships and corporations, and the new 31-month holding period rule.
• Unintended consequences introduced by the proposed IRS regulations, including the potentially precarious position that investors will be in when it comes time to exit by the end of 2047.
• Biggest unanswered questions that the industry is still waiting on the IRS for guidance.
• How Tony’s clients are beginning to move forward with opportunity fund investing.

Featured on This Episode

• Follow Tony on Twitter: @nittiaj
• Tony’s articles at Forbes.com
• Tax Geek Tuesday: Reaping The Benefits Of Investing In An Opportunity Zone at Forbes.com
• IRS REG-115420-18: Investing in Qualified Opportunity Funds
• The Tax Adviser
• WithumSmith+Brown

Industry Spotlight: WithumSmith+Brown

Headquartered in Princeton, NJ and with offices in New England, the mid-Atlantic region, and Aspen, CO, WithumSmith+Brown is a nationally ranked top 25 CPA and advisory firm with nearly 1,000 employees. Withum represents clients ranging in size from small entrepreneurial startups to billion-dollar public companies, and is one of the leaders in understanding the new opportunity zone tax incentive introduced by the Tax Cuts & Jobs Act in 2017.

About the Opportunity Zones Podcast

Hosted by OpportunityDb.com founder Jimmy Atkinson, the Opportunity Zones Podcast features guest interviews from fund managers, advisors, policymakers, tax professionals, and other foremost experts in opportunity zones.

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Show Transcript

Jimmy: Welcome to the Opportunity Zones podcast. I’m your host, Jimmy Atkinson. And today I’m joined by a real estate and Business Tax Law expert. My guest is a CPA and tax partner for WithumSmith and Brown. Additionally, he serves on the editorial advisory board for the “Tax Adviser,” which is the monthly trade magazine published by the American Institute of CPAs. He’s also a regular contributor at forbes.com where just a few weeks ago, he published an extremely thorough and also somewhat amusing primer on the Opportunity Zones Tax Benefit. Tony Nitti, thanks for coming on the show.

Tony: Jimmy, thanks so much for having me. That is definitely the first time anyone’s ever used amusing and Opportunity Zones primer in the same sentence. So, we’re off to a good start.

Jimmy: You might be right. We’re setting some records here already right out of the gate. So Tony, obviously, you have a lot of credentials. I know you’ve been a CPA for quite a while now. Could you tell me a little bit more about your background, how did you get your start and how did you get to where you are at today.

Tony: Sure. Well, yeah, I started my career, man, about 20 years ago now with Arthur Andersen, now defunct Arthur Andersen. But I spent a couple years with Arthur Andersen, couple years with PricewaterhouseCoopers working with some of the biggest clients in the world. And then through a string of circumstances, I ended up moving back to the east coast where I’d grown up just long enough to get married. And that is how I landed at an East Coast based firm, which Withum is and then promptly brainwashed my wife into moving back out to the mountains. So we’ve actually been in Aspen for the better part of the last decade. And pretty much right when we moved here, about 12 to 15 years ago, I really made the kind of commitment within the industry where I was going to adopt kind of a niche within the greater tax world where I represent a class of people that are either affectionately or derisively referred to, depending on your standpoint, as kind of a codehead.

So I make my living in the Internal Revenue Code. I make my living in the law, understand the law, writing about the law, teaching about the law. And that’s just kind of where I’ve spent the better part of the last decade. My firm’s got 1000 people and a lot of sophisticated clients and you can’t afford to ever let new law come down the pipe that somebody at the firm doesn’t have their finger on the pulse of and that’s just kind of been my responsibility.

And then from there, it was just kind of a natural step to say, “Hey, if I’m gonna learn all this stuff about the law, I might as well share it. I might as well read about it.” And then just through, again, a string of right place, right time circumstances, I ended up being hired over at “Forbes” about six years ago now to write about tax law for them. And so you do enough writing about the tax law, eventually, someone’s gonna ask you to teach about the tax law. And so when I’m not working for Withum, when I’m not writing about the law, I’m doing what I’m doing now, which is traveling around the country and teaching people about things like the opportunity zones, which is every bit as enthralling as you can imagine.

Jimmy: Oh, I’ll bet. I know you were just at the National Tax conference in DC and I believe you’re in Springfield, Illinois right now. Is that right?

Tony: I am. I’m looking out my hotel room window at the sprawling downtown of Springfield, Illinois.

Jimmy: Sounds awesome. So tell me a little bit more about your work at with WithumSmith and Brown. Who are your clients primarily and what’s your specialty?

Tony: Yeah, it’s kind of interesting because when I left the Big Four to go to a more regional firm, obviously, the experience I originally had at the Big Four kind of became almost overkill because I was working with huge consolidated corporate returns, your Sun Microsystems, your AOL Time Warners, and those just typically aren’t clients at more of a regional size firm. So for the last 15 years or so, my specialty really has been partnerships in S corporations, what we consider pass through entities. But over that time, my firm has grown to almost be the size of some Big Four offices and so some of that large corporate consolidated return has become necessary again. But again, it’s kind of interesting when we talk about the nature of my clients, my clients are all the firm’s clients.

As I said, my job is to know the law as best I can and make sure that I can serve all my firm’s clients when they have a need. If a businesses being bought and sold, if the real estate law changes or if somebody is just trying to do some structure and then some planning, those things all tend to come across my desk. And so kind of an unconventional career. It’s almost more trending towards the academic. I don’t sit there from January through April 15 and crank out a bunch of tax returns. Rather, like I said, I’m structuring M&A deals and I’m setting up businesses and consulting on next steps where tax consequences have already taken steps and things like that.

But if I were to narrow to an industry, certainly between my role at an East Coast firm and then my location in Aspen, Colorado, I work primarily in the real estate sector. It’s just kind of where I make my, you know, kind of earn my keep, because it’s just, in Aspen in particular, it’s a very real estate heavy industry or real estate heavy area I should say, and pretty darn similar back in New York and New Jersey. So the real estate tax law is probably where I focus most of my attention.

Jimmy: Good, good. So that takes us to opportunity zones. Obviously, there’s a lot of real estate investing interest in these opportunity zones. Let’s talk about that a little bit. I know you wrote that great article on “”Forbes”” that I already mentioned. And for anybody listening, I’m gonna link to it in the show notes OpportunityDb.com. That article was a very thorough dissection of the program. So I know you’ve done your research and thought a lot about this. What is your view of the Opportunity Zones tax benefit, and how much of an impact do you think it’s going to make over the next several years?

Tony: You know, it’s really a wonderful question to start with, because I think a lot of people in my industry are taking the same view of it, at least a lot of the people I’ve kind of informally polled, which is look, on the surface, right, this is very unique. I mean, you’re talking about offering significant tax benefits that we can certainly get into, the types of tax benefits that just aren’t readily available elsewhere in the code. I mean, you start with tax deferral, which people really appreciate, but then you also layer on top, as we can talk about at some point, potential exclusion, which is far better than deferral. And so that sounds great. Hey, instead of recognizing gains now, we can recognize them as late as 2026. We can eliminate up to 15% of our gains and then all future appreciation or new investment can be tax free. Who wouldn’t be interested in that?

But the reality is, I don’t know, maybe I’m oversimplifying things, but in my experience, a lot of my clients that have made a lot of wealth for themselves have done it in a fashion that they’re comfortable with. So they invest in certain areas or they’re in a certain business. And what we’re gonna find here with the opportunity zone incentive is the IRS isn’t gonna give you these tax benefits without having to meet a number of requirements. And the overarching requirement that hangs above all of this is you have to be heavily invested in an opportunity zone. And that’s not everywhere, right?

Jimmy: Right, right.

Tony: I mean, we have about 9,000 designated opportunity zones throughout the US, but they tend to be lower income areas, higher poverty rates, and you just have clients that don’t have experience working in those areas. And so that, to me, is just something right there. It’s amazing how many times I have the conversation with clients already just saying, “Hey, this is out there. What do you think?” And they’re all on board until I start mentioning the rules of where they have to invest and different requirements that I’m sure we’ll get into at some point here today. And you can just see that their enthusiasm starts to wane a little bit as they say, “This is little bit outside my comfort level.” And so I’m really curious to see how much it’s going to be used. And one of the things I’ve been thinking of is the drivers of this aren’t really gonna be the people who have recognized gain that they want to defer. The driver is gonna be the people who are already doing the types of things that opportunity zones are designed to do. So let’s just take a step back and talk about that for a minute at a very high level.

The point of an opportunity zones incentive is to provide motivation for people to invest in low income areas. Okay. You know that, I know that. And so, like I said, some people that have a lot of money that can make these types of investments, not really their cup of tea, not something they got experience with. But you have other taxpayers who that’s what they do. They go into low income areas, they build hotels, they build apartment complexes. And so, originally, I think we thought the people who recognize gains, the wealthy investors, they’re gonna be the one spearheading this. But taking a step back and looking at it, I think it’s gonna be the opposite.

I think the drivers are gonna be the people who will be doing this work anyway, who don’t actually have gains to defer but say, “Hey, I’m building a hotel in this part of the country or I’m building apartment complex in the part of Springfield, Illinois I’m looking out over right now, which I’m fairly confident is probably an opportunity zone. I’m doing these things anyway. And hey, I need investors.” And so, “Hey, investors, you’ve got gain. You’re not experienced with this. Don’t worry. I am. You invest in my project and in return, you’re gonna get a whole lot of tax benefit.” How much it’s gonna be used, you’ve heard numbers kicked around. I know Treasury Secretary, Steve Mnuchin, said he expects about 100 billion of investment to flow into opportunity zones. I know some of the big hedge funds have already started to put some of these investment entities together. But this is my 5,000 word response as a way of saying to you, I’m kind of in wait and see mode. I’m really curious to see where it goes.

And the reason I know I’m not alone on that is, as you said, I wrote, I don’t know, 10,000 words about this stuff for “Forbes” and a lot of people around the country reached out to me that appeared to already be in the opportunity zone in business, you know, lawyers and syndicators. And when I would ask them what their experience has been like, a lot of them said, “Well, we don’t really…we haven’t actually done any projects yet. We’re just learning about this the same way everybody else is.” So I think it has tremendous potential. And I think it speaks to the new tax law as a whole where, like I said, you can see there’s these huge tax breaks there for the taking. But you gotta be pretty darn smart to figure out how to access them. So I think the opportunity zones are perfect emblematic of that concept where there’s some really nice benefits here, but who’s gonna have the appetite, one, to maybe do something a little different in terms of investment and two, the appetite to figure out these requirements of which there are many.

Jimmy: Right. Yeah. So I think you’re right. I think a lot of people are in wait and see mode just because, well, first of all, it’s a relatively new piece of legislation, right? It was passed less than a year ago. And the opportunity zones themselves weren’t even designated until, I think it was July. But at the same time, the clock is kind of ticking a little bit because in order to get full advantage of the 15% step up in basis, you need to have your investment made by the end of 2019. Am I right about that?

Tony: Yeah. Let’s talk about that for a minute, kind of unpack everything you said for your listeners. First things first. Yeah, December 22nd, 2017, we got handed a complete body of new tax law, the most comprehensive overhauled internal revenue code in 31 years. There was a lot, a lot to address if you’re in our industry. And I gotta tell you, opportunity zones was probably about 20th on the list of priority of things that we had to figure out.

Jimmy: Right. It was kind of buried in there, wasn’t it?

Tony: It was very much buried. And when we stopped, you know, when we got past item 19 in the list and turn our attention to opportunity zones, what we were greeted with, and I don’t think it’s unfair for me to say this, were eight pages of the most poorly written statute that I’ve come across in my time covering tax policy. So it’s not like when we originally read the law, we said, “Oh, this is very clear. We know what we need to do here.” And so we’ve really been in wait and see mode until we got some proposed regulations, which we finally got about a month ago, about 84 pages of proposed regulations, which certainly help, still some unanswered questions. But we finally feel like we have enough to move forward. And like you said, timing is so important in all aspects of the opportunity zone, starting with how we get into the funds and going all the way through to when we get out of the funds.

But what we see here is, as you said, 2019 becomes a very important year. Why? Because to get the maximum tax benefit here, somebody who has gain they wanna defer is really gonna wanna put that cash in— for that gain, put that cash into one of these, what we call qualified opportunity funds before the end of 2019, because you get to defer gain, but you only get to defer this gain until the end of 2026. And when you get to that point, the kind of second and third tranches of tax benefits. The first is very clear cut. If you have a million dollars of gain in 2018 and you invest a million dollars into one of these qualified opportunity funds, you don’t have to recognize the gain. But that gain is simply deferred, and it can be deferred long as, late as 2026 if you haven’t sold that. But the real benefit, because deferrals fine, but eventually it comes home to roost and you have to pay tax. The real benefit here are the second and third tranches of tax benefits.

If you hold this new investment for five years, 10% of your deferred gain magically disappears. So if you deferred a million dollars of gain by putting a million dollars into a fund in 2018, sometime in 2023, $100,000 of your gain forever disappears. And then if you hold for another two years, so you get to seven year holding period, another 5% magically disappears. And as I said, the key here is, and as you said, the drop dead date for when you have to recognize that million dollars of deferred gain is the end of 2026. And so you need that seven year holding period to have been reached prior to December 31, 2026. And so that means you’re gonna want to make this investment before the end of 2019 if you’re gonna fully capitalize on the tax breaks. And so it is not a great position to be in because, as you said, the clock is running. It is time to get these things going and get them done. But we don’t have as much in the way of concrete guidance as we would like.

Jimmy: Right. It seems that the clock is ticking so fast and yet, as you said, we don’t even have all of the guidance available to us. Do you think there’s a chance that the IRS could push back that 2026 deadline maybe by a year or two at some point?

Tony: That is a great question. I don’t that’s on the IRS’s radar just yet. I think they’re more inclined, particularly after hearing from the IRS at the tax conference this week in DC, they’re more inclined to really push the envelope on the front end here and really try to get guidance out to us as quickly as possible in terms of final regulations, I would think this was always intended to be a short term incentive. I would think 2026 will end up being a hard date. I guess you never know under the tax law, you know, we see what were supposed to be short term incentives. I mean, when bonus depreciation came out in 2001, it was supposed to be a short term incentive and here we are in 2018, it’s still here. So you never know. But I think the nature of this investment, what it’s supposed to do and then don’t forget, there’s a date that all of this ends.

And maybe we should address that as well. We’ve talked about the three tranches of tax benefits. You defer that million dollars of gain in my example in 2018. 2023, $100,000 of it disappears. 2025 in my example, another 5% disappear. 2026, remaining $850,000 of gain comes home to roost and you have to recognize and pay tax on it. But then that leads us to the fourth, and really what is the most dramatic and unique tax benefit under the opportunity zones, is if you reach a total of 10 years of holding period.

We’ve already recognized all the original gain that we deferred, well, not all of it, but 85% of it. But all future gain on this new investment we made into an opportunity zone, all of it is tax free once we’ve held for 10 years. So if we put a million dollars in and 10 years from now, 10 years and a day from now, it’s worth $7 million, you walk away with $6 million of gain tax free. I mean, you don’t get that anywhere else in the law. But the crux is, because this is meant to be a short term incentive, they are going to make sure if you want that ultimate tax benefit, you do have to dispose of your investment in this opportunity zone and the drop dead date for that is December 31, 2047.

And so we have all these investments that people are gonna be making, but the clock is gonna be ticking because if they want the ultimate tax benefit that’s dangled in front of them, which is tax free appreciation on the investment in the qualified Opportunity Fund, everybody’s gonna have to exit their investment by the end of 2047. So the whole point of that story, other than a nice way to sneak in the last of the tax benefits we haven’t addressed yet, is that there’s a finite lifespan as of right now for this opportunity zone incentive. You have the fact that opportunity zones themselves, the designation disappears in I think 2028. In 2026, you have the deferral come to roost. In 2047, everything’s kind of gotta be wound up and done if you want your tax benefits. So I don’t know. I think the dates are probably here to stay.

Jimmy: Right. Right. So a lot to unpack there from that big explanation. So first thing I wanna point out is that obviously, the biggest benefit is that last tranche that you referred to, the elimination of all capital gains on opportunity zone investments after a 10 year holding period. The step up in basis or more simply put the reduction in capital gains from the original investment of 10% at the 5-year mark and 15% at the 7-year mark start to go away after 2019, but you’re still through, what was it, I think 2021, you can still get the 10% reduction at least and then up until, what year, I guess is the final year you can invest and still be able to reap the benefit? I guess it would be 2037 would be your last chance to get in on this?

Tony: No. Well, that’s a great question. I hadn’t even thought about that. You’re gonna need, yeah, 2037 because you’re gonna need a 10 year holding period. It’s a good question. I have to think about that because I actually think…I don’t think that would work because I think the… No, it would not work. The only investments that are gonna be eligible for the end of day grand finale exclusion on capital gains are those that were originally invested subject to a potential gain deferral. And those are gonna have to happen before the end of 2026. Do you see what I mean?

Jimmy: I do.

Tony: Because 2026 is when deferral come home to roost. So I believe if you were to look in the preamble to the regulations, and if you do, I apologize in advance. But if you’re to read the preamble to the regulations, you’ll see that…I think it says the whole point of the 2047 rule is that any investment that’s gonna be eligible for the overall exclusion would have to be made before the end of 2026, and you’d have to hold it for 10 years. So now you’re at 2036, and then they didn’t want everybody rushing to the exit on 10 years and a day, potentially and so they gave another 10 year period. So yeah, I do believe that by 2026, you gotta make your investment or else you’re really just investing in a fund with no…

Jimmy: No big tax benefit.

Tony: …tax benefit. Yeah.

Jimmy: No, that makes sense, then. Yeah. I think that’s probably the right interpretation there.

Tony: And then for the benefit of your listeners, you and I have been saying the same thing. When we use my million dollar example, you’re saying it more appropriately. You’re saying after five years, you get a 10% basis increase. And what’s important there is your basis begins at zero dollars. So your basis goes to $100,000, and after two more years, your basis goes to up to $150,000. When I was saying that you exclude the gain, it’s two ways of saying the same thing because if your basis is increasing by $150,000, your gain is naturally disappearing by $150,000. So just so we don’t create confusion for anybody. When Jimmy says you get basis increase and I say you get gain exclusion, they’re the exact same thing.

Jimmy: Same thing. Thanks for clearing that up, Tony. I appreciate it. I wanted to talk a little bit about those IRS regulations that came out. What were your biggest takeaways from that publication? Were there any surprises?

Tony: Yeah. I think there were a couple surprises. First of all, I think the IRS did pretty a good job, and again, they had nowhere to go but up because the statute truly was a mess, like I said, eight-page statue, and it created confusion within one sentence. And so the regulations had their work cut out for them. What was confusion within one sentence in the statute or the title of the opportunity zones, instead of provision basically says special rule for capital gains invested in opportunity zones. But then the first sentence of the provision said any gain from the sale of property. And that’s important in tax parlance.

I know most normal people wouldn’t care, but capital gains are a specific type of gain under the tax law, from things like selling Facebook stock or selling raw land or selling maybe an appreciated rental property or apartment building or something like that. But there are other types of gains like ordinary income, somebody that develops property and sells it to customers, or someone that sells inventory. And so within one sentence of the statute, they created ambiguity, because the title says capital gains, but the text says any gain from the sale of property. So the regulations quickly shut that down and made very clear that the original gain you recognize that it’s gonna be deferred by being reinvested into an opportunity zone, it has to be capital gain. So anything that generates ordinary income, you’re not gonna get there. Right. That knocks a number of things out of the park right then and there.

Then, as far as surprises, they gave us some friendly rules here. Number one, we were kind of curious who was eligible to reinvest gains and use these opportunity zones. Was it just individuals or did it expand beyond that? And the regulations made clear that pretty much anybody that recognizes a gain can defer it using opportunity zones. So it can be an individual, it could be corporation, it could be a partnership, and S corporation, you name it. So that’s pretty expansive. Now, that naturally led to another piece of needed advice because if a partnership or an S corporation has a gain…partnerships and S corporations, they’re conduits. They’re pass-through entities. So they don’t pay tax on their gain. They just pass out the gain to the ultimate owners, and they pay the tax.

And so the question would arise. Okay, well, what if a partnership chooses not to defer gain that it recognizes and passes it out to the partners or an S corp does the same thing? Do they then get the option to defer the gain? And the regulations made clear that absolutely, they do. And so that led to another need for clarification, because one thing we haven’t touched on yet, we’ve mentioned over and over that there’s a constant clock running.

Jimmy: Yes, so there’s an issue with the 180 day timeline in that case, right?

Tony: Yeah. So the moment you recognize gain, you don’t get to just sit back and hold on to your cash for a year and figure out what you wanna do. The clock starts running. From the moment you recognize your gain, you got 180 days. That’s six months. Six months to say, “Am I gonna do it, or am I not gonna do it?” And that needs some complexity, for example, with a partnership, because let’s say a partnership sells property for gain on February 1st of 2018. The partners might not even know there was a gain at the partnership level until they get their schedule K-1 from the partnership in March of the next year, 2019. But what has happened by March of ’19, that 180-day window from February 1st is long gone.

And so the proposed regulations say, look, if a partnership passes out gains to a partner or an S corp to a shareholder, even if that gain arose on say February 1st, for purposes of the 180-day window, it’s treated as if the gain arose on the last day of the calendar year. So that’s huge because that means even if the sale happened on February 1st, a partner or shareholder can treat the gain as if it occurred on December 31st, and that means the 180-day window hasn’t run yet. That was a bit of a surprise. And then the big thing we were looking for in the proposed regs was…let’s be honest here. Who is going to really use the opportunity zones? And you and I already kind of talked about this. It’s gonna be people that have experience in real estate development in low income areas. And so you’re gonna be looking…it’s not necessarily that it has to be this way.

But I think in reality, these are gonna be real estate projects. These are gonna be people that buy an old building and refurbish it, or they buy land and build a building. And the thing is, these things take time. And we haven’t gotten into the nuances and I don’t know how much we will because it’s so nuanced. But when you take your money and you invest it into one of these qualified opportunity funds to defer your gain, these funds again, they’re not allowed to just sit there and hold your cash and you get to defer gain. There are a number of requirements that will really leave your head spinning because so many of the critical terms sound so similar. They differ by one word. But the point is, and I’ll kind of keep it high level for your listeners, is when this money goes into a fund, the fund has to put that money to use in a qualified opportunity zone pretty much right away. And there’s actually this test that 90% of the assets of these funds that people invest in to get these tax benefits have to be employed in a qualified opportunity zone. They have to represent what’s called qualified opportunity zone property.

And so one of the big concerns we had when you put all that together is let’s say, a bunch of rich people sold stock and they put $10 million into one of these funds with the idea that the fund is going to refurbish or completely improve an old building, that would qualify as being the type of business that kind of fits the bill here. But the ball has to get rolling, because if that cash just sits around in this fund while you’re out there seeking approvals and things like that, you would run afoul of this 90% test because that’s not property being used in a qualified opportunity zone. It’s just cash sitting in a bank account.

And so these proposed regs gave us a much needed bailout. Without it, who knows? Maybe qualified opportunity zones wouldn’t have even been useful, because if we think real estate development’s gonna be the key attractor here, then without this rule, I don’t know that that would have existed. This rule basically says, “Look, we’ll give you some time here. Okay, we’re gonna give you up to 30 months to put this cash to use as long as you meet certain requirements.”

So as long as you have kind of a written plan that says that the cash is being used to replenish or to refurbish or improve property and as long as you actually go ahead and do it in accordance with that plan, then they are going to give you, like I said, up to 30…sorry, 31 months, not 30 months. That’s a different rule under the tax law. But they’re gonna give you up to 31 months to go ahead and put this cash to use and convert it from cash into an improved building or a hotel or an apartment, whatever it may be. And so that’s kind of a lifesaver. Without that, who knows if opportunity zones would have been widely used at all, because I do think much more people are gonna use it to build apartments and buildings than to create manufacturing, distribution or something like that.

Jimmy: It’s very difficult obviously to take $10 million and then deploy it the next day. The 31 months is absolutely necessary for that case. You’re right.

Tony: Yeah, and until we got the regs, you know, we didn’t have anything like that. But we did think it needed to be deployed the next day, because anytime a qualified opportunity fund does not meet that 90% test, it’s gotta pay a penalty to the IRS. And so a lot of people were just waiting to see, well, how’s this gonna work for us? Like, how do we, get some time to go and to convert this cash into a building? And so the 31 month rule is really key. And then the last thing that was a bit of a surprise in the regs, and I think it’s a surprise for all the wrong reasons, and maybe somebody with economics degree can tell me different.

But I find it very strange that as we talked about earlier, in order for an investor to get the ultimate benefit they’re probably looking for, which is deferral on the back end, I mean, not, sorry, deferral, the exclusion on the back end of this new investment of all future appreciation, they do have to sell and they have to sell by the end of 2047. So, what I keep coming back to thinking is just, you’re trying to provide incentive to invest in a low income community, but what happens to these low income communities if in 2045, 2046, everybody’s pulling out their investment, everybody’s rushing to the exit, so they can cash in on the tax benefits?

Jimmy: Yeah. I wanted to ask you about that. It seems like that would put a lot of downward pressure on the values of these investments.

Tony: I don’t understand how it can’t. I don’t understand, and I ran it by some friends of mine that are economists that are far smarter than I am on these types of things and, yeah, they say that’s a really tough policy decision. But the IRS did address it in the preamble to proposed regs. They did talk about their options. And one of the options would have been to say, “Okay. Well, in 2047, just draw a line in the sand. And even if you don’t sell your business, figure out what it’s worth and that amount of appreciation will never have to be recognized.” But in the preamble, they said, “You know what. We don’t want to put taxpayers in a position where they have to value the businesses at that moment in time,” because one, it puts an administrative burden on them, but two, that can be gained, right?

Jimmy: Absolutely.

Tony: You bump up that value as much as you can justify so that any future appreciation is kind of mitigated in terms of taxable gain. But I just find that really strange that you’re creating a rush to the exit that’ll probably start somewhere around 2043 or 2044, where people that still hold their investments are gonna wanna get out before the values drop.

Jimmy: Yeah. That’s a tough one. But I don’t know, yeah, I wouldn’t know what the better alternative would be.

Tony: Yeah. We’ll see. I mean, that could definitely change in the final the regulations. I think some people are gonna have issue with it, but we’ll see.

Jimmy: Yeah. So what do we still not know from the IRS? What are some of the biggest unanswered questions we’re still waiting to get clarification on?

Tony: There’s a of couple things, to be honest. I mean, number one, there’s some key terms that we don’t know that, you know, your listeners might chuckle about because it seems like these are maybe some of the first things we should know. But, for example, we’ve said that these businesses have to take place in an opportunity zone. And if you build an apartment complex, it’s pretty clear that that business is in an opportunity zone.

But not all businesses are so cut and dry. I mean, you might have businesses where there’s trucking operations that are constantly leaving the opportunity zones or construction equipment that’s constantly leaving the opportunity zones. And how much is okay? How much is enough? And so the statute says that…and the regulations say that substantially all of the property has to be used in a opportunity zone for substantially all of the property’s holding period. But it doesn’t, at least at this moment, define what substantially all is. And so we know we have some wiggle room. We know that businesses don’t have to be 100% located within an opportunity zone.

But we don’t really know yet how much is enough or like, how much of it has to be inside the zone or that’s outside the zone, how much of it, of the holding period of the property does it have to be inside the zone versus outside the zone? So those regs have been reserved, and we all kind of have an eye on understanding what that means, because if opportunity zones are going to expand beyond pure real estate development into more operating businesses, then we’re certainly gonna need some clarification on what it means for such a basic definition. What does it mean for property to be in an opportunity zone, particularly property that’s mobile, property that can move around?

So that’s gonna be one key thing that we’re still waiting on. Another key thing is just some subtle things, like what happens with installment sale gain. If you have gain that you’re gonna recognize, you sell something in 2018 and you’re gonna recognize gain in each of the next five years, do you get five opportunities at deferral? It certainly looks like you do, but I think some more clarification on that would be welcome. Other than that, again, just some key definitions. There are some strange results in the proposed regs that we’re not sure if they were intended or unintended. But let me just kind of give it to you in a way that hopefully people can understand.

Jimmy: Yeah. Go for it.

Tony: So, your investors who recognize gain and they gotta invest in a qualified Opportunity Fund. We already talked about that. The qualified Opportunity Fund, in turn has to be invested in a qualified opportunity zone property. 90% of the assets has to be in qualified opportunity zone property. But there’s three kinds of qualified opportunity zone property. Really, they go into two buckets.

The first two kinds, you can own property by owning stock or a partnership interest in a subsidiary, and that subsidiary in turn operates a business within the qualified opportunity zone. Or alternatively, you can say, “Forget the subsidiary. My fund will just hold property directly.” And when I say there were some strange consequences, we know that 90% of the funds and assets have to be in qualified opportunity zone property, but we also know that that property can be in the form of a stock or a partnership interest in a subsidiary. Well, then the proposed regs tell us that that subsidiary, whether it’s a corporate or partnership, has to be operating what’s called a qualified opportunity zone business. And part of that definition says substantially all of the assets have to be qualified opportunity zone property.

So it has to be property that’s held in a qualified opportunity zone. There, they do define substantially all, and they say, as long as this corporate or partnership subsidiary has 70% of its assets in a qualified opportunity zone, that’s gonna be good enough for us. But if you do the math on that, that means if the fund only has to have 90% of its assets in this stock or partnership of the subsidiary and the subsidiary only needs to have 70% of its assets in qualified opportunity zone, that means that if a fund operates a business through a corporation or a partnership subsidiary as little as 63%, 90% times 70%, a little 63% of the assets have to actually be in a qualified opportunity zone.

Jimmy: Right. So then you got more than…more than a third of the assets can be invested anywhere else.

Tony: Anywhere else. Whereas if you choose that third option, and your funds says, “Forget the subsidiary. I’m gonna operate the business directly,” well, then you’re locked in to the 90% rule. There is no 70% rule. And so that seems so strange. Who’s gonna ever want to operate a business directly? Everybody’s gonna wanna set up a corporate or partnership subsidiary because it gives you much more wiggle room because, again, you’re talking about a 63% standard versus a 90% standard. And so that’s a strange result. I think a lot of people have an eye on that to see if that was intended or unintended. It doesn’t make a lot of sense that you would have one result for one and one result for the other. But that’s something where we’re still waiting for answers as well.

Jimmy: Yeah, because like you said, I mean, the flexibility there of owning the business through a subsidiary, everybody’s gonna opt for that option it sounds like.

Tony: You’d be crazy not to the way the law’s written right now.

Jimmy: So what’s the timeline for getting all these rules set in stone more or less? I think we’re still waiting on the IRS, obviously, for some additional publication. And then is there a final approval that needs to take place? What does the process look like from here? What’s the timeline like?

Tony: Well, we’re gonna have public comments on the regulations here in a couple months. What happens there, people like me and people at the AICPA will write letters to the AICPA saying, “Here’s what we like about the regulations. Here’s what we don’t like about the regulations.” And then we also have the opportunity to go to the IRS in DC and basically verbalize those comments. And then from there, hopefully, the IRS, the drafters of the regulations put some thought into what we’ve said and what we’ve written and they’ll come out with final regulations.

Now, I gotta be honest with you. Opportunity zones are not the number one priority. There’s other areas in the new tax law where we haven’t even gotten proposed regulations yet. And then there’s other areas where we’ve gotten proposed regs, and final regs are going to be bigger demand than opportunity zones. And I think the most optimistic we could be to ever get final regulations on anything under the new law would be by New Year’s Day, and I don’t think, like I said, opportunity zones will be the first thing to come out. I do think it’ll be in the top three. And so I would think maybe March, you know, March of 2019, we’re getting some final regs. That’s probably a little aggressive, little optimistic, but i think the nature of opportunity zones and all these critical terms you and I have thrown around, 180-day rule, 2019, 2026, 2047, they gotta get moving.

Jimmy: Right, right. So still in wait and see mode here for several more months it sounds like while we get all this sorted out. What have you been hearing from your clients about this program? Obviously, it’s a new program, and I know it’s not on a lot of normal people’s radars yet, as you refer to non-codeheads, I guess. But are clients approaching you about this program or you and your colleagues having to do a lot of education and come to your clients with ideas about this? So what are we talking about here?

Tony: It’s been fascinating. Let me break it into two segments, my clients and then the outside world. My clients, like I said, it’s been really a mixed bag. I’ve been super excited to tell everybody about the incentive and I’ve been met with mixed reactions. There are some who are selling businesses for $40 million and gonna have huge gains that are certainly willing to take a hard look at this, absolutely. The ones, again, that have made their wealth kind of being a bit more one dimensional, whatever that may be, aren’t quite as excited about it.

And then even some within the real estate world, they should be so excited about this, because even though they may not have gains to defer themselves, they have projects they wanna work on, and if they’re willing to build in a opportunity zone, there’s gonna be no shortage of capital available because other people do have gains they wanna defer. But some of these clients have been leery because…what we haven’t really talked about yet you and I, is when someone wants to defer a gain, their investment into one of these funds, or if the fund invests in a partnership, it has to be an equity investment. It cannot be a loan. And a lot of my real estate developer clients are reticent to give out equity. They’d rather do mezzanine lending. They don’t wanna give away that equity stake.

And so it’s really taken some massaging to get people to see the full advantage here of opportunity zones. And so again, I think it’s an incentive that offers very unique tax advantages, but no one so far is, at least in my orbit, it is jumping at it.

And then compare that with a situation where the rest of the world seems like they can’t get enough of opportunity zones. I mean, I just glanced at my laptop since you and I started talking, and I have three emails from total strangers, and the subject line has something to do with opportunity zones. I mean, when I wrote that article for “Forbes”, I mean, listen, when you write about tax law for a living, you know you’re naturally writing to a limited audience, and it’s been overwhelming how many people have reached out to me to talk about these opportunity zones. And so it’s, like I said, just kind of this weird dichotomy where globally, there seems to be so much interest in this provision. But I’m not gonna get too excited until I actually have one of my clients go through it from beginning to end.

Jimmy: What are you advising your clients to do? If one of your clients with a multi-million dollar gain comes to you and says, “Hey, I wanna invest this in an opportunity zone,” do you have any advice for them at this time? Are you still in wait and see mode? What are you telling them?

Tony: No, I think we’re in ready to move forward mode. The key is where to move forward to. And I have been lucky, I built up a network just for my writing of some lawyers who are effectively acting as syndicates that are putting together these qualified opportunity funds and just now waiting for investors and waiting for projects. But the funds are set up, the projects are kind of identified. And so if a client is really ready to pull the trigger, then what it’s a matter of doing is if, it depends on the client’s mentality. If they have an idea of what they want to do, then that takes on a different level of work.

But if they just say, “Hey, give me a conduit to defer my gain. I don’t care what project it goes to. I just wanna defer the gain,” then I can kind of tap into my network and say, “You know, what projects are out there that would use this type of investment, and are you looking for investors at this particular time?” But I don’t think at this point anybody can sit back and say, “We’re waiting for more,” because, as you alluded to earlier, the clock really is running. And a lot of these funds and a lot of these real estate projects have already gone through the process of getting zoning approvals and things like that because they wanna make sure that 31 month period they have to convert their cash into real property that it happens within 31 months.

So a lot of them are being aggressive on the front end, getting the zoning, getting approval before a lot of the cash comes in, so that they can expedite the use of that cash. And so I think we’re all systems go at this point. I just think we’re gonna see a trickle-down effect where maybe the fund set up by Goldman Sachs will be the first ones that people are investing in and hitting the ground running, and then we’ll see it spread out more throughout the country and or down to kind of, not the Everyman because the Everyman’s not gonna have the type of gain that wants to be deferred. But you know what I mean?

Jimmy: Yeah.

Tony: People that use more of a local accounting firms and regional accounting firms, and things like that, that don’t have the ability to tap into a huge fund that’s been set up.

Jimmy: Right. So how has that process been going? Like my local tax guy or my local financial advisor on the corner here on Main Street in my in my little town, does he know about opportunity zones yet or is he just starting to get up to speed on these?

Tony: Yeah. It’s highly unlikely. At this point, the Big Four are doing a good job. There are more than a handful of regional firms, like, with them that are kind of leading the charge on understanding opportunity zones and then building the network. A lot of it right now is building the network. But a lot of it has been kind of set up by big law firms at this point that, again, are almost acting as syndicators, just setting up the fund before they had any idea what these funds were going to do.

But I find it very hard to believe that your 10-person shop is gonna be up to speed on opportunity zones for the simple matter of, like I said, it’s so far down the priority list of things that affect most accountant’s lives. I mean, most accountants are just figuring out how to grasp the new law. And to think you’re gonna get into an incentive with this many constraints and this many requirements and this many time deadlines that maybe only one or two of your clients are going to have a need for, yeah, it’s probably a bit of a reach. So I think this is gonna be the domain of the top 30, 40 accounting firms in America and then obviously the top law firms.

Jimmy: Right, right. Shifting gears a little bit. I know we’ve talked a lot about this program in terms of being beneficial for real estate investments. Obviously, there’s a lot of benefits to using it for real estate investing. But what about businesses? Are you seeing any interest in investing in business?

Tony: I’m really not yet, and a lot of people I’ve spoken to around the country aren’t yet. Right now, it appears to be kind of strictly the domain of the real estate developers. I think a lot of that owes to what we said before. We don’t really understand how some businesses are gonna be treated in terms of location within an opportunity zone and satisfying those requirements. And so again, we know that it’s intended to reach to just your normal operating businesses, but I think there’s enough unanswered questions that really, at this point, everyone that’s moving forward is building out real estate. It’s just really kind of the nature of what we’re seeing so far.

Jimmy: Gotcha. Yeah. No, it makes sense with a place-based policy like this, you know your real estate isn’t gonna move. With the business, it could. I wanna talk with you about some of the nuances of the tax benefit that may not be receiving enough attention. One that just piqued my interest a few days ago, it’s the first time I heard about, is the potential to completely eliminate depreciation recapture. Are there any other nuances that you don’t think you’re receiving enough attention?

Tony: That’s actually a great point. You bring up one of, you just asked me before, you know, what are the major areas we’re looking for clarification on. Remember, all of this is predicated. If you wanna exclude gain down the road on something like depreciation recapture, any appreciation inherent in these new buildings or new businesses, you have to eventually dispose of the business. And one thing that is not made perfectly clear, but it seems like it’s clear, is do you have to sell your ownership interest in the fund? What if the fund sells its assets or the corporation or partnership that the fund owns, owns its assets, what happened then? And I would argue with you that if the corporate… Then, for example, it’s not gonna be a corporation.

But if a fund sets up a partnership that owns a hotel, or forget it. Let’s not even complicate things. If the fund itself builds a hotel, and the hotel 15 years down the road sells all of its assets to a buyer, I don’t see how anything that I’ve read in 1400Z-2 at this point would protect you from recognizing the gain on the sale of those assets inside the business. If you were to sell your investment in the Opportunity Fund, well, then we’re talking. Then you get to exclude the gain. But that creates a bigger issue because this is something I kicked around with other people in the industry, and it certainly appears that this section contemplates a sale of your equity investment beyond 10 years to defer all of the gain. And that may not sound like a big deal to a lot of people, but you have to remember, buyers don’t wanna buy equity. Buyers wanna buy assets from the business so that they in turn can take big depreciation deductions. And so that is something we’re kind of waiting for clarification on.

I would agree with you that you could defer or exclude, I should say, future depreciation recapture if you sell the ultimate ownership interest in the fund, and that’s what you’re gonna need to do for most of these benefits anyway. But I’m really curious, if you lose a lot of these benefits, if 12 years down the road, 15 years down the road, you don’t sell your interest in the fund, the fund sells its assets or the corporation the fund invested in sells its assets. And so it’s gonna put taxpayers in a precarious position, because, again, if you have to sell your investment in the fund to get the maximum tax benefits, that’s great and all, but not many people want to buy equity investments. They want to buy underlying assets.

Jimmy: Right. The market just won’t quite be there potentially. That’s a good point.

Tony: Yeah. It’s something we deal with in other areas of the code with other provisions. There’s a provision of the code that gives you 100% exclusion on certain small business stock you’ve held for five years. Oh, great. That’s wonderful, except nobody wants to buy your stock after five years. They wanna buy the assets. And so it definitely tempers the advantages of the provision a little bit and that might be something similar to what we’re facing here.

Jimmy: No, that’s right. Yeah, there’s a lot of sizzle, so to speak, from the tax benefit when you first read it. But the underlying investments and being able to exit is hugely important and something that investors should not overlook.

Tony: Well, not just, you know, can you sell your equity interest versus assets? But how are you gonna sell that equity interest if everybody’s selling their equity interest at the same time because 2047 is coming to a close?

Jimmy: Like you said earlier, 2044, 2045 is gonna roll around, people are gonna start exiting early. Yeah, I hear ya. I hear ya. Tony, thanks for coming on the show today. Where can my listeners learn more about you and read more of your stuff?

Tony: Yeah. Well, again, if you make your living in the tax world and what Jimmy said at the outset, makes sense, things like the “Tax Adviser,” I mean, you know, I write for “Taxes Magazine”, “Tax Adviser,” you name it. But if you’re just a normal person who doesn’t wanna be reading code sections, that’s really kind of what I do at “Forbes” and forbes.com is just write more for people that aren’t in the tax industry but really wanna understand these incentives. So “Forbes” would be a great place to start. Probably the most reasonable place to start would be my Twitter account @nittiaj, N-I-T-T-I, A-J. Anything I write, formal or informal, will end up on there, and like I said, so will some of these kind of extreme consciousness stuff where I’m asking questions about opportunity zones that maybe don’t have an answer yet and just seeing what the tax Twitterverse has to say in response. Believe it or not, there can be some pretty good tax discourse on Twitter in the darkest recesses of the social media world.

Jimmy: Oh, I’m sure. I’m sure. Well, Tony, hey, again, I really appreciate you taking time out of your day to chat with us. Thanks for coming on the show. And hopefully we’ll talk to you more on a future episode.

Tony: Yeah, Jimmy, sounds great. Like I said, maybe we’ll get back together after final regs come out.

Jimmy: Absolutely. Sounds good, Tony. Thank you.