QOF Formation Legal Considerations, with Jessica Millett

Jessica Millett

What are some of the most important legal considerations when forming an Opportunity Zone Fund? What are some of the pros and cons of corporation, partnership, REIT, and synthetic fund structures?

Jessica Millett is partner, chair, and “Wizard of OZ” of the tax practice group at Duval & Stachenfeld, a real estate law firm headquartered in New York City.

Click the play button below to listen to my conversation with Jessica.

Episode Highlights

  • The challenge of interpreting the Opportunity Zones statute before IRS regulatory guidance was published, and how the regs have opened up the market for OZ dealmaking to start.
  • Why setting up a Qualified Opportunity Fund (QOF) as a single-member LLC is a bad idea.
  • Why a QOF should be set up under a “two-tier” structure.
  • When funds would want to use a REIT, corporation, or partnership structure, and how exit considerations factor into this choice.
  • What a synthetic fund is and why it may be preferred by some funds.
  • The legal documents that every QOF should have.
  • An estimated range of legal costs to form a QOF.

Featured on This Episode

Industry Spotlight: Duval & Stachenfeld

Duval & Stachenfeld

Founded in 1997, Duval & Stachenfeld is a New York-based law firm that specializes in complex real estate transactions. Their practice areas include corporate, finance, fund formation, joint ventures, tax, and of course Opportunity Zones.

Learn more about the Duval & Stachenfeld

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.

Show Transcript

Jimmy: Welcome to the Opportunity Zones Podcast. I’m your host, Jimmy Atkinson. Tax law was complicated enough before the Opportunity Zones Program was introduced into law in late 2017 and it’s obviously gotten a lot more complicated since then. Here to speak with us today about some Opportunity Zone legal tax issues is Jessica Millett, partner and chair of Duval & Stachenfeld’s Tax Practice Group. Jessica specializes in tax, real estate, and opportunity zone law and she joins us from her office in New York City. Jessica, thank you for taking the time to speak with us today and welcome to the podcast.

Jessica: Thank you. I’m happy to be here.

Jimmy: Great, great. So when did you first learn about the Opportunity Zone Program and what was your initial reaction to it?

Jessica: So we first heard about the Opportunity Zone Program in early 2018. I will be honest, when tax reform was happening at the end of 2017 and we were all poring over the new provisions and the house report and the Senate report and conference bill and all that, Opportunity Zones did not come across to me as this hot new thing in tax reform that would really be turning into what it has turned into. We were focusing a lot of the big-ticket items that everybody else was focused on. And then it wasn’t until early 2018 that we first started looking at it and getting calls about it. And once we looked at it in more depth, it was kind of a no-brainer for us to really make the decision to move into the space.

Duval & Stachenfeld is a real estate law firm here in New York City and given that the Opportunity Zone legislation is a geographically-based program, no surprise that real estate was really the first wave of investments. And since real estate is really the primary focus of the firm, all of our clients as soon as we told them about it, I remember sending out our first, we called it a white paper back then, our first paper on Opportunity Zones in May over a year ago. And as soon as we sent it out, the phone started ringing and the emails started coming in. So it really took off right after that.

Jimmy: Yeah. I think in those early days, a lot of people were really starved for information and there was a dearth of information out there so you helped fill that void I’m sure. You told us a little bit about Duval & Stachenfeld already but can you tell us a little more about it? How big is the firm and what are its strengths and who are some of your clients? Or you don’t need to give me specific names but what types of clients do you serve?

Jessica: Yeah, sure. So at Duval & Stachenfeld, we are coming up on our 22nd anniversary in just a couple of months. We’re based here in New York City. This is our only office. We have about 50 attorneys. So by New York City standards, we might be on the small side. And the firm is really all about real estate, every flavor of real estate. Our tagline is, “the pure play in real estate.” So we do every flavor of real estate deals from, you know, buying and selling the dirt to more complicated corporate structure. Everything from a “simple” joint venture which, of course, is never as simple as it seems to more complicated and complex structures which is in-depth platform investments, and obviously these qualified opportunity funds have been a big deal for us.

We also do a lot on the finance side in convential mortages, Nasdaq preferred equity. We do leasing, we do a special…with New York City specialty practice groups here for like New York City real property tax and zoning issues. So if real estate is involved, then there’s a good chance that we do it. We have a lot of institutional clients, a lot of real estate funds, proper big real estate and commingled funds. Typically, we don’t do a lot of the up to your fund work but we do a lot of the deal work. So all the investments that these big institutional real estate funds invest into, we negotiate those investments for them. We have a lot of big institutional lenders.

We also represent a ton of developers. So we get to sort of see these transactions from both sides of the table, which I think is one reason why our clients really…our clients are very loyal.And I think they appreciate the fact that we can bring a lot of market intelligence to the table in terms of advising them, well, not only on the legal issues but also on what’s happening in the market and what they should really need to be looking out for.

Jimmy: Excellent. Excellent. And can you characterize your general approach to working with your clients? Maybe you have a new client who wants to set up a qualified opportunity fund or maybe just want something really super complicated in terms of how it’s structured. What’s your general approach? What’s the approach you take with someone like that?

Jessica: Well, I think the first thing that needs to happen is education. I think that even now still, more than 18 months into living in the Land of Oz, shall we say, there’s still a ton of misinformation out there. There’s a lot of misunderstanding. I view my most important job in the first instance as really to educate my clients and let them know that this is how the program works, these are the tax benefit, this is what the structure will look like. And then most importantly, it’s really important for them to understand what we know, what we don’t know, and where the fuzzy areas are.

You know, tax law generally, they’re shades of gray. It’s very rare to get an answer that 100% yes or a 100% no. You’re often sort of trying to interpret things and borrowing from different areas of the tax law and there’s a lot of interpretive issues there, which is what I like. I like the analytic process of it. But I think that it’s important especially in an area like Opportunity Zones where we don’t actually have a lot of guidance on point. For the first 10 months, all we had was those two sections in the Internal Revenue Code, which just generated a lot more questions than they answered. And now, we have two sets of regulations, which are certainly helpful. You know, they’re in proposed form. But again, a lot of the issues that come up in trying to structure a qualified opportunity fund, they beg more questions and then well, where are you gonna find the answers?

And so it’s a question of what other areas of tax law can you look to and if it’s reasonable or not in certain instances to rely on those other areas in the tax law? And so I think it’s important for anybody looking at this space and trying to understand it is that on the legal side, on the interpretive side, the tax lawyers, the accountants, CPAs, we are all doing our best to interpret a very skeletal outline of this legislation and fill in the holes. And so it’s important for people to understand that some things are clear but more often than not, there’s always going to be lingering questions about well, is that what they meant or is that the right way to do it or what does that mean. So it’s a constant process of education and explaining.

But again, the most important thing in all of that given the uncertainties, if I really try and give my clients a very frank view of what’s happening, like “Well, look, I think that you’re gonna be okay on this because of X, Y, Z,” or, “That, frankly, is fairly risky and if you wanna do it, I can explain the risks to you but just understand that you may be a little bit sort of on the other side of the line from where I would typically advise you to go.” But look, everybody is an adult, everybody is making the commercial decisions they need to make and as long as I can be frank and upfront with them about where they are in terms of comfort on the various points, I think they appreciate that.

Jimmy: You mentioned a very skeletal frame or a skeletal outline of the statute. I can only imagine how difficult it must have been to interpret that statute in the first few months before we had any sort of regulatory guidance. I’m sure you must have been breathing a sigh of relief when we finally got the first and second tranche and now, you’ve got a little bit of meat on that skeleton to work with. Is that fair to say?

Jessica: Yeah, absolutely. I mean I would sit in…I’d be in so many meetings trying to explain the legislation to people before the regulations came out and there was a lot of shoulder shrugging and well, maybe, and who knows. And it’s very difficult obviously to be an effective adviser in a situation like that because again, I can tell my…I’m comfortable telling my clients where the uncertainties are but when there’s so much uncertainty, who’s gonna be comfortable going ahead with that? And I think that’s the reason why there was a real delay in terms of people actually doing these deals. Everybody wanted to talk about Opportunity Zones. Everybody wanted to understand them but nobody was willing to pull the trigger on it. And now finally after the second round of regs, we’re starting to see some movement there.

And I do think there are certainly still some outstanding questions and things that need to be clarified and things will hopefully change. But I think we really at this point have the bulk of the guidance that we’re gonna get in terms of being able to structure these deals and put them together. So once people hear that, at that point, it becomes a commercial decision. Are you comfortable given what we know and given the guidance to go ahead with it, understanding that there’s gonna be a few leaps of faith in there because not everything is crystal clear and laid out for you? But if it’s a good deal and the deal makes sense, then that’s really the reason to go forward.

The tax benefits are great. But if the deal doesn’t work, if you don’t make any money on the deal, then the tax benefits aren’t really worth anything. So at the end of the day, what we told our clients is, “Look, do the deal if it’s a good deal and obviously, we’re gonna do our best to structure it in a way that accomplishes that result that the qualified opportunity fund is set up the right way and you meet all the requirements, but at the end of the day, don’t do this just for the tax benefits. Do it because it’s a good deal.”

Jimmy: That’s right. And that issue comes up on almost every episode of this podcast. You gotta make sure the deal makes sense. You can’t just get into it for the tax benefit. The underlying investment has to make sense as well. Jessica, can you tell us a little bit about your personal background? Earlier, you mentioned the phrase “Land of Oz” and if I understand correctly, you are referred to, at least, internally at Duval & Stachenfeld as The Wizard of Oz. You’re really there Opportunity Zones specialist. But how did you get to that point? How did you get to where you are today?

Jessica: Yeah. I certainly did not have dreams growing up of becoming a tax lawyer. So I guess it’s funny where life takes you. But I went to Johns Hopkins for undergrad and as I was rounding out my senior year there, I realized that I didn’t really know what I wanted to do when I grew up. So I actually joined the Peace Corps and I went and I lived in West Africa for two years. And when I came back from West Africa, I still realized that I didn’t know what I wanted to do with my life. But when I in the Peace Corps, I became interested in international law and international human rights, in particular. And so I said, “Well, maybe I’ll go back to school and I’ll study international law.”

So I went to law school having dreams of being an international human rights lawyer and then I found out that that doesn’t really exist. So now, of course, I’m in law school and I’m racking up law school debt so I figured I would kind of do the path of least resistance and go and get one of those law firm jobs because that’s what people did. And the summer in-between my first and second year of law school, I did an overseas program. I was at a law school in Dukes down in North Carolina and I did an overseas program in Switzerland. And I needed one more kind of bs summer class to fill things up and I chose international tax law because it sounded kind of interesting and I figured it was only a couple of weeks. How bad could it possibly go? And I was hooked.

I was fascinated by the way that different tax systems worked and how they interacted with each other. So when I came back and I did all of my interviews to get a summer associate job for the next summer, I asked to speak with all the tax groups for all the law firms that I interviewed with. And from then on, it was a pretty clear path. Once I actually started practicing tax law in the next summer, I was super confused. I had no idea what anything was but it was interesting. And then I tried out corporate law for a few weeks and I switched back to tax because I said, “Well, whatever it is, I’m not gonna be a corporate lawyer. That’s not interesting at all.”

So it was a pretty clear path from then on and I found that I really, as I said before, I really like the analytical process. I was looking at the language and the code and I’m looking at the regulations and I’m looking at the guidance and I find that there’s, as I said before, there’s some fuzziness there. And so you look at the facts that a client presents you with and says, “Okay, well, this is what I’m trying to accomplish. This is my commercial goal.” And I can look at the law and I can say, “Well, you know, under those facts, this is where you’re gonna end up. If you don’t wanna end up there, are there any facts we can change? Can you change the structure? Can you change the way the payments work? Can you change debt to equity or equity to debt? And will all that work with your commercial objectives?”

And it’s a way to take the client’s ultimate objective and sort of put them through the tax law maze and say, “Okay, if you wanna get there, this is how we can get there.” And so it’s a fascinating process and the Opportunity Zones were just super, super interesting regardless. And then I found there was a nice symmetry too given the fact that the Opportunity Zones are really all about investing in these low-income areas in the country which kind of takes me back to the fact that I started all of this trying to kind of help people over something at the Peace Corps. So I don’t know if it’s come quite full circle but I managed to kind of overlay my professional skills with trying to do the right thing. We’ll see if that works out.

Jimmy: Yeah. Overlaying your professional skills with your original passion. I think that’s great. I think you have come close to full circle as you mentioned and yeah, you’ve caught the tax law bug and there’s no cure for it, it seems. You’re in tax law now.

Jessica: Yeah.

Jimmy: I want to shift our conversation to Opportunity Zones now specifically some technical issues that a lot of people get hung up on. How does someone form a qualified Opportunity Fund? I know all you really have to do is file form 8996 with the IRS or is it a little bit more complicated than that?

Jessica: Well, in terms of the actual legal formation of the entity and the self-certification process, you’re absolutely right. You form an entity. A qualified opportunity fund needs to be either a corporation or a partnership for tax purposes but the regs did clarify that you can use a limited liability company. Keep in mind though that an LLC, a limited liability company, that is wholly owned, only has one owner. It’s a disregarded entity for tax purposes and is ignored. So a GOF cannot be a wholly owned LLC that is a disregarded entity. Either you need to make an election for it to be a corporation, which is not always the most tax efficient thing to do unless that corporation is going to be a reach. But if you’re gonna have a via partnership, you do need another member in there. It can be kind of a de minimis one-percent partner or something.

So you form your entity. You file form 8996. And there are some bells and whistles that you need to put into the operating agreement for the entity to comply with the regs and the instructions on the form, mainly in the purpose section of the document which isn’t too taxing. Then there’s just a question of complying with the 90% test, and the structure, and if there’s a QOZB, and all the rest of it. So legally, the legal formation isn’t so tricky but then it’s, of course, making sure that the structure works overall in the context rule.

Jimmy: Now that’s an interesting point you bring up regarding the single-member LLC. That’s a no-go I suppose. That kind of would defeat the whole purpose because it’s just a disregarded entity and everything would pass through and there would really be no…what was exactly the logistical problem there? There’d be no…you wouldn’t be able to apply the game properly?

Jessica: It’s more just the fact that all of the tax benefits that investors are eligible for under the Opportunity Zone Program, all of those tax benefits are really affected as between the investor and they have qualified Opportunity Fund. They do that with some basis adjustments and everything else. But if you have a single-member LLC that’s a disregarded entity for tax purposes, then the rules just don’t apply. You can’t have basis in something that doesn’t exist. So you really need to make sure you have a regarded entity there for tax purposes.

Jimmy: Gotcha. I’m gonna talk about structuring a Qualified Opportunity Fund. You know, IRS forms aside, what are you legally supposed to do or what are your options for legally setting up one of these funds and forming these fund agreements? I know you’ve got a different one-tier structure or a two-tier structure and again, it depends on who the investors are and whether you’re forming a single asset fund or a multi asset fund. Can you go into all of the various nuances of the different ways to set up a Qualified Opportunity Fund?

Jessica: Yeah, sure. You know, one of the few things that we did know straight away from the statute was the universe of possible structures because they really laid out in 1400Z-2 of the code what your alternatives were there. And you’re absolutely right. There’s basically a single-tier structure and there’s a two-tier structure. Under the single-tier structure, the investors are investing to a qualified Opportunity Fund and the qualified Opportunity Fund owns qualified Opportunity Zone property. And that structure, we don’t like very much because it’s very inflexible. At the QOF level, you had a 90% asset test that needs to be met twice a year. And we had a little bit of relief in the April regs this year in terms of timing and exactly when you have to apply that 90% asset test that’s newly contributed cash from the investors.

But otherwise, you don’t really have any ability to hold other cash there. You don’t really have any flexibility. So that single-tier structure in my mind is not very helpful. The other structure which we’ve been advising all of our clients to use and which I’ve sort of seen generally in the market is what is the so called two-tier structure. And under that two-tier structure, you have investors in the QOF and you have the QOF owning that qualified Opportunity Zone business. And with the QOZB, you have the same issue there about disregarded entities. The QOZB needs to be either as a corporation or a partnership as well. So you have not accomplished the two-tier structure if you have your QOF owning a single member LLC. That doesn’t work if you really need to have a corporation or a partnership as the QOZB.

But the reason why we like the QOZB in the structure, even before we found out that they were going to define substantial for purposes of that tangible property test at the QOZB level at 70%, we knew that you had a lot more choices down there. We knew there was a 70% tangible property requirement. We didn’t yet know what it was. But even if they had defined it as high as 90% for that purpose, that meant that you had a kind of a bucket at each level that you could sort of put other assets in or other cash in if you needed to. So we automatically knew there was gonna be more flexibility by having to two tiers in your structure.

The big thing that’s helpful for real estate deals in particular but even for the operating business rules is this ability to have a reasonable amount of working capital at the QOZB level. You don’t have that at the QOF level. You only have it at the QOZB level. Even once you have your projects up and running and built, you can have a reasonable amount of working capital. They haven’t defined it. So it’s whatever is reasonable for the business. And then in your initial ramp up phase, whenever you’re building, whatever you’re building, or improving whatever you’re improving, they put out this 31-month safe harbor for working capital. And I think that’s helpful too and, again, they’ve given us the more flexibility there in terms of how that works and what do you do with money in terms of over time? And what do you do if you’re waiting on the government for an approval?

So having all of that flexibility at the QOZB level is really pushing everybody towards using this two-tier structure. It’s not really clear to me why they haven’t harmonized the rules at each level. But maybe Treasury felt that wasn’t within their regulatory authority, given some drawings was in the code. But for whatever reason, the more complicated structure with these two tiers ends up getting you a better result. The other thing to think about in structuring these deals is the exit, right? Because you have to think about the end even before you get started. And this isn’t necessarily something that would result in a restriction in the code and sort of thing. You have to do it this way. But it’s sort of an indirect result of something in the code. And the issue here is that the big 10-year tax benefit. I mean, that’s the brass ring, right? That’s what everybody is going to go for.

The language in the code says that for investors to get the 10-year tax benefit, they need to sell…after 10 years, they need to sell their equity in the QOF. And that gave a lot of people in the real estate industry significant pause. Because real estate investors like to buy and sell the dirt, right? You don’t want to buy an entity and entity has its liabilities and God knows what’s been going on in that entity. So you like to buy the dirt. You know, entity deals do happen but they’re a lot more painful, I would say. There’s a lot more negotiation. There’s reps and warranties and indemnity, and everything else. So when the real estate industry says, “Wait a minute, that means after 10 years I have to sell my QOF interest?” It gave people a little bit of pause. And a lot of people wrote letters to Treasury and said, “You’re really inhibiting the market here with this.”

But more fundamentally, aside from the fact that doing a deal at the end is kind of a pain, if you really do have to sell your QOF equity at the end of at the deal to exit, then that means that if a buyer is buying your QOF, they are buying the QOF and they are buying everything inside the QOF. So if you have a single property in your QOF and the buyer wants to buy the single property, then, okay, it maybe a little bit of a pain. You may take this like pricing haircut by having to do an entity sale, but at least you could do it. Your buyer could buy your single asset QOF to get the single property. But if you have a whole portfolio of properties in the QOF, then all of a sudden, that means that after 10 years, you’re looking for a buyer to buy the whole portfolio of properties, which potentially limits your universe of buyers, depending on how big the portfolio is.

So a lot of people, especially the investment banks of the world were not very happy with that because they don’t…they’re trying to get their high net worth investors to…they want to give them a product, right? They want to give them diversification. They don’t necessarily want to tell them, “Oh, buy an interest in QOF that owns this one single property that has a lot of development risk to it.” So again, Treasury got a lot of comments on that. And they came back in the April Regs with what is a little bit helpful, but not entirely helpful. And I don’t know if that’s what they intended to do or not. But what they said in the April Regs is, “Okay, you know, we hear you. So we’ll give you a little bit of flexibility. After 10 years, you have a choice. Either the investors can sell their equity in the QOF, or the QOF can sell its property.”

So at first glance, you know, great, they’re letting you do property sales. But then if you look at the language, it really was limited to the QOF selling the property. But, to me, I just told you nobody is doing these single-tier structures, everybody is doing the two-tier structure. And then the two-tier structure, the property is not held by the QOF, the property is held by the QOZB. So Treasury said, “Well, the QOF can sell its property.” Did they forget to say that, “Oh, and we also meant that the QOZB can sell its property,” or did they leave it out on purpose? That’s the question I don’t know the answer to. But if they really wanted to permit property sales, if they really wanted to give you that level of flexibility, then they really should have said that the QOZB can sell its property too.

So people are now kind of struggling to figure that out. I mean, “What did they mean? What didn’t they mean? How should this change the structure? What can you do? What can’t you do?” We’re still advising our clients to set these things up in a way to facilitate QOF entity sales if you have to. Because in addition to the fact that the rules are a little bit unclear, this particular section of the proposed regulation is the only one that you cannot rely on right now. So we’re still in a little bit of limbo. In my mind, this is the biggest thing that still needs to be cleaned up and clarified. There’s a little bit more flexibility than there was at the beginning. But it remains to be seen exactly how all that’s gonna play out.

Jimmy: I gotcha. So it would just be easier if all of these funds were just single asset funds. But the only problem with that is then the funds themselves lack any diversification. So what’s your solution there in the meantime? Are you recommending that your clients set up multiple funds, maybe one fund for each different property? Or what exactly are you advising them to do?

Jessica: So there’s a couple different things that you can do. The first thing, which I know some people right out of the gate were doing to sort of deal with this issue. If you can set up your Qualified Opportunity Fund, can be a real estate investment trust. And, using a real estate investment trust because a REIT is actually a corporation for U.S. tax purposes. It’s made the REIT election, there are some technical rules in the code, again, outside the QOF context, that say that if a corporation sells all of its assets pursuant to a plan of liquidation within two years and then liquidate, the shareholders in that REIT are actually treated as if they filled their equity in the corporation. So you have a technical basis there to actually have a true commingled fund, due property sales at the end and have your shareholders get the right to have tax treatment.

The people who are using REITs and going out of the gate and saying, “Maybe we’ll make a REIT election.” And their proposed Regs in April also gave some additional helpful clarity for REITs. You’re no longer stuck with this to your plan of liquidation. You can actually sell properties and reach shareholders. You can get the benefit that way. The issue in my mind was doing a REIT because then you’re stuck with both the QOF rules and the REIT rules. And you’re taking two very complicated tax structures and layering them on top of each other. And there’s going to be some friction there. The REIT rules don’t always mesh in every instance very well with the QOF rules. Not to say it can’t be done. People are doing it and it can be done. But there are certain types of assets that you’re just not going to be able to because it’s a REIT.

Or, you know, if it’s something that requires the use of a taxable REIT subsidiary in aREIT restructure that doesn’t really work so well with the QOF. So the REIT is an option, but it’s going to be very fact-specific. The other thing that our clients are doing and I know others in the market are doing as well is kind of doing what I’ll call a synthetic fund. So you go out to investors and say, “Okay, why don’t subscribe to my qualified Opportunity Fund. I’m raising $7 billion,” or whatever it is. But then actually the legal form of that is not one single QOF, right? The legal form of that is going to be multiple QOF. And so when investors sign up and sign your subscription agreement, you’re not taking their money and admitting them to a single QOF. You’re taking their money and you’re putting them into a series of QOF. And you have a series of thedr single asset QOF, which permit you at the end to do the entity sale if you need to because each QOF will only own a single property.

Kind of a little bit of a compliance, rather a reporting issue, I would say because then your investors are getting multiple K-1s at the end of the year, which they may not like. And the other thing that investors don’t necessarily love about that is that if you think about a traditional commingle fund, that’s a single partnership, a lot of times the carrier that’s being paid to the manager, the GP, that’s usually done on like a blended basis. So you’re looking at all the deals, and you’re saying, “Okay, what’s the overall return from all these deals?” And if the hurdles are high, and if you get enough cash back, then that’s when you have to start paying a promote to the GP or the manager. And the investors like that because it gives them some protection, right?

If you’ve got one deal that’s doing great but all the other deals are doing poorly, you don’t have to necessarily pay to promote because in overall, you’re not making that much money. But if you have a single asses deals and the promote is calculated on a deal by deal basis, then if one deal is doing great, you’re going to end up paying the promote on that one deal, even if all the other deals aren’t. Because there’s some tax issues about crossing that promotes that get a little bit tricky if you really want to maintain the single entity nature of each of the QOF.

So, you know, again, each of these structures can work but none of them are squeaky clean. There’s always like an insular issue about that one or something to think about what the other one. So people are trying to get creative and figure out what’s the right structure. And it’s going to be very fact dependent, depending on the investors, depending on the property, your properties, depending on the sponsor. So each one of these ends with always being a little bit different.

Jimmy: Yeah, that’s really tricky. There’s drawbacks to each one of these different types of structures. And I guess there’s no perfect universal solution yet. Maybe there will never be probably. When would you use different structures? Like when would you advise a client to use a REIT or in which situation would you use a partnership or an LLC? Or in which situation would you want to structure it as a corporation?

Jessica: So the main time when I think you would want to use the REIT is… If we don’t get any further flexibility on this exit issue from Treasury, then using a REIT is probably a good idea if you really want that true commingle fund model. Because that’s the one model right now that really allows you to do property level sales and have investors still get the 10-year tax benefit. Again, you have to make sure that the underlying property is going to work within the REIT rules. But right now the REIT is really your best option for doing that. The partnership structures are helpful because then you don’t have to deal with the REIT rules. But again, you have this issue about…or if it’s just a single asset, then yes do a partnership. I think that’s a better way to go.

If you are doing multiple deals and you want to give investors that exposure, and maybe if it’s not 20 deals, that might be a bunch. But if it’s kind of three, four, five, maybe six, maybe that synthetic fund model will work. Make sure you kind of get your investors on board with the fact that that promotes aren’t going to be cost. People really aren’t going to be using regular old C corporations here just because of the tax inefficiency. I know people have spoken about using S corps. You can use an S corps also in the QOF context. So depending on how many investors you have and what the ultimate goals are and S corps may also be a vehicle that you can think about using. But for the most part, by and large, we’re seeing partnerships.

Jimmy: Gotcha. I want to get to a couple more of these technical questions here. So let’s say that I’m going to go the traditional route. You and I have talked for a while and I’m setting up a QOF. And we’ve decided we’re going to do the traditional two-tier Qualified Opportunity Fund as an LLC partnership. What types of agreements do I need? What type of paperwork do I actually need to structure those?

Jessica: So the first thing that you’re going to need no matter what is you’re going to need your QOF operating agreement, right? You’re going to use the operating agreement that actually governs the relationship between all the investors in the QOF and… that you’re the sponsor, so you’re raising all the money. And they’re looking to you to operate the QOF as a good tool. So you’re going to need that operating agreement. And that’ll set out the economics. And the governance rights or lack of governance rights, more often than not. And then if you have a future structure, you’re going to need the operating agreement for your QOZB. And, again, whoever is managing or the general partner that QOZB is going to have to have certain provisions in there promising or not promising how much they’re going to comply with the rules.

And, again, there’s going to be economics at that level as well. The other potential big document or documents that you will need, depending on who your investors are and the size of your fundraise and everything else is going to be potentially you’re going to want to have a PPM, private placement memorandum, and a full-blown subscription agreement. And I’m not a securities lawyer, but there are laws that are in place to govern disclosures that you need to make and registering or not registering with the SEC and all the rest of it. But the private placement memorandum is really a document that protects the sponsor. And because what you do in the private placement memorandum and you described the project and you say, “This is what I’m going to do. This is how I’m going to do it. This is my timeline for getting it done.”

You describe the teams, right? Who’s going to be doing this and how much experience we have? Then you have a risk factors. And the risk factors can be…it’s, like, everything under the sun, right? And these are all the things that could go wrong. So just the litany of, like, doomsday scenarios. But you put that in there because this way you’ve given that to investors. And if something does go wrong, it’s a protective document for the sponsor. If something does go wrong, an investor turns around and says, “Wait, but this was supposed to be good QOF deal?” Or, “This was supposed to be some brand new development that you were going to build and I wasn’t expecting this.” And then you can point to the PPM and say, “No, I told you there were all these risks. I told you there was environmental risk. I told you there was construction risk. I told you there was tax risk. I told you nothing was certain about the QOF rules.” You have this whole set of potential outcomes listed in there.

And investors need to sign on and say that they received it and say that they read it. And I don’t know if they actually do read it or not. You also have disclosures in there. Like, there’s a full-blown tax disclosure explaining how the tax rules work. And given the fact that the QOF regime is so new and there’s still so much misinformation out there, most of our clients, even for deals that otherwise, we probably wouldn’t even bother doing with PPM, they’re doing PPM. Unless their investors are really friends and family or super sophisticated investors that have all invested with them before we’re advising our clients to do a PPM just for their own protection. And most of them are going in and taking us up on that. Remains to be seen as the program develops, whether or not that will change. But for right now, we’re advising people to do PPMs as well as full-blown description documents, which, again, there’s a lot of reps in there. And investors have to sign on and say they’re making all these reps about how they understand the deal and everything else.

So there’s more legal documentation around these QOF deals at least now than there might be in a non-QOF deal. But I think it’s because everybody is still trying to figure out exactly what’s the best way to go ahead and do this. I mean, people really want to do this deal but at the same time there’s a lot of money moving back and forth. And you just want to make sure that you’re protected on the legal side.

Jimmy: Good. Now, that’s why wise. You want to make sure you’re crossing all your T’s, dotting all your I’s. If I’m setting up a QOF and I’m just doing a traditional QOF like we discussed, just a two-tier LLC partnership, that’s probably the most traditional, what can I expect to pay in legal costs to make sure that I get everything set up the right way?

Jessica: We’ve had deals over the map in terms of legal cost. Most law firms, including ours, we work on an hourly basis. So you sort of pay for the time that we spent. But, again, it’s a super, super simple to the extent that there’s the thing, right? If it’s a super simple deal and it’s all internal like, let’s say, give me like you and a couple of your friends want to pool your money together and put it into QOF and everything is going to be decided jointly and there’s no negotiation and it’s super straightforward, that’s going to be a much different legal billl at the end of the day than if you have somebody raising $200 million from true third parties.

And maybe if they’re partnering up or sort of utilizing one or the big investment banks to source all the investors, you’ve got negotiations. And you first you got term sheets and negotiations, and back and forth, and all these people weighing in and this and that. Those bills can get up there. So those bills are not for the faint of heart. But for the most part, it’s all sophisticated people who are doing that anyway.

Jimmy: I’m sure. I’m sure there’s a pretty wide range. Can you give me a sense of what the range is on the low end and on the really high end for super fancy, super complicated QOF?

Jessica: Yeah. I mean, like I would say that we’ve done a couple of , I’ll call these like internal QOFs between maybe affiliated entities or friends and family and things like that. And what we’ve done just for the QOF document itself, not thinking about the JVE or anything else, or the purchase and sale agreement to the property or anything. We’ve done some super simple QOF from, and I’m going to call it like starting around like $20,000. Kind of once you do that and they go up from there. And we’re doing one deal that has been going on for months at this point because we had sort of an existing structure and property owner and they’re sort of selling the property over and they’re coming in for a piece. And we’ve got seller financing. And so you’ve got all these different moving pieces and different documents and loan agreements and everything else. That bill is a little bit higher than that.

Jimmy: I’m sure it doesn’t take much to start getting up into the six figures at some point.

Jessica: Yeah. Yeah. Well, I mean, I guess so. We are a New York City law firms so I guess we will wear that badge.

Jimmy: Of course. Well, Jessica, thank you for sharing all these insights with me today. You really are the Wizard of Oz and I can approve that nickname for you now. This has been great. Where can our listeners go to learn more about you and Duval & Stachenfeld?

Jessica: Yeah, sure. So we’ve got a website. It is…and I’m sure Jimmy you can sort of post this with the show notes.

Jimmy: I will.

Jessica: But it’s dsllp.com. And we’ve got a whole page about Opportunity Zones with links to all of our…we call them roadmaps like white papers and sort of articles that either I’ve been quoted in or our managing partner, Terry Adler, has been quoted in, or Bruce Stachenfeld our chairman. So we’ve been making a big splash both on the tech side and on the real estate side really to get into the space and we’re having a lot of fun with it.

Jimmy: Yeah. No, it looks like you are. Duval & Stachenfeld definitely does have a wealth of information on their Opportunity Zone resource center. So I will link to that in the show notes page for today’s episode. So for all the listeners out there, I’ll have links to the resources that Jessica and I discussed on today’s show at the Opportunity Zone’s database website. And you can find those show notes at opportunitydb.com/podcast. Jessica, again, really appreciate your time today. Thank you.

Jessica: You’re welcome. It’s been a pleasure.


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