Family Office Strategies for Opportunity Zone Investing

How are family offices investing in Opportunity Zones? And what are some of the biggest considerations that family offices take into account when deploying an Opportunity Zone investing strategy?

Jeff Feinstein of Pinnacle Partners, John Sciarretti of Novgradac & Company, and DJ Van Keuren of Evergreen Property Partners join Jimmy Atkinson on today’s webinar.

Webinar Highlights

  • Brief overview of Opportunity Zones.
  • Trusts and estate related matters, including GSTs.
  • Selling real estate located in an Opportunity Zone.
  • Pre-TCO Opportunity Zone projects for cash flow.
  • Opportunity Zones as impact/ESG investing.
  • Opportunity Zones under the Biden administration.
  • The latest data on how family offices are investing in Opportunity Zones.

Featured on This Webinar

Webinar Transcript

Jimmy: Alright. Welcome to today’s webinar: Family Office Strategies for Opportunity Zone Investing. We’ve got a great panel with you today. My name is Jimmy Atkinson. I’m the founder of the Opportunity Zones Database at OpportunityDb.com and host of the Opportunity Zones Podcast.

Joining me today are Jeff Feinstein, managing partner at Pinnacle Partners, John Sciarretti, partner at Novogradac & Company, and DJ Van Keuren, managing partner at Evergreen Property Partners.

Today’s agenda, we’re going to have a very, very brief overview of Opportunity Zones, just a refresher course, like really quick 101, in case you need a refresher or if you’re new to the program, it might be helpful as well. We’ll go through some issues that family offices should consider when they’re doing Opportunity Zone investing, trusts and estate-related matters, including GSTs, selling real estate located in Opportunity Zone, pre-TCO Opportunity Zone projects for cash flow, Opportunity Zones as impact investing. The very end of the day, we get these questions a lot the last few months, what’s Biden going to do with the program?

So, we’re going to try to address some concerns there, how Opportunity Zones are going to evolve under the new Biden-Harris administration. And we’ll also throughout the course of the presentation, have some data from family offices on Opportunity Zone investing, how family offices are conducting their Opportunity Zone investments. So, to begin, we’re going to do that really quick crash course on Opportunity Zones and I’ll give that and then I’ll turn it over to the real experts here, DJ, John, and Jeff.

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But the Opportunity Zones is a place-based tax incentive. It was passed as part of the Tax Cuts and Jobs Act in 2017. And the designations were finalized in July of 2018. Today, there are 8764 census tracts across the entire country that are designated as Opportunity Zones. Thirty-five million people live in the zones. And over the last, roughly two and a half year period, since the first Qualified Opportunity Funds hit the marketplace, tens of billions of dollars have been raised by those funds for investing in Opportunity Zones so far. John’s firm, Novogradac, helps track a lot of that data.

Here’s a quick map of where the Opportunity Zones are located. Again, each Opportunity Zone is a census tract. Some of the census tracts you’ll notice in the rural parts of the country are much larger than the ones in the more urban centers of the country. This is because census tracts are designed to contain roughly 4,000 people on average. So, you get larger ones in the less densely populated areas. Each state was able to designate up to 25% of their low-income census tracts, with some caveats that we don’t have time to get into today.

One notable exception is down here in the corner, you can see Puerto Rico was granted an exception to this rule to help with the economic recovery from the hurricanes that devastated the island. And as such, nearly the entire island of Puerto Rico is essentially a large Opportunity Zone. So, what are the benefits? There’s three main tax benefits, and again, there are nuances to all this that we don’t have time to cover today. But the tax benefits start when you or a client of yours accrues a capital gain, and recognizes the capital gain. There’s a capital gain tax incentive, you take that capital gain and roll it over into Opportunity Zone investing through a vehicle known as a Qualified Opportunity Fund. And that gain and subsequent gain is subject to these three benefits.

You get to defer recognition of the gain for a few years until year-end 2026, you get to effectively reduce the gain recognition amount by up to 10%. If the gain is invested by the end of this year, note that this is expiring at the end of this year. And finally, the third big benefit, and this is the big one. There are no capital gains tax liability that you pay on any gain that is accrued, any appreciation that accrues within the Opportunity Zone investment, so long as you hold for at least a 10-year period.

So, that’s just a really quick crash course on Opportunity Zones. I hit some things really fast there. If you have any questions, please feel free to submit a Q&A or use the chat. I’m going to turn it over now to John Sciarretti, partner at Novogradac & Company. Novogradac is a national accounting firm that has really been on the leading edge of Opportunity Zone expertise before the program was even released. So, we’re really pleased to have John Sciarretti here with us today. John, how are you doing? Say hello, introduce yourself a little bit. And what can you tell us about OZs?

John: I can tell you a lot about OZs. Hi, thanks for being here. And thanks for inviting me to be here, Jimmy. Like, Jimmy said, we’ve been involved in Opportunity Zones at Novogradac since actually before inception, and I lead a working group with about 100 firms and organizations. So, we’re talking about this stuff all the time where we’re helping to structure deals. We’re an accounting firm, so we do the backend tax and compliance work and audit some funds. So, we know a lot about it. I’ve seen a lot of transactions, and hopefully, I can help fill in some of the gaps today.

Jimmy: Yeah, that’s great, John. Great to have you here today. To start us off, can you talk about what are the types of returns or yields that investors can expect from Opportunity Zone investments? How do they differ from a normal type of investment?

John: Well, it is a tax incentive. And so you have to look at it on an after-tax basis. But it’s not uncommon for us to see an increase of about 30% and a transaction after tax, that is a typical real estate deal, 3 to 400 basis points. There’s a number of factors that weigh in on the returns.

One is the appreciation, like, Jimmy said, and if you hold your investment for 10 years, you don’t have to pay tax on the back end on any subsequent gains. And also any sort of recaptured appreciation. So, how fast assets depreciate or another factor of return. You know, typically, when you sell real estate or any asset, any depreciation that you’ve taken during the term that you held that asset, you have to recognize gain and recapture that depreciation.

Nice thing about Opportunity Zones if you hold your assets for 10 years, that recapture doesn’t happen. So, it’s a huge increment to a normal return.

Also, short-term gains are eligible to be invested. So, it’s only capital gains that are allowed to be invested, but short term capital gains, because the tax rate is so much higher on a short term capital gain, that when you look at a return, from a short term capital gain invested, it’s exceedingly higher, because the rates are ordinary rates.

Another thing to consider is state taxes. You know, most of the states conformed Opportunity Zones. And so you get a state incentive along with the federal incentives. I think there’s only four non-conforming states, California, Massachusetts, Mississippi, and North Carolina, and all the others conform in some way, some you have to actually make the investment in the state for your investment to conform. But when you look at states, like New Jersey that has almost an 11% tax rate, or New York at 9%, or Oregon at 10%, Minnesota at 10%. You know, it’s a huge increment to your return. So, it’s something to consider.

Jimmy: Yeah, great answer there, John. Yeah. So, it can juice the returns considerably, especially if the state conforms, you’ve got a high rate in your state. There are other incentives that are also available for investments in Opportunity Zones. And there’s also some tax credits that may be available as well. Can you talk about what some of those incentives and tax credits can be combined with Opportunity Zones to further juice the deal numbers?

Johnn: Yeah, I can. So, there’s a number we call place-based incentives that are targeted to distressed communities. One of those incentives is the New Market Tax Credit. So, the New Market Tax Credit, which is what I’ll call finite credit. Opportunity Zones, anyone can invest gains, as much gain as you have, and as many times as you want. New Market Tax Credits is finite in that there is $5 billion tax credit authority per year. And the intermediate entities, called Community Development Entities, we refer to them as CDEs, they hold the power to offer this credit to projects.

So, it’s an investor tax credit, but it’s based on project investment. And there are a number of deals that qualify for Opportunity Zones that also qualify for new markets. They’re both based on low-income communities. Opportunity Zones is only 25% of those low-income communities per state. So, not all low-income communities in a state are Opportunity Zones. But they both meet that similar definition of low-income community.

New market investment terms 7 years versus 10. And typically, there’s institutional investors that have bought new market tax credits. There’s some issues with individuals buying New Market Tax Credits or investing in New Market Tax Credits, and that their preference item for AMT. So, we haven’t seen a lot of individuals invest in new markets, but there’s been a number of projects we’ve been involved in that have new market credits alongside the Opportunity Zones credits, and happen to be different investors investing in each one.

Also, the Historic Tax Credit. We’ve seen a lot of Opportunity Zone projects, and that there’s a lot of qualified historic properties in Opportunity Zones. And so this, again, is a project-based credit and it’s based on the expenditures to rehabilitate a building, which is similar to the substantial improvement rules in the Opportunity Zones. And Opportunity Zones, you have to make an investment in a new property, like a new bill or you have to agree to substantially improve a use property. And so what that means is you have to spend, basically, spend more than you bought it for, in order for that property to be qualified.

Historic is similar in that you have to make…we have expenditures equal to the basis in the property. We have seen where Opportunity Zone investors also qualify for Historic Tax Credits, and sort of double-dip, which has a negative connotation but you’re allowed to double-dip in these credits if you’re investing in a property in an Opportunity Zone. There are some limitations on Historic Tax Credits as well because they’re passive credits. But there are a number of investors, high net worth individuals that either have sufficient passive income to take those credits, or they’re real estate professionals, which has an exception to that passive rule.

So, both new markets and historic we’ve seen either side by side or twinned type investments in these projects. Other credits in these Opportunity Zones is the Low-Income Housing Tax Credit. Going in on housing projects do not need to be in low-income communities, but there are a number of them that are placed in low-income communities. And so Opportunity Zones have a lot of affordable housing investments overly. We’ve seen where sponsors of low-income housing properties or affordable housing properties have taken advantage of the Opportunity Zones incentive. The investors that buy the credits haven’t today, sort of double or twin their investment dollars to receive Opportunity Zones benefits.

When you look at an affordable housing project in Opportunity Zone context, you know, the big benefit of Opportunity Zones is that you have appreciation in property to get that 10-year benefit on the backend. And affordable housing projects typically don’t have that appreciation to take advantage of that, because they all come with an affordable covenant attached to them, which sort of artificially lowers the value going forward. So, you typically don’t have that appreciation on the backend that Opportunity Zones investor is looking for. And then state and city subsidies in Opportunity Zones. There’s a number of them.

I mean, most states and cities have coalesced around their Opportunity Zones trying to attract investment. There’s a number of priorities for projects in these areas, tax abatements, tax credits, TIF districts, priority zoning, and even grants that are available or prioritized towards the Opportunity Zone projects. So, the country has done a nice job of coalescing, like I said, and bringing investment into these areas.

One anecdote, Ohio actually has a tax credit if you invest in an Opportunity Zone. And that’s a 10% tax credit for any investment that you make in an Opportunity Zone in Ohio. And it really had a lot to do with attracting investment in Ohio. Ohio has raised, like 650 million in our Opportunity Zones today. And that’s fourth on the list of all the states and Ohio is, I think the 10 largest states. So, you can see where the credit has attracted a lot of additional investment.

Jimmy: Yeah, for those of you who don’t know, John is joining us from the Buckeye State today. So, we had to get in some data on Ohio there, of course. John, talk to us about estate planning, and particularly, you know, if you’re a high net worth or family office, how can someone’s estate plan benefit from Opportunity Zone investment?

John: In the Opportunity Zone space, we talked about inclusion events, so you invest your money and you can defer gain, but you don’t defer that gain indefinitely, you have to realize that gain or recognize that gain in 2026. So, we’re getting closer to that day, every day, and investments are worth less than they were in 2018 when they became available. But if you were to sell your investment before 2026, or gift your investment, it’s an inclusion event.

So, you have to recognize that deferred gain early. But death is not an inclusion event, which is good. And so your beneficiaries would receive your investment and with what they call a tax holding period. So, the beneficiary of your estate would have that deferral carried forward until 2026. And so that’s a good thing. The step-up, if you’re familiar with the state taxes, property is stepped up the fair market value on the data deaths in a state.

And so your beneficiaries typically receive a fair market value basis in the investment or in the recede of that investment. The code is such that the beneficiary, even though they receive a step-up, they still have to pay that deferral tax, that the original investor would have deferred and so its income and respect to the decedent is the terminology there, so. So, any beneficiary is going to receive investment at a fair market value basis, less this, this deferral that the original investor didn’t pay tax on yet. But if you…

Jimmy: That tax liability is still due in 2027, I guess, right?

John: That’s correct. That’s correct. Now, but as I said, that’s not an inclusion event, but gifts are an inclusion event. So, if you were to gift Opportunity Zone investment to an heir, or to a child, or a sibling, it would be an inclusion event, and you’d have to pay that deferral tax at that time you gift it. What a lot of folks are doing to do estate planning is, you know, estates are taxed based upon the value of the assets in the estate. And there’s a rather large exemption right now. It’s a little over $11 million per person.

And so they… But despite that, and that’s fairly new, that happened in the Jobs Act of ’17, this higher estate exemption of $11 million. That $11 million exemption actually sunsets and reverts back to a $5 million exemption in 2025. And so, what high net worth folks do is they, in order to get the value out of the estate so they don’t have to pay estate tax, they obviously gift assets to what they call a grantor trust, where the estate holder actually pays the tax but doesn’t own the asset, technically. But they can pay the tax on the asset, which isn’t a gift. And so that’s an estate planning strategy to gift assets early on, the grantor trust, where the trust controls the assets, you can pay the tax, and that value is taken out your estate.

Well, as I said, gifts are inclusion events, so you would have to pay the Opportunity Zones tax. But there’s an exception in the regulation that says, any asset given to a grantor trust is not an inclusion event. So, that’s a really nice strategy that folks can use with Opportunity Zones investments. And that you could… Well, let me go back. The problem with gifting early is that assets, that appreciation is out of your state, but there’s no step-up for your heirs. So, as I said early when a person passes away, all of their assets are stepped up to fair market value. Well, if you gift early, your heirs do not get that benefit.

With an Opportunity Zone, you sort of get the best of both worlds. You can gift an asset to a grantor trust, get appreciation out of your estate, it’s not income, it’s not an inclusion event for Opportunity Zones and the heirs still get the step-up in basis if they hold the asset for 10 years. And they don’t have to hold it for 10 years, they have to hold it for the remaining years that equal 10 from the first investor. So, it’s a nice strategy, I see estate planners doing to sort of use Opportunity Zones to get the best of both worlds around gifting assets in estate.

Jimmy: Yeah, a lot of good considerations there. To wrap up your segment here, John, today, and then we’re gonna come back to you later, because we’ve already got a few questions that I know are right in your wheelhouse. We’ll get to those during the Q&A period. But let’s talk about 1031s for a second because this program is often compared to 1031 exchanges and investors are more familiar, more comfortable with 1031s. What are some of the similarities and differences between Opportunity Zones and 1031s? And in your mind, which incentive is more favorable to an investor?

John: Yeah, I think is when you look at what’s more favorable, I think it really depends on the facts and circumstances of each investor. I mean, Opportunity Zone is definitely more flexible than the 1031. You know, Opportunity Zones, you can defer a capital gain from any asset, and a 1031, otherwise, call it like-kind exchange, it’s limited to the exchange of real estate. And they made that clear in the last Tax Act, it has to be real estate, you can’t like kind of change other similar assets.

Opportunity Zones, you only have to invest the gain. And so, you know, if you were to sell something for $10 million dollars with a $5 million gain, you only have to invest the $5 million to defer the tax on that full amount, or with a 1031, you have to reinvest the total value of the asset that you exchange. So, it’s more flexible that way. And Opportunity Zones can invest in any fund. You know, there are a lot of funds where they’re captive, where it’s their own fund, the investors investing in their own fund into their own assets. But you can invest in any fund. Wherewith 1031, there’s very strict rules on property identification and the timing of that.

As we talked about earlier, and Jimmy talked about the Opportunity Zones have this capital gain exemption. The first exemption is in 2026, what’s left now is a 10% exemption, so you only have to pay 90% of the tax on that original deferral, if you held the asset for five years, where there’s no… and then you get the 10-year exemption, obviously, if you held your investment for 10 years, you exclude any additional appreciation Opportunity Zones investment. Wherewith 1031, there is no exclusion, you can continue to defer, but there’s no exclusion in a 1031 exchange.

Also, it’s easy to defer gains through a partnership under an Opportunity Zones investment. You can do this in a 1031, it’s complicated, they’re a very complicated strategy. But for Opportunity Zones, it’s easy. If the partnership doesn’t want to defer the gain, then the partner can defer the gain. Very simple process. Both incentives haven’t had this 180-day period to close on your next investment. But for Opportunity Zones, that’s sort of the start of the next investment. Because for Opportunity Zones, you have 180 days from the gain, the general rule to invest in a fund, which in turn has more time to invest in a business, which in turn has more time to invest in property.

And so there’s this longer-term to actually get to the replacement property in the Opportunity Zone where it’s pretty strict in a 1031, you have 180 days to get that replacement property. You know, OZ is limited, and it’s deferral. Like, I said in 2026, you gotta pay the tax that you deferred. And so where 1031, you can hold it indefinitely, and you can sort of keep deferring through more exchanges of property. And so that’s the one benefit of 1031. Although, folks should remember that when you make a like-kind exchange, you have a carryover basis. So, eventually, you have nothing to depreciate.

And so it’s almost like the deferral is gone because I’m not depreciating that new property. Where with Opportunity Zones, you do have to pay the tax, but you get the basis back and can take depreciation through that investment. As I said earlier, the substantial improvement requirement for Opportunity Zones, you have to spend as much as you bought a property or use a piece of property for. So, there is an investment requirement. Where with 1031, you don’t have to invest additional monies, you can just exchange and hold the property.

So, that’s one benefit for a 1031. So, you know, that’s some sort of the highlights of the difference between the two. And, like I said, it really comes down to the facts and circumstances of the investor, and which incentive meets their needs and their objectives for tax planning.

Jimmy: Great. Well, thank you, John. Thank you for your insight. We’ve got a lot of questions for you that I hope we get to later. We had questions on return of capital, IRS extensions, Biden administration, tax rate increases, census tract redrawing. I want to try to hit all those topics toward the end here. But first, I wanted to turn it over to DJ Van Keuren.

Right before we turn it over to DJ actually, I want to introduce our first polling question here. We want to know what is your main interest in Opportunity Zones? Is it the returns, the social impact, or the tax benefits? So, give everybody a chance to answer that. This poll question is anonymous, by the way, and all the poll questions today are, so feel free to answer them truthfully, and honestly, to the best of your ability.

But we’re very pleased to have DJ Van Keuren, who will be our next presenter up today. DJ is the managing partner at Evergreen Property Partners. And he’s also involved with the Family Office Real Estate Institute. And he has a lot of great data on family offices and Opportunity Zone. So, let’s end this poll now.

We’ve got almost everybody voted into it, and I’ll share the results. And looks like majority, 55% of you are in it for the tax benefits, but a pretty good amount involved answered that they were interested in the returns or the social impact as well. And DJ, I’m curious to see how that may or may not line up with some of the data you’ve collected from the family offices.

DJ: So, Jimmy, thanks for having me here today. So, a little bit about myself. And you can see the screen right now, Jimmy?

Jimmy: Yes. Looks good. Yep.

DJ: Okay. Great. So, I’ve worked for three prominent families over the last five years. Some of those, you may have the gut, they’re pretty prolific. One is the Hammond family if you remember Giorgio perfume, Giorgio Beverly Hills. The other one is a family member that owns the Colorado Rockies, baseball team. And most recently, over the last six, seven months I’ve been doing some work with the Marriott family and Distressed Hospitality.

So, I entered this space probably about five, six years ago. Over that period of time, I’ve been pretty fortunate named as a top 30 real estate investor at a family office by Trusted Insight, top 10 family real estate professional by Family Capital, actually a top 40 Opportunity Zone expert. And then, as Jimmy had mentioned, there’s a new family office real estate program that’s just starting up at the University of Denver’s Burns, School of Real Estate and Construction Management. And that’s the Institute of Family Office Real Estate, which we launched in May of 2021, which is pretty exciting.

And I also think that, you know, listening to, you know, John go over a bunch of the stuff, it’s definitely a number of topics that would be extremely beneficial for people taking any of the courses at the university. Managing partner of Evergreen Property Partners now, and that was because, over the years, I’ve just been asked to work with a lot of different families, but have always been with one family.

So, now, we had formed Evergreen to be a real estate investment platform for families to invest together. So, we just got out the loan. And so today, what I want to go over and Jimmy mentioned too is actually an annual family office real estate study that we’ve done. This is the third year, is the largest of its kind, actually on a global basis, we have about 55, 65 questions. We’re in our third year right now that we’re doing. And so we’re starting to be able to pull back information as a whole and comparing that. And that’s one of the things that we’re going to be going over today.

So, you had just asked that question, Jimmy, which is pretty interesting, because this is the first one that I’m leading off with. And the reasons that families are investing into Opportunity Zone. And the number one reason that we have, and this is for this year, we didn’t do it the last two years, but for this year is for returns, that’s where the number one area of interest is. Second is social impact. And if you see that one is most important, that’s the light blue. The dark blue is, you know, secondarily. Red is in the middle, fourth is somewhat important, and then the yellow is what’s least important.

So, you’ll see here that once again, that social impact is the biggest that’s taking place. And then if you look at being able to invest in direct deals. One of the things about the Opportunity Zones, which I do think they made a mistake on is that they call an Opportunity Zone Fund either an individual deal or a cumulative deal, right? Where you’re an allocator. So, from this perspective, the question was, you know, would you invest in a fund that invest in other funds or individually? Where families like to invest.

And this we hadn’t done the prior years, but we did do it the first year is… The number one place is real estate, where families had wanted to go into an Opportunity Zone, then followed by private equity, manufacturing was very small as well as, you know, other reasons, which might be like having their own business within there.

So, how do family offices directing or invest in the Opportunity Zones? If you notice there’s an LP in 2019, 2020, and currently, what we have in 2021 is about 40% on average will invest into Opportunity Zones, and these are families as an LP. That number for investing directly has gone up pretty considerable from 2019 to 2020. And currently, the 2021 stats show us that it’s pretty similar to 2020.

And then you’ve got less numbers which coincide with people that are going or families that are investing direct in ’20 and ’21 as both the GP and LP. And one of the main reasons is because they are looking to do it themselves. Now, whether that’s like John mentioned, where they could form their own Opportunity Zone and then, in turn, they invest into other Opportunity Zones, could be a question. But for the most part, families are looking to do this more directly.

So, what percentage of families plan on investing into Opportunity Zones? So, if we look at 2020 to this year, 14.7% said yes, they’re definitely going to, but 10.7% currently in 2021. Thirty-six percent said no in 2020. But 43% in 2021 said no. And … is right around the same number between the two or enough about it. A lot of it in 2020 had to do because those guidelines weren’t out yet. And so families are starting to have a better idea. But one of the misnomers, I think, which happened at the beginning of this was that, you know, all these families were going to be investing. And what we found is that it has been high net worth and primarily institutions.

So, there’s only been, you know, on average 12.5% of the families that plan to definitely invest into Opportunity Zones. And a lot of that does have to do with education and awareness, like what you’re promoting Jimmy. When they look to invest in 2019, you know, zero to 500 is about 15%. And you had much greater numbers in the $5 million to $10 million in 2019 and $10 million-plus compared to what we’ve got in 2020.

And then you’ll see that $5 million to $10 million marker has increased from 5% to 10%, from 9% up to 19%. You know, $500k to $1 million is 14%, $1 million to $3 million is 19%, and $3 million to $5 million invested into between $3 million and $5 million. So, we saw a little larger amounts. And, you know, that seems to be coming back a little bit between the $3 million to $5 million and $5 million to $10 million marker. When you look at the percentage of allocation of family offices, real estate portfolio to Opportunity Zones, there’s a pretty significant number that doesn’t plan on investing into Opportunity Zones in 2021 as part of their portfolio. And then you can see that the majority is between, you know, 5% to 10%, for the most part.

So, what’s been the potential for increases for family offices? Well, one of the things I do think we’re going to be seeing an increase of some sort, possibly coming into this year. And a lot of that has to do with because a lot of families, initially, focused on their equity portfolios when COVID hit. And so a lot of families were taking money off the table, and they were reinvesting those monies.

And so there should be some monies that are coming in throughout this year with capital gains from some of these larger families, which is one of the reasons why I think you saw some of that increase happening this year compared to last year. And also the potential change in tax laws under the new administration, which I know John, you’re going to talk about. Jimmy, there’s been a number of questions on that. Because if that changes, you know, that could have a significant impact on Opportunity Zone, as a whole.

So, that gives you a little bit of an idea about families from… And I’m happy to share this. Also, if people want the full report, because it’s a lot about their information, we’re happy to do that as well. But families are still a little bit lukewarm, I think as a whole. You also know that a lot of families like to hold 5 to 7 years, some people do say to 10-plus years. But I also don’t think that they’re taking into consideration a lot of the tax benefits that can come along with it, like, John’s talked about.

And, you know, once again, focusing a lot on returns rather than social impact. And I think I mentioned this before, too, Jimmy is that the social impact is really what’s being driven by the younger generations, and not as much as the patriarchs today. But for a place to do have an impact, and as things continue along to actually…

Jimmy: Sorry, DJ. We kind of lost you there for second. You’re starting to break up, but I think you were wrapping up. Jeff Feinstein, I’m gonna turn it over to you next. For those who are unfamiliar with Jeff, Jeff is a managing partner at Pinnacle Partners, and Pinnacle is a source of strategic relationships for JV partnerships with actionable opportunities and targeted Opportunity Zone markets. And they’ve already capitalized $400 million in OZ development projects.

So, Jeff, thanks for joining us today. Jeff is also the mastermind behind this whole thing, I got to give him credit for pulling this whole thing together. So, thanks, Jeff, for participating and being here today, and corralling all of us. I appreciate it. I’ll turn it over to you now.

Jeff: Welcome, Jimmy. Yeah, well, thank you very much for the kind introduction. Thanks for facilitating all of this, you’re very good at what you do. And I think we’re imparting an important message to our audience today. So, I’ll dispense with the overview of Pinnacle Partners, but suffice it to say, we’ve seen a lot of deal flow. And so we’ve evaluated deals generally across the criteria that was established by the poll on return basis, on social impact basis, and, obviously trying to take full advantage of the tax benefits, potentially even combining tax benefits.

We believe our thesis, and it’s been demonstrated by some of our large investors who are family offices and representing a number of high net worth clients and ultra-high net worth clients. There’s a tremendous opportunity to preserve wealth and build wealth, while in some cases meeting social impact objectives. So, what I’m going to do today very quickly is I’m going to profile four case studies, really the anatomy of a single entity, direct investment opportunity, not a multi-asset deal. We do only single entity offerings that we put forward to our investor base.

So, we’re going to look at impact investing, the aforementioned social impact, low risk immediate cash flow, because as you talk about substantial improvement, you talk about 10-year hold, it seems that immediate cash flow is elusive. But I’ll share with you how it can be accomplished with a particular type of deal. Combining incentives, which is what John spoke of, I’m going to focus on the historical tax credits, which are generally available in Opportunity Zones. When you can consider adaptive reuse, adaptive reuse is taking an existing structure and improving it, modernizing it. And if it’s historic in nature, you can obtain those credits, in addition to the OZ.

And then, you know, other types of structures that might provide a significant return on capital. So, I think one of the questions to John, and he might speak to it later is, can you do a return on capital through refinancing? And if you do an unlevered deal, no debt, you can actually get a large portion of your invested capital back under certain conditions. So, these are four case studies I want to share with you. Again, we’ve seen hundreds of deals, as Jimmy mentioned, we’ve done and capitalized over $300-plus million dollars in projects.

So, the first is impact investing or ESG Investing. That’s generally our focus has been on affordable housing. And so you can take an opportunity to deliver an affordable solution, as described I think by John, the yields are typically a little bit lower because you’re self-regulating, you’re maintaining rates, maybe below market, but when you add the 300 basis point lift to the OZ, then it becomes a market-rate return.

So, we’re seeing a lot of interest in this category. Some people have interest in sustainable building materials and new processes that can deliver a low carbon footprint. And so we’re seeing an opportunity to meet your social and impact needs, ESG objectives with Opportunity Zones, principally around affordable housing.

The next opportunity is what we call pre-TCO. And maybe John can get into the technicalities of it. But this is the temporary certificate of occupancy. So, a developer is taken, the developer has an opportunity in an OZ, and maybe they acquired it before the legislation was enacted, say it’s ’17. And it wasn’t designated in OZ because obviously, it was a pre-existing asset. But what a developer can do is take it all the way up to and almost finalize the development and then sell it to a Qualified Opportunity Fund. So, now it’s an OZ, the development risk has been reduced dramatically, if not eliminated.

And if you do something like we have seen a student housing opportunity where there’s pre-leasing, so you’ve removed, did urban risk and you also have pre-leased, so your occupancy rates are going to be higher, so you can begin to generate, in this particular example, a 7% cash on cash return, right? And still, meet the OZone qualifications. And then obviously, your holding period for 10 years.

So, this is a significant opportunity to yield cash on cash and to reduce risk. Generally, your net returns are going to be a little bit lower. For the obvious reasons, you’re paying for almost finished product. Here’s another example of the combination of OZ benefits plus HTC benefits. So, I gave an example of how you can take an existing asset and reposition it and obtain the HTC credits. When you take OZ benefits plus HT benefits, your yields are going to go up. So, your return objective, one of the three criteria here, can be substantial in this scenario. This is generally again, redevelopment.

So, you got an existing asset, you want to modernize it, retain the historical charm, certain artifacts, preserve or restore certain pieces of the original asset, and then generate those HTC benefits, which as John described, can be offset one to one against passive income that you might generate elsewhere in your portfolio.

The last example is an unlevered deal. So, typically, you put debt on a project, maybe for construction purposes, you don’t have to do that, of course, and that’s a bit of a dampening effect on the return. But, in certain product categories, where COVID it’s uncertain, what the post-COVID impact will be. We’ve seen some deals where people have just gone, you know, straight ahead, unlevered, let’s just put all the equity in, and then we’ll wait for the market to adjust, maybe improve, return to pre-COVID rates, whatever that may be, leasing rates as an example.

And then you put debt on the asset. And by doing so you can return a substantial amount on your capital. We’ve seen as much as, you know, 60% return on capital. So, that has you getting, you know, depending upon when you exercise the leverage technique, you could be getting 60% or 70% of return on capital in years three, or year four.

So, the point I want to make here is that there are different structures, different deals to meet your objectives. So, we had three objectives, return, social impact, and tax benefits. And here, I hope I’ve provided examples of combining tax benefits, focusing on an ESG or impact investment or optimizing returns that could be cash on cash or return on capital, and then ultimately, your yield over a 10-year period. So, Jimmy, I hope that’s instructive. And I think I’ll conclude right there.

Jimmy: It was. That was great. Thanks, Jeff.

Jeff: You’re welcome.

Jimmy: This is great, too. We’ve got 15 minutes left that we can get back to John and DJ and Jeff with some questions. Before we move into the Q&A period, and again, if you do have a question, please use the Q&A tool in your Zoom toolbar. I’ve already got quite a few stacked up here and a few in the chat as well. But before we move there, I wanted to get back to our second poll question.

Getting back to a point that DJ made earlier about how family offices, it seems like they should be well-positioned to invest in Opportunity Zones. But there has been some hesitation there. The percentage of Family Offices that are investing in Opportunity Zones is still pretty low. And we know that there are a lot of obstacles, but we want to ask you, our attendees here today. If you do have any hesitations about Opportunity Zones investing, what is it? Are the requirements too tough to comprehend, are the returns too low, tax benefits aren’t great enough? Maybe if you’re here, you’ve kind of pre-selected yourself as not having any hesitation.

So, I’m seeing a lot of people answer that. Or maybe you have other. And if you do answer other, maybe you can chat. Maybe you can type in the chat what your reason is. I’m gonna leave that poll question up for another minute. And we’ll get into some of the questions here. John, I’ll throw this first one at you. I’ve got a question from Scott, who asks, what happens with the current census tracts in Opportunity Zones after the next census is taken? So, we just had a census in 2020, and some of those tracts might be redrawn, or some of the data might change? What are your thoughts there, John?

John: Well, we don’t know yet. We actually, as part of our working group, recommended that they keep the geographic lines the same. We expect that that’s what’s going to happen, but we don’t know for sure. So, that’s the answer there. There are going to be some… We think there will be some tracts or higher income in the original lob, you could select a contiguous tract, a state could select a contiguous tract, a tract might be near a low-income community, but not an income local community itself.

And some of those higher-income tracts receive some bad press early on in the program. So, we think that there is a bipartisan effort to exclude those high-income tracts in the near future here with a grandfathering rule, so allow investments that are already in them to be good investments.

Jimmy: But nothing’s been determined. We’re in wait-and-see mode at the moment?

John: That’s right.

Jimmy: I’m sharing the answer to that poll question now. The majority of you don’t have any hesitation. So, maybe we’ve kind of pre-selected an audience, people who are already heavily invested or interested in Opportunity Zones. Of those of you that do have any hesitations, it seems that most of you answered, it’s because the requirements are too tough to comprehend. Or maybe you had another reason I couldn’t think of. So, if you do have another reason, and I’m seeing a few answers come in now, feel free to chat that over to us. We’d love to hear more.

DJ: What are some of the others?

Jimmy: Go ahead, DJ. What was that?

DJ: What are some of the others? It says here other answers? I was just curious what some of those others…

Jimmy: Oh, some of the others? Let’s see. So, Scott says future tax rates with Biden. Andrew says he’s selected other because he has a concern about deferring LT cap, long-term capital gains at today’s rates and potentially having to pay ordinary income tax rates on those deferred gains in 2026 if tax laws change. So, yeah, a couple of people have some concerns about tax rate risk on the deferred portion of the gain.

Let’s talk about that, actually. And let’s talk about… Because I did promise we’d get to some discussion about the Biden administration. And, John, I’ll throw this over to you again. You’re a resident expert here. Since you’re on the Novogradac Opportunity Zones Working Group, which really spearheads a lot of this policy effort in terms of understanding and suggesting to the powers that be in Washington. What are your thoughts on how the Opportunity Zones policy may change under the Biden administration over the next few years?

John: Well, Biden actually publicly announced that he felt that the incentive itself was a promising incentive, but suggested a need to be modified, to be more aligned with what the original policy was. Really, that comes down to where he actually indicated three things, incentivizing funds to partner with nonprofits, because nonprofits don’t typically receive investment, because it’s an equity investment in a business, and more Treasury Department oversight, and then more impact reporting in public disclosure requirements around the impact.

The original law actually had those requirements in them for reporting, but it was sort of stripped out in reconciliation. And so I think there’s a bipartisan effort to get more reporting around the program. And I think we’ll see that. So, that’s the incentive in general. And with respect that indirect effect on the Opportunity Zones, you know, we all probably expect tax rates to rise, I think Biden, in his run-up to the election, indicated that he would like to see capital gain rates be the same as ordinary tax rates, which are 37% now. And folks expect ordinary rates to even go up to the 39% they were.

But I think it’s been 100 years where capital gain rates have been less than ordinary rates. And there have been proposals that make them the same. And that’s never happened. And with the recovery, we’re in now, I don’t expect capital gain rates to go to 39%. But they may go to 28% from their current 20%, actually, is 23.8% because there’s an investment portion of that rate, but they may go to 28%. And we sort of ran the numbers around 28%.

It has an effect, but it’s negligible when you’re looking at keeping that same rate on the backend, as well, obviously, that’s a crystal ball. So, if you pay more, a little bit more on the inclusion of the deferral gain, you know, and rates tend to stay high, then the benefits on the back end, obviously, outweigh them. So, it’s a negligible effect that that 28% rate, obviously, it’d be a larger effect than a 39% rate. But we think corporate taxes have probably increased, or at least there’ll be a push to increase. We don’t see much by way of corporate investment in the program. There’s a couple reasons for that. One is that banks tend to be the investors in low-income communities through tax credits, that’s programmatic for most of the big banks in the country.

And so number one, it takes a while for banks to ramp up a program, a different investment program. But the other side of it is banks really don’t have capital gains, or at least the periodic source or portfolio of bad capital gains to invest, because most of the sales of their assets are loans, and those are ordinary income for banks.

And so it’s difficult for the community development groups and the bank to access or find capital gains that attach to the investment. So, we haven’t seen a lot by institutional investment, although, there has been some. And like I said, I think as time goes on, banks will interrupt their programs around incentives. So, corporate tax increase will give folks more incentive, you know, to invest so pretty low now at 21%.

And then lastly, the estate tax. So, Biden publicly indicated that he’s going to reduce the exemption by 50%, which I said in the beginning, we’re a little over $11 million now per individual. And that was changed in 2017. It used to be 5 million. So, even go back to that $5 million. Interesting thing is the $5 million actually comes back online, it was a temporary increase in that exemption through 2025. And so it’s going to happen anyway.

So, I don’t know, you know, if they’re going to make the effort to decrease it, you know, in the interim, but if it does, it may give folks more incentive to undertake the strategy that I talked about earlier where they want to get appreciation out of their state. So, it might be good to do it through an Opportunity Zone investment and get the exemption or get less pressure on the exemption and get the appreciation taken out of the state with a step up to basis through Opportunity Zones versus the estate tax. So, those are the three things that I think Biden would have effect around the program.

Jimmy: Yeah. Thanks for the insight there, John. If I just may piggyback off of what one thing you said, in particular, was really key, I think the tax rate increasing and affecting that deferred amount of gain that you recognize at the end of 2026. Again, it’s a net present value equation at the end of the day. What’s the net present value versus, you know, 28% versus 23.8%? Because of the 39%, maybe there’s a little bit of a concern, but at 28%, like, you say, I do agree it’s negligible.

The other consideration is if the more tax rates go up, the more important that backend benefit is, the ability to exclude capital gains tax liability after disposing of your Opportunity Zones assets after a 10-year hold. Jeff, or DJ, did you have anything else you wanted to weigh in on in regards to Biden or tax rate risk?

DJ: I was gonna ask Jeff a question though, is that, you know, one of the big things we talk about that you do have to pay those capital gains, or you were just saying, Jimmy, right? And so having that money available in order to pay that, you know, I wonder if there’s going to be some issues on the high net worth perspective, first and foremost, if they don’t have deep pockets, like a family office? Jeff, how do you guys look from an investor perspective that has an interest in the corner?

Jeff: Yeah, so all of our projects we look for, if not, demand that there’s a return on capital provision before year six. And it’s generally around this refinancing that I described using the unlevered deal as a good example. And maybe John can opine for just a moment. But you can go through these refinancing and say construction and then converting to permanent loan after stabilization, you can return on capital, deliver, as I mentioned, maybe 30% up to 60% on capital tax-free.

And there’s some terms associated with that, as John will probably suggest, but anyway, we’re always looking to optimize tax efficiency from beginning to end. And then we’re always looking to provide fairly consistent cash flows to the investor during the life in the holding period of 10 years. And then with a substantial lump sum return, if we can engineer it, so that the investor can pay the deferred gain. John, is that a correct statement on return on capital through refinancing activities?

John: Yeah, that’s correct. I mean, it’s just like a traditional debt finance, distribution, and all real estate, that works for Opportunity Zones as well. And you have to have basis in the debt. But typically, it’s a nonrecourse that you’re refiling with and all the partners share in the basis of that. The one caveat is that in Opportunity Zones, you have to wait two years from the date of your investment before you do that debt-financed distribution. And that’s not unreasonable, I mean, typically takes that long to stabilize anyway, and so it’s not an unreasonable time to wait, they just don’t want to see folks put money in and take it out the next day and still get tax benefits for it, so.

Jimmy: Well, good, guys. Well, we’ve got a few more minutes left until the top of the hour. We might go over a little bit, we’ve got a lot more questions to answer. If we don’t answer your question live today, I’m going to try to get these questions over to DJ, and John, and Jeff, and hopefully, they’ll be able to spend some time and follow up with you one on one via email afterwards.

I wanted to launch our final poll question here, which is the money question. Really? Do you plan on making an Opportunity Zone investment in 2021? So, yes, no. Or maybe you’re still thinking about doing some research learning a little bit more about the program? I’ll leave that poll question open for a few more minutes.

I had a question I’ll address to everybody here. But, you know, what if you are a family office or high net worth, and you own real estate already that’s located in Opportunity Zone? Maybe it’s been in the family for generations? What are your options there? Well, can you unlock any of the incentives in the Opportunity Zone program? Or what would you advise people to do if they already own real estate or business in an OZ?

DJ: I’d be curious on John’s comment about this. But one thing that I have seen happen with families is that they’ve actually contributed land as part of the investment, right? And there’s different particulars to doing that. But that’s definitely one thing I have seen happen.

John: The qualification of the business that you’re investing in, ultimately, whether that business be rental property or an operating business is really based around its assets and 70% of those assets have to be qualified assets. And there’s a couple things for an asset to be qualified. One thing is, you had to purchase it after December 31st, 2017. So, if you own this property before December 31st, 2017, that asset would not be a qualified asset. And you can’t sell it to yourself, in other words, you can’t sell it to a related party. And the rules are pretty stringent around the related party in this statute. It’s a 20% threshold. Where typically related parties in tax law are 50%, this is 20%.

So, it makes it difficult to sell, let’s say, land into a special purpose entity that you own more than 20% of. So, you’re not going to retain the same ownership in that land, and have it not be disqualified due to the related party. But the thing to remember if it’s land, you have to only have, like I said, 70% of your assets only have to be qualified. So, if you’re going to go vertical on that land, and happens to be 80% of the total budget, it doesn’t matter, right? Twenty percent of that asset that doesn’t affect my overall qualification of the business. So, yeah, you can do that. You can’t contribute property as well.

Let’s say that land was purchased after 2017, and instead of selling it, you just want to contribute it to another entity property in order to qualify, it has to be purchased with cash. And so any contribution of property will also disqualify it. But like I said, if you’re going to make an investment in that property, after that contribution, or after that related party sell and that investment, such that it rises you through that 70% threshold, then you’re okay. And we see a lot of that. You can also lease, you know, you could lease the land to the project, and related party leases are okay.

But there’s some problems with that because you’re trying to get the appreciation benefit in that partnership that you’re going to sell. And if you’re leasing it, you know, and the land happens to go up in value, you’re not going to benefit on that, you know, that appreciation, the land portion anyway, so.

Jimmy: Jeff, did you have anything else to say out there?

Jeff: I was gonna say, yeah. I mean, as you describe, many families have multi-generational ownership with no basis. And they’re looking to monetize that somehow, some way. So, we’ve seen and entertained opportunities where they sell, as John described, to a new entity retain 20%, roll the preponderance of gains into a different OZ investment, and still participate in the original assets. So, yeah, we see quite a bit.

Jimmy: Yeah. So, a few options there. Do want to share the results of our final poll question today. Looks like the vast majority of you on the webinar today do plan on making an OZ investment at some point this year, which is great. And a good portion of you still considering it, doing research, as well. I wanted to mention that we are a couple minutes after the top of the hour. So, we want to be respectful of your time. If you do have to drop off, we won’t hold it against you. But Jeff, John, DJ, if you’re able to stay around for a few more minutes, maybe we can get to some of these other questions.

John: Sure.

Jimmy: Okay. So, we have a question here from David. He asks, how does Section 1202 impact the 2026 holding period?

John: Section 1202 is a small business stock incentive in that if you hold the stock for five years, you can avoid 100% of the gain on that stock. So, there are some funds that actually couple the Opportunity Zone incentive with the small business stock incentive. You get the deferral on the front end, and then you can sell your asset in a shorter-term five years and exclude that at any gain in a five-year term versus waiting 10.

Any interim gain from the sale of an asset in Opportunity Zone structure is taxable. It’s not sheltered, you have to hold it for 10 years. If you hold your investment or fund for 10 years, you can…there’s ways to sort of have a shorter-term investment in the property, but for the most part, you got to hold it for 10 years. And so yeah, 1202 doesn’t affect Opportunity Zone. It actually, what I would say is enhances them.

But the assets that are eligible for 1202 investments are limited. I mean, you can’t do real estate, you can’t do service businesses. It has to be an original issue stock, which is similar to new market. But it’s primarily operating businesses, active businesses that don’t include real estate in certain service businesses. So, it’s limited in that respect.

Jimmy: Good. Jeff, this next question is for you, it comes from Michael. Michael wants to know, he wants you to go back to one of your examples here, on your cash return example, he missed how the Qualified Opportunity Fund requirement for improvement in a QOZB is met if you are purchasing an asset that is substantially complete?

Jeff: Yeah, yeah. Great question. And I’m going to kick that to John for the right answer, and I did call that out. But so yeah, again, in that example, right, we’ve got an asset that was acquired in ’17, substantial improvement has been made, they’ve gone vertical on the property. And now here we are pre-TCO, and we want to qualify that in as an opportunity structure. John, can you opine on how that’s accomplished?

John: Yeah. So, as I said, any asset that’s been used needs to be substantially improved. And so if you buy a building in an Opportunity Zone, you know, you pay a million dollars for it, you got to spend a million and one dollars improving it in order for it to be a qualified asset. But any new construction, obviously, you’re purchasing, it’s all-new, it’s all good property. But the definition of use property is placed in service, so it can’t be placed in service.

And so what folks have done is sort of a build where they’ll build an asset, get it substantially complete, but not a TCO, meaning it’s not ready for its intended use. It’s not placed in service, and then sell it to an Opportunity Fund. And it says if the Opportunity Fund had new property, they don’t have to spend another amount above their acquisition of that property. So, like Jeff says, it takes the construction risk out of the investment.

Jimmy: Good. Well, thanks, Jeff and John, hopefully that answers Michael’s question. We’ll get to a few more questions here. Next one from Thomas. Thomas wants us to talk about operating business. We spent a lot of the day talking about real estate, or giving real estate examples. But, you know, he’s more interested in operating business. He’s a sponsor, currently has a QOZB under LOY. Maybe this is a question for you, John. John, you’re our go-to guy here. Can you talk about Opportunity Zone operating businesses, and the best way to structure those transactions?

John: I mean, I’d say the best way to structure…

Jimmy: It’s a loaded question. So, it’s a lot to consider, maybe just at a high level.

John: All right, depending on what you’re operating business, a lot other facts. But, you know, when you look at the operating business investment, I think the intention of this program with the 10-year benefit in the multiples of an operating business versus real estate being, you know, typically on average, you would expect the hit-a-home run in an operating business where you’re going to get 10 times the value or more in 10 years, that it can be a really beneficial incentive for an operating business. Operating business rules were pretty complicated.

Well, at least they weren’t real clear at first. And the final race did a nice job of giving us safe harbors for operating businesses to qualify. And so I think it’s a lot clear and maybe it’s taken a lot of the compliance risk out of investment. We just have not seen as many operating business investments as real estate. I think it’s common in incentive that the first mover is going to be real estate. With all the compliance risk and sophistication, it’s nice to probably have a little less risk on the asset side. So, that’s part of it.

We track funds, investments, a subset of the market. I think we track about 650 funds. And we have 15 billion today has been invested in Opportunity Zones based on our subset. And our subset, you know, maybe it’s less than 50%, maybe it’s less than 30% of the total marketplace, but we do direct surveys of funds. And out of that $15 billion, there’s been less than $500 million invested in operating businesses in that sample. But we’re seeing it tick up. We’re seeing it tick up by 25% in the last quarter of last year.

And so that’s fantastic to see. I think folks are getting more comfortable, and you’re going to see more operating businesses in the program. You know, our structure, I mean, I would think that, you know, it depends on a lot of factors. I mean, if you are looking to get the 1202 benefit, the five-year thing that we talked about, that operating business has to be a C-corp that you’re investing in versus a partnership. So, most of the real estate that are partnerships, so, if not all.

DJ: Jimmy, I want to say one thing. One of the things real estate, you know, is one of the major areas to invest. One is the … is absolutely amazing. If I was a venture capital firm, building and I run an incubator out of there. I think that there’s a tremendous amount of upside, you know, if you invested a million dollars in growth to a billion dollars, now granted you do have a timeframe, but that would be a significant use of the OZ. I haven’t really seen it out there maybe once or twice, but that could be pretty…

Jimmy: Yeah, there’s…

John: Yeah, and we are seeing a lot of startups. I mean, the portion of that $500 million is a lot of startup-type investment.

Jeff: And so I want to agree with the panel, and we’ve been looking opportunistically at OZ businesses. And, you know, as you call it, John, you get the twin benefits, right? If you can locate the business in the real estate in which you’re investing in, you know, it could be very, very compelling. So, we’ve been looking at light manufacturing and industrial locations, we’ve been looking at startups, incubators, DJ, like, you’ve been a part of, in creative office spaces. We’ve looked at storage, right? Business unto itself in an industrial location. So, we’ve been… And we continue to look for that kind of twin opportunity to invest both in the business and the real estate in which the business resides.

DJ: I’m sure you’ve thought about this, Jeff. But I’ve always thought that if you could get some of these incubator companies in there and part of the rent are shares.

Jeff: Yeah. Yeah, that would be great.

DJ: You could do quite well, all right?

Jeff: Absolutely.

DJ: Because you’re paying off the building, you’re paying them. But then if one of them hits…

Jeff: That will be fantastic. Yeah. We’re doing some work on this space, so stay tuned. And glad to hear from John that the data is showing an increase in investment allocation. It’s due.

Jimmy: Yeah, that’s important. It lagged for a while, I think because the real estate regs came out first, it took a while for IRS and Treasury to come back with clarifications on how businesses could qualify for the incentives. We got a couple more questions here. And then we’ll try to cut loose in a few minutes here. Next question from Kareem asks, let’s see. If we are developing property in an OZ, can we sell it before completing the project, and then move the money into another OZ project? So, how does that work if you kind of move in and out of assets within the OZ Fund?

John: Yeah, so I mean, you can sell it, there’s no… You’re permitted to sell it, if there’s a gain, which most likely that gain, that interim gain is going to be taxable, you can’t defer the gain inside the fund unless it was after 10 years. But you can take that gain and reinvest it. Opportunity Zones, you’re not really direct tracing the dollars, right? Any gain that you have, it’s a capital gain, you can invest against that, you sort of designate it on your tax return. And so it doesn’t have to be those proceeds. But if you had a gain in any year, you’re permitted to reinvest it, but it just starts the clock over. It starts the 10-year clock over.

DJ: Okay. So, that’s a question. Yeah. And I have, because my understanding, and this is part of the problems, I think, with Opportunity Zone where there’s one interpretation of what people think. And then there’s another one. What I was under the impression was that if you did sell, let’s say in year four, that your clock doesn’t start again. You’ve already got four of those 10 years completed within that zone. Are you saying that would be the case or it is.

John: Yeah, and that is the case. It doesn’t start again. Right. Right. Yeah. It starts over. Yeah. And then we had sort of… You know, when you look at the statute, there are certain provisions in this statute that we were hopeful that that’s how Treasury would interpret it in the regs, but they were pretty clear that any interim gain is going to be taxable. And so, right now, we don’t have any guidance that says that interim gains can be reinvested and continue a deferral.

Jimmy: So, the interim gain, the gain within the fund?

John: The gain within the 10 years, is what I’m referring to.

Jimmy: Right. But the original gain, like, you sell your Facebook stock, and you put it into a QOF. And the QOF sells an asset four years down the line and then reinvest in another asset, that clock on the original gain, what happens with that clock? Can you clarify that?

John: I’m not sure I followed you.

Jimmy: Well, I guess I need an explainer on what you mean by interim gain within fund?

John: Interim gain will be… So, if you have a gain, so you have a $10 million gain, you put it in a fund and then invest in a multifamily asset, let’s say. You say in four years, you sell that multifamily asset for $15 million. Just hit a home run, right? $5 million gain that you realize has to be recognized, and you can take that money and reinvest it. And you still have your 10-year holding period in your first investment, is just that extra $5 million, you know, is you have to be taxed on.

Jimmy: Yeah, the extra $5 million, understood on that. But the original $10 million gain, you can continue to roll that over, right?

John: That’s correct. Yeah. Yeah. I mean, you’re not really rolling it over. It’s just, you’re just still invested, right? You never exchanged it. You never sold it. You never sold investment in the fund, right?

Jimmy: I guess that makes sense. Gotcha. Gotcha. That makes sense. That makes sense. Let’s see. A couple more questions here. One from Jeff.

DJ: Jimmy, I wanna… Jimmy, really quick, I want to thank you very much. And Jeff and John, good to see you again. I do have another call. I do have to get to. But I’ll look forward to circling back with all of you guys.

Jimmy: All right. Thank you for joining us today, DJ. Appreciate it.

DJ: Thank you.

Jimmy: Let’s see. We’ve got two more questions that I want to get to. Jeff asks if you elect to defer payment of long-term capital gains by investing in a Qualified Opportunity Fund, can you later elect to go ahead and pay the taxes at any time prior to 2026 or 2027 without penalty?

John: Yeah. Without penalty, I mean, you can’t… So, you can create an inclusion event, right? Which means, like, you sell the fund or you can…

Jimmy: That would be a way to change your mind and pay the taxes early, I guess.

John: There’s no… But then you lose your 10-year hold benefit, right? So, when searching for a way to sort of accelerate that event, in the event of tax rates going up and still keep your 10-year hold benefit and you can do a debt finance distribution if it was an inclusion event. That would be one way to do it. Except for if I’m doing a debt finance distribution, I typically don’t have an inclusion event, because the basis is dead.

Jeff: So, John, I’ve received the same question many, many times. So, maybe I’ll ask a little bit different. It’s 23.8 as today, I’m invested in the QOF, 2026 I got to pay it again, right? Now, the tax on the gain? I’m hearing rumblings Biden’s gonna raise it to 28%. I want to pay now, I want to pay at 23.8% as it is today. Can I do that? Can I pay my deferred tax before 2026?

John: No.

Jeff: That’s right.

John: Unless you have an inclusion event, then you have to pay your deferred tax rate. So, you can create an inclusion event, which means sell your investment or take a distribution, you know, debt basis for which is, you know, most of the time if you’re going to get the money, you have the debt basis. So it’s difficult… There’s no automatic that just say I want to recognize it today. Yeah.

Jeff: Exactly. But I think what was really important to hear that you’ve done the analysis on the NPV on a 28% rate in 2026 versus the 23.8%, which includes the 10% step-up, right? And you’re considering that to be kind of net neutral or negligible …

John: Well, it’s not neutral. Yeah, it’s not as is… And again, that also assumes those rates stay there for 10 years, you know, for your 10-year hold. But, yeah, when you look at it that way, right? It’s negligible.

Jeff: Got it. Cool.

Jimmy: Good. We’re going way over here, boys. Thanks for sticking with us.

John: I have a 3:30 hard stop.

Jimmy: Thanks for sticking with us. We’ll get out of here. And we’ll get out of here in a few more minutes. But the question just keep on coming in. I think we’re adding value and there’s still a lot of attendees still on the line with us. So, Kevin just chatted, I think he wants you to clarify what you said in your previous answer there, John. He says that there are funds that claim that they can sell every three to five years and not restart that shot clock. He put it. Can you clarify that or add any insight into what they’re doing there?

John: I already did clarify. You can’t.

Jimmy: Okay.

John: Yeah, you have to… If you have a gain, you have to pay tax on it. Okay. You don’t have to restart the clock on the original investment, which we went through, right? But there’s no way to defer that gain. So, yeah, the clock does not restart for your original investment. But, you know, they can put that money back to work and not give it back to you. And your original investment still stands. Just there’s no way to avoid the gain. But you can defer that gain, just restarts the clock. So, maybe it was just a misunderstanding of how I explained it and how he was thinking about it.

Jimmy: No, I think that’s helpful. Thank you. Thank you. Last question here. It’s from Reed. Reed went on a little bit of a rant, but I think his main question is, his main point is OZs are a little bit ugly. What can be done to improve Opportunity Zones? I mean, what would you like to see improved, John, and what would you like to see, Jeff, and then we’ll wrap up there.

John: I think the biggest improvement would be the interim gain issue that we’ve been talking about. You know, I think, we could see a lot more operating business investment because the business matures in seven years and the market’s ripe and you want to sell it, you know, you’re not going to wait the extra three years to get this benefit. I think that’s where folks are hesitant to get into sort of the private equity venture capital thing, you know, Opportunity Zone investments, because 10 years just seems to be three years, maybe too long.

Jimmy: Jeff, what about you?

John: Other than that it’d be nice to have a, you know, extension of it because it did take a couple years to ramp up. And, you know, if you hold your investment for five years, you get 10% reduction, another 7 years, you get 5% reduction. So, you have a 15% inclusion, 5% is gone. And we’re really close to that inclusion data 26%. So, the deferral period is shortened. So, it’d be nice to have an extension of a couple years, and there’s some activity around that, you know, where folks are proposing those sort of things. So, hopefully, we see that.

Jimmy: I think, Senator Scott’s IMPACT Act, if I’m not mistaken, is one of the primary pieces of legislation that addresses those concerns. Am I right there?

John: You’re correct.

Jimmy: Yeah. And, Jeff, how about you? I will let you…

Jeff: I don’t know what’s ugly about it first, you know, “Ugly.” I did see in the poll question complexity was an issue. I think you do a great job with your forums routinely to demystify OZ execution. And it’s quite straightforward now we’ve got lots of examples of success. I agree with John like this whole 23% versus 28%. If you could just fix it at the time of investment, at the prevailing rate. And you could plan for that. And it’d be predictable. And so I’d like to see that enhanced, so just fix it. Whenever you invest, you lock your rate, you know, it’s 23.8% today or it’s 28% in the near future. We don’t know. But that’s what it is. And I think that would give a lot of comfort to investors. But you know, again, pleased to hear John say that it’s negligible at that rate. So, that would be the one thing I’d look for.

Jimmy: That’s great. Well, we went way over, we wrapped up with 15 minutes ago, and then we had just tons and tons of questions coming in. So, I really want to thank our attendees for engaging with us for as long as you did and being so interactive with us. Before we wrap up, John, can you tell us where everybody can go to learn more about you and Novogradac?

John: Yeah, our website is novoco.com. We actually have an Opportunity Zones portal on the site with a lot of good information, current events, things like that, tools. So, look forward to seeing ya there someday.

Jimmy: Excellent. Thanks, John. Thanks for joining us. And Jeff, where can the attendees here today go to learn more about you and Pinnacle Partners.

Jeff: Yeah, pinnacleoz.com, and [email protected]

Jimmy: Excellent. Thank you, Jeff. Thanks for coming on today. And I’m Jimmy Atkinson. Again, you can find more information about me at the Opportunity Zones database at OpportunityDb.com. And I’m hosting an OZ pitch day on March 9th, coming up in just a few weeks here. You can find out more about that at OZPitchDay.com, is a great way for investors and deals to match-make, so to speak. So, anyways, again, I just want to thank all of our attendees here today, I want to thank John and Jeff, and DJ had to hop off few minutes ago. I want to thank him as well. Thanks, everybody. And we’ll send that recording out and get the slide decks to everybody by tomorrow afternoon. Thank you, take care.

John: Thanks, Jimmy. It was fun.

Jeff: Thanks, Jimmy.