OZ Pitch Day - March 23rd
Opportunity Zone Marketplace Roundtable, an ADISA Conference Panel
Are Opportunity Zones being underutilized? And what’s in store for the Opportunity Zone marketplace as we come out of the pandemic and head into the second half of 2021?
This episode is the audio recording of a live panel from the ADISA 2021 Spring Conference. Erik Hayden (Urban Catalyst), Matt Iak (U.S. Energy Development Corporation), and Greg Genovese (USG Realty Capital) were the expert panelists. The panel was moderated by Jimmy Atkinson (OpportunityDb).
Click the play button above to listen to the panel.
- A brief crash course on the Opportunity Zones tax incentive.
- Why Opportunity Zones are being underutilized, three years into the initiative.
- The intermediary mismatch between those who distribute it and those who buy it.
- Why Opportunity Zones are a lot like high school sex.
- What investors can expect from post-COVID Opportunity Zone marketplace conditions.
- How day traders with substantial short-term capital gains from the past 12 months can stand to benefit even more than traditional long-term capital gains investors.
- What the Biden administration and the Democratic Congress is proposing, and the impact that future changes to the tax code may have on Opportunity Zones.
- The benefits of converting a direct 1031 exchange or DST investment to an Opportunity Zone investment.
- Ideas for how Opportunity Zones can be improved.
Featured on This Episode
- Erik Hayden on LinkedIn
- Matt Iak on LinkedIn
- Greg Genovese on LinkedIn
- ADISA 2021 Spring Conference
- UC Berkeley / JCT Study: $24 Billion of Investments by QOFs in 2019
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.
Jimmy: Welcome to the Opportunity Zones Podcast. I’m your host, Jimmy Atkinson. Back in May I hosted a live Opportunity Zones panel at the ADISA Spring Conference. What follows is the audio recording of this panel. Enjoy!
Well, we made it. We made it to the last panel of the day. I think it’s the best one, Opportunity Zones, right boys? What do you say? Should we fire this up or what?
Together: Let’s do it.
Jimmy: My name is Jimmy Atkinson. I’m the founder of the Opportunity Zones database at opportunitydb.com and the host of the “Opportunity Zones Podcast.” Had the privilege of having all three of the gentlemen sitting in front of me today as guests on my podcast, pretty much back there. Appreciate that. A quick intro to Opportunity Zones, for those of you who don’t know, we’re gonna go through a very brief intro of what the tax incentive is.
I think it’s the greatest tax incentive ever created, possibly. And it starts with a capital gain. So it could be a capital gain from stock, from real estate, from crypto, from art, from virtually anything, basically, and you get three huge tax benefits. One is the deferral period, you get to defer recognition of the capital gain until the end of 2026. Think of it as an interest free loan from Uncle Sam.
Two, you get a reduction in the amount of gain that you recognize when you do have the recognition event at the end of 2026 by up to 10%. That benefit is actually going away at the end of this year. We’ll talk a little bit more about that later. But the third benefit is by far the largest one. It’s the elimination of all capital gains within the Opportunity Zone investment. So if you appreciate your asset from $1 million dollars to $2 million, your $1 million capital gain gets wiped out, tax free. So it’s quite an incredible tax incentive program, I think. And just to give you an idea of the size of the asset class, it’s a new investment vehicle that was created at the end of 2017 as part of the Tax Cuts and Jobs Act.
A report was recently released by UC Berkeley in cooperation with the Joint Committee on taxation. And they discovered that approximately $25 billion of investment was made in 2019 alone. Estimates as high as $75 billion over the life of the program to date have been floated around. It’s a very large asset class. I think over $100 billion, possibly $200 billion been raised when all is said and done.
So I’d like to introduce my panelists here today now. They represent three distinct product types that are represented up here today. We have at the far end, Mr. Erik Hayden, he’s founder of Urban Catalyst. And his product is ultra-focused on real estate development in San Jose, which is one of the hottest areas in the country. In the middle here we have Matt Iak. He’s the executive vice president of U.S. Energy Development Corporation and his qualified Opportunity Fund offering is investing in the energy space.
And last but not least, we have my friend Greg Genovese, a CEO of USG Realty Capital and the Investors Choice OZ Fund. And he has a broad-based real estate development nationwide. So just to paint a picture of how we got to where we are today, as I mentioned in 2017, the legislation was passed as part of the Tax Cuts and Jobs Act that created Opportunity Zones. The zones themselves, the place-based communities where these taxes apply were finalized in 2018. And the first funds started rolling out then. In 2019, the IRS regulations were finalized.
And then we’re coming into 2020 real hot in this industry, and everything’s coming along, and then everything shut down with COVID. So I’m going to turn to the panel now. Let’s get this conversation rolling here. Why are OZs being underutilized today, do you think? Erik, I’ll start with you, at the far end there. We’ll go right to left for the audience.
Erik: For sure. It started off with the lack of clarification, the program, when it came out as a part of the 2017 Tax Cuts and Jobs Act. When it came out, they said they were going to be three rounds of clarifications, the final round didn’t come out until December of 2019. And before that, there was a lot of confusion associated with the program. And investors saw confusion really equaling risk. But since then we’ve seen a lot of investors start to understand the program but then, of course, COVID. So you kind of got hit with a timing double whammy.
Matt: So not to duplicate that on, I would say that you had Biden, which is great. But on top of that, so you have this long period of time and this long delay. And then I think you also have kind of a bifurcation of understanding of those who distribute it and those who buy it. So I actually know a lot of real estate developers who have utilized it. I know a lot of wealthy who have utilized it. There seems to be an intermediary mismatch between the style of the funds and the risk that many of the distributors might take, broker dealers and such not versus the end users.
So I think there’s somewhat dislocation there in terms of vested interests of all the parties that are delayed. So we always quote this, and sorry to be inappropriate, we call Opportunity Zones a lot like high school sex, a lot of people talking about it, nobody doing it. But it’s funny because it is the single greatest tax reform I’ve ever seen. It’s a super off. You’re only limited by how much you have in capital gains to turn into tax free accounts. It’s insanity when you look at the nature of the law and the flexibility it affords and it is way over utilized in…
Greg: The only think I would echo… First of all, let me echo what Erik and Matt said, and if I were to add anything at all, I think there’s two other factors that we really need to look at. But Erik really hit it out of the park, as far as really understanding. It comes down to understanding. But it also comes down to timing. So what I’ve seen in the industry, and our group’s been involved right from the start with our first program back in 2019, there’s two other factors that are really going on. One is, everybody has been so hyper-focused in the opportunity zone world on the 15% reduction and the 10% reduction. And so, there’s this feeling that this is the last year the 10% reduction, so people are already kind of calling it in a little bit on what they believe the maximum benefits are.
And so I think that’s a little bit short-sighted. And so hopefully, we’ll get a chance to talk about that and why it should be utilized even past that date. And then the second really is that, if you look at the majority of the producers in our world, in ADISA, the independent broker dealers, the RAs that are affiliated with BDs, the focus on real estate really has been on the 1031 exchange, for all the right reasons. And so, there’s definitely some education that needs to happen on the side of the fence. The broker dealers need to get their head around utilizing Opportunity Zones. And then quite frankly, the last thing I always say whenever I’m speaking publicly is, whenever there’s a new tax initiative, I always say you need to worry a little bit because I always say I guarantee you in three or four years, there’s going to be an article in the LA Times about two guys in L.A. that ripped off a bunch of people in Palm Springs.
And so trying to figure out who the players are, who the good, the bad, and the ugly are, who are using regulations and compliance, good oversight, third party oversight, I think it’s important. And quite frankly, kind of to Erik’s point, I think it’s taken the investors, it’s taken the RAs, it’s taken the BD channels a pretty good amount of time to understand who the players are. And I think you add it all up in with the timing issue, I think is really fostered underutilizing the asset class.
Jimmy: You’re absolutely right. There’s a lot of headline risk with any new tax incentive program like this one. And I think we already saw some nasty headlines come out in the mainstream media, the first couple of years of the program. That didn’t do the industry any favors for sure. So we’re here to discuss post-COVID Opportunities Zones investing as it says on the screens behind us. So let’s do that for a moment now. We’re getting into what I like to refer to as post-COVID. We’re all here in person at a conference for the first time in 18 months, and the market starting to rebound, the economy is starting to rebound. So as we’re starting to come out of COVID, what can investors expect in terms of post-COVID market conditions, specifically for Opportunity Zones? You can take it, Matt.
Matt: Right. So I think one major…well, there’s a bunch of hanging chads still out there that I think are critical. The one that you were mentioning that is extremely important is the importance that’s put on the least important part of this tax code, which is the deferral, right? And we get it because investor incentive is they want that immediacy. We all understand human behavior and the immediacy of deferring that capital gain. And with the fear, especially in this administration that you’re gonna have a significant rise in capital gain rates, I think there’s a pause. If everyone is putting the importance on, “Hey, we’re gonna have this capital gain and now we’re gonna defer it potentially at a much higher rate,” there’s that big concern. I would call that a hanging chad amongst many other hanging chads. It’s probably the single biggest issue.
Again, I think people are failing to recognize that the 10 year has a lot more value than the deferral, but it’s understood. So I would say that’s one big hurdle that’s coming out of COVID right now. There is a hurdle in Washington in that, I would say the party in power right now has not been a fan of how OZs have worked to date. So I’ve had several discussions with several committee members in both the House and Senate. And I will tell you that there’s been a huge frustration on the left side to where the capital is going. So that is something that we ought to be cognizant of, that they wanted a lot more urban centers that is more significantly in gentrification. So I think we found a lot of diamonds in the rough that people will take advantage of, that are in the 2010 census tract that happened to be good investments already. So there is a bit of a frustration on a certain side of the aisle that I think we ought to be cognizant on going forward, because it might cause some reform in the post-COVID. There’s so many things I can say but I want you guys to be able to talk so…
Jimmy: Yeah. So I want to focus on the Biden registration, specifically what we think his administration may do and what those changes may have an impact on investors in a minute. But, Greg, what do you say?
Greg: I couldn’t agree with Matt anymore, you really hit it down the fairway. What I would say is, this is just my own thinking. I think there were different COVIDs when it comes to real estate. If you look at when the Opportunity Zone initiative first hit, it hit the space, we were already at the top of the real estate market. We were at the top of the stock market. We had bone-crushing government debt. We had bone-crushing student debt. We had the lowest interest rates in history. And we had the top of the real estate market, lowest cap rates. And for those in the audience that know this, we had an inverted yield curve twice during 2019, which really signals the next recession. So we were kind of looking at it from a standpoint of, we need to recession-proof or recession-resilient these performance, not the asset class, but the performance. And then COVID hit. So I think there was a pre-COVID then I think there was COVID. And nobody knew what to do and the lenders were pulling back and there was all this stuff. And then there was the Valley of COVID. And then I think there’s post-COVID where we are today.
And a lot of things really came to light. I think a lot of it was looking at the potential conflicts of interest between developer and asset managers sort of came to light. But the silver lining, in my opinion, is that it’s given the real estate markets an extended runway. We felt that we were in a late stable period in the real estate markets in 2018 and 2019. And I think COVID has actually given sort of a reset button. We’re kind of back to 2018, from a pricing standpoint and it’s given us a little bit more of a runway. So I think that’s a big advantage. But you couple that with people feeling that the runway is running out, and that could cause a bit of an issue. But I hope my colleagues here also keep echoing what Matt had said before which is, a lot of the marketplace is too focused on these reductions in capital gains tax over the long-term period and how long you can actually hold on to that investment.
It’s basically a five-year tax free loan from the government for the next five years. And you hit the ability to go into one, two, let’s say these three programs here, deferred 100% of those capital gains tax, get the returns that have years to compound and compiled in those five years. To me, that is way more important and way more valuable than the fact that in 2026 you get a 10% reduction. And kind of segueing into the Biden’s side, I think we all probably agree with what the Biden administration is looking to do isn’t necessarily all that bad, from a reporting standpoint. And that is, third party reviews, social impact studies. Where’s the investment? How creative is it going to be for the local economy, public private partnership with the local community? I’m totally for that.
Matt: … cap gains, but everything else is relatively positive, right, for Opportunity Zones.
Greg: I agree.
Jimmy: And let’s talk more about Biden in a minute. But I want to turn to Erik again here, what’s your take on the post-COVID market environment? What can investors expect, particularly in Opportunity Zones. And maybe you can think about San Jose in particular if you want to.
Erik: What I can really say is I’m really happy this is a post-COVID Opportunity Zone investing panel and not a mid-COVID Opportunity Zone investing panel because I’m really just happy it’s coming to an end. And it’s really great for investors. And obviously, the benefits are going down slightly in the program, 10% to 0%. You only get to defer until 2026. And a lot of folks forget that the third benefit is really the largest benefit, and that is tax free profits after 10 years. And then for investors most Opportunity Zone funds are based around real estate. And here at Urban Catalyst we’re based around real estate. And what we found is a lot of what Greg said that, typically, real estate and the economy it runs in like 7 to 10 year cycles.
And when we were out in the market talking to investors, prior to COVID happening, we got a lot of, “Well, obviously we’re 10 years into this run and it’s going to come to an end. What’s going to happen when we go into a recession?” And now, when we talk to investors, it’s, “Well, we went through the recession. We’re out of it now. So we have another 10 years of the market expanding,” right? So that has been a little bit of a positive that it looks like we have more runway. And then another thing that’s interesting because our fund…in our first fund we had some office properties and our second fund, we have a large office property. And is everybody going to work from home forever? How is COVID going to impact office space? I think I’m so sick of answering that question. But the answer really is, it turns out, it’s not going to have a whole lot of impact. Folks are going back into the offices.
And what we’re seeing is that, especially in Silicon Valley, a lot of the tech employees understand that and our investors, in general, a significant portion are in Silicon Valley. They are in the tech world. They’re investing capital gains in the sale of stock and they can understand, put their minds around, “Okay, office is coming back. Fund that has an office product in it is going to be a successful fund.” And it’s a very positive sign out there in the market. And then, I won’t go too into Biden and his plans yet because I know Jimmy has smart questions, but as far as the reporting requirements, personally, that’s something I want to see. I like that because I want to make sure our government is doing the right thing. But with all of its tax incentivize programs and we’ve done some internal studies about some of the positive impacts that we have in downtown San Jose, and it’s pretty significant. So, once they have a framework, it’s like we get to go out and brag, which is gonna be kind of fun.
Matt: Specific to our industry in the energy space, there’s one, I’d say, difference in the post-COVID energy industry… make a macro statement. We look at this as, there’s been a large movement and change inside the EMP space over the last 10 years. And it comes from every possible force. You’ve had about 10-year run of equity returns and even significant debt risk in default at this point in time because of price volatility, that’s that space, the energy space. You’ve seen Wall Street force a major company to operate within their own cash flow, which isn’t just a massive sea change for us. Post-COVID, to me, the most unique thing is the overall ESG movement laid on top of that has really sucked away the majority of capital that’s been in our space for 20 years.
And when there’s a void of capital, the investment opportunities have just dynamically changed in the last six months. Up and down the value chain, we have seen opportunities that we haven’t seen in 25 years. We review about 700 deals a year and normally less than 2% make it through our IRR and ROI analysis that we want. Over 90% are hitting it right now. There’s just so much deal flow and no capital to fund it. And I’m sure it’s not that extreme but I’m sure office space has some benefits that are… We’re seeing something that is just unprecedented. And I think because of the overall ESG movement, we have a much longer runway in our space where there’s still gonna be a significant lack of capital in traditional EMP because of that fear of EMP and … we’re not really worried about it, because it still takes more oil to make an electric vehicle than it does traditional. So we’re not really concerned about it in the economics when you run down the long-term chain.
Greg: And Jimmy, I thought of one more thing while Matt was talking. One of the things that we’ve seen in the space is that investors that had a capital gains event that was a sale of stock, man, there’s a lot of day traders that have made a lot of money since March of 2020. And that is short term capital gains, the Opportunity Zone program benefits them more than regular ordinary capital gains. So a lot of…I call it a significant increase in investment from day traders over the last year.
Jimmy: Yeah, that’s a really good point. Well, let’s turn now to the topic of…a lot of conversation that I’ve had in my inbox at least. I get emails from concerned people all the time asking me, “Okay, Biden got elected, are OZs in danger. Is he going to do away with OZs? What’s going to happen with OZs?” I have to talk them down a little bit, calm down. But I’ll pose the question to you gentlemen and I’ll start with you, Greg. What is Biden proposing exactly and are OZs in danger or do they stand to benefit potentially?
Greg: Interesting question because then… I’d be interested to hear what Matt has to say, because it sounds like you’re pretty close to some of the government issues. And we’ve reached out and we’ve talked to…this is more sort of roundtables that I belong to for Opportunity Zones. And before the switch these roundtables actually provided comment and guidance to President Trump’s Opportunity Zone counsel. And the one thing that we’ve noticed is, the information flow isn’t quite as transparent as it was before. So anything I say right now it’s just a really educated guess. I can’t say this is what everybody’s been wanting to. But what we’re hearing, and I don’t know if you’ve seen this resolve, Matt, but what we’re hearing is the idea of an Opportunity Zone is not something that the Biden administration wants to get rid of.
In fact, for the members of the audience, hopefully, this was something that actually the Obama administration wanted to bring out in the 2012 Tax Act, but crowdfunding took precedent at that time. And so this is really something that was generated from the left side of the aisle, which then Trump took and put into the 2017 Tax Act. And so, unfortunately, I don’t know if anybody has been reading the news or seeing the news, but there’s a lot of partisan bickering going on in the last couple of years. Yeah, it’s just the rumor that I’ve heard. And so, trying to understand, to figure out the wheat from the chaff here is really hard. So the idea of Opportunity Zones going away isn’t really the issue, it’s, how does it look? So when Opportunity Zones hit all of a sudden “The New York Times” and a lot of these publications were out there, this is a big tax break for the rich. There was all that, you know, taking position.
Jimmy: The Trump program…
Greg: Yeah, exactly. It was just if it’s theirs, then it’s not ours, kind of thing. Now that it’s theirs, how does that fit? And it’s really about making it fit so that it works. So the idea of…this is…our thesis is it’s not going away. In fact, we believe that the Biden ministration is embracing them. However, there is going to be some changes as far as reporting. And then how it fits into…we’re looking at anywhere from 23.8% or 24%, if you round it, up to 40% in capital gains tax now. So does Opportunity Zones benefit? And I think one of the things, this is a guess, one of the things that I believe the Biden administration is going to have to grapple with in a very adult fashion, and that is taking your idea but also being pragmatic about it. Up till this point, there’s been a lot of ideas but not a lot of pragmatism.
And so, at the end of the day when you look at the 1031 exchange, possibly being eliminated and look…and when they really dig in and see…really the heart and soul of how real estate is traded and … to returns. If you look at giving people the opportunity to defer their capital gains tax, these are things that we believe the administration is going to embrace. The third thing we think the administration is going to embrace is the surety of what those taxes are going to be in 2026. So we’re on the soapbox saying, you really should push out these benefits another year or two because people like to call this a tax break for the investor. Really, it’s a tax initiative for the government. Because the government’s basically saying, “How do we loosen up billions and billions of dollars of capital gains into taxes? How do we get people to do that? And if we get them to do that, we know on date certain that X amount is going to go into the Treasury.”
So it really is something that is an incentive for people to sell high appreciated assets. And, yeah, we’re gonna let you…that’s terrible English. Yes, we’re going to let you defer your gains and…defer your capital gains, but at least we know we’re going to get it. And that’s sort of the deal that the Opportunity Zone industry and the investors have made with the government, and we believe that that’s going to continue.
Jimmy: You mentioned billions of dollars of capital gains potentially getting unlocked. I think the number that was floated around at the beginning of this tax incentive back in 2017, 2018…so this number is a few years old, was…I think the estimate was, there were over $6 trillion of unrealized capital gains on the balance sheets of corporations and individuals.
Greg: I’m just trying to be realistic.
Jimmy: But yeah, of course, you’re trying to be realistic. That was the number that was floated. I’m not trying to pretend that we’re gonna unlock $6 trillion and it’s all gonna flow to Opportunity Zones. That’s the scope of the investable amount of money that’s floating around out there.
Greg: It is.
Greg: So I guess my 2 cents or 22 cents because I don’t wanna…
Jimmy: Twenty two cents on Biden, what’s he proposing and are OZs in danger?
Greg: I’ll just keep it to the absolute for a quick second. I think there’s very likely anything going to happen right now because no optimal conversation is on the table. So I don’t think you’re going to have it in the reconciliation bills. I think you’re gonna have right now. And I think that’s going on. If something does happen, it’s probably going to happen post 2021 into 2022. And really, what they’ve been looking for is trying to tie it to more reporting and more functionality, to get more what Cory Booker wanted on it versus Tim Scott. So I think they want to do more towards, can we get more reporting? And they’ve made comments such as, if they did, they might extend the rolling five, so that this could go on or they have a five-year window for people, not just 2026. But not unless they get the sustainability part of this or X or Y.
So they want to make sure that it’s not going in. They may want to change in the 2010 census tracts. That’s really where they’re most upset, as a Democrat right now. They’re furious that there’s so many already pre-gentrified investments in Opportunity Zones, they’re furious of that concept. They really wanted to go towards a lot more gentrification. So if they can get a little bit, they say they’re willing to give more on the five-year rolling and other such things. We’ll see. I don’t think this is going to make this work at all from my perspective. And honestly, I think if they make changes in 1031s, obviously, it’s going to push a lot more money to Opportunity Zones. And it might already push a lot more money.
I think people realize that in a 1031, if you’re taking your recapture, your 1231 gain, you can pop that into an Opportunity Zone and you’re still going to be at a 25% rate. Because recapture isn’t on the docket for change either. So just think about the math there, you know it’s not going to go up. So if you’re using it as a partial amount to use and create some opportunities, there’s a whole bunch of planning mechanisms that are out there right now, that people aren’t really thinking about in terms of…in the overall process of financial planning that don’t have any of those risks that they think about with Op-Zones.
All right, well, a lot of stuff in the Biden administration the information that I get is from the National working group that advises the Treasury IRS on a lot of the ongoing changes. My partner, Sean, is in that working group. And the Biden administration reached out to the working group towards the end of last year and said very similar to what Matt and Greg said that overall, they liked the plan. They weren’t like super thrilled about it, but they didn’t plan to make a lot of changes. They wanted to see more reporting requirements. And it’s hard to do a framework of reporting requirements for Opportunity Zone funds because they’re so diverse. Matt’s fund versus Greg’s fund versus my fund, all really different types of things, even though we’re all Opportunity Zone funds. So it’s how do you scale that? How do you judge that? And I think that’s been one of the big problems of why we haven’t seen the reporting requirements come out yet. And by the way, Matt, we don’t say the word gentrification in the development space, we say revitalization.
Matt: Sorry, I apologize.
Erik: We’ve seen stuff at the national level get passed around committee that has never made it out of committee, things like getting rid of certain Opportunity Zone areas, certain census tracts in areas that are better off, which in downtown San Jose, we have four Opportunity Zones. And they have slated two of those as being too good to be in the program, which doesn’t make any sense to me, because all of downtown San Jose really requires that type of revitalization and the census tract data proves it. But we’ve also seen positive stuff like extending 2016 to 2018. And retroactively giving everybody that invested in 2020 the 15% benefit instead of the 10% benefit. But none of this has happened. And like, Matt, I don’t think a lot of it’s going to happen this year or next year. We’re just going to continue to roll along. If Trump had been reelected, he was a huge fan of the Opportunity Zone program. I think we would have seen an extension on that rolling five year period, because of his sort of thoughts about the program. I don’t see that coming out of the Biden administration. But we’ll see. It is a very bipartisan program, and perhaps the left will embrace it.
Jimmy: Good thoughts there. We’ve touched upon the 15% basis step up benefit, which essentially can reduce the amount of capital gain recognition in 2026. The 15% benefit went away at the end of 2019. So now we’re down to a 10% basis step up. That’s going away at the end of this year. Is that a big deal? Are people missing the boat here? What are your thoughts? Let’s start with you… Matt, let’s start with you. Yeah.
Erik: We know what Matt likes.
Jimmy: Oh, we already know what Matt likes. You wanna go, Greg?
Greg: So Matt said something that was really intelligent remark on…let me just back up a little bit, what he said about Biden administration, where things may go, I think that was really…it was practical. And I think if I had to put money on, I think that’s sort of the direction we’re going. But as far as the 10% reduction, I have this idea that I talk about all the time called the power of 10. And the reason is sort of a dynamic way of saying you shouldn’t be so focused. And that is, whether they extend it or not, the most powerful tool in the Opportunity Zone initiative is the fact that you don’t have to pay your taxes. Not that you get a 10% reduction. But the most powerful tool is, as I said before, really look at it as, at this point, an interest free five-year loan from the U.S. government.
The other side of that is you can’t…if it’s something I’ve picked up from this panel, we have Erik on the left there talking about Opportunity Zones in San Jose office, generally speaking, and then you have energy, then we’re nationally diversified in different things. But at the end of the day, it’s about the project. It’s about the asset. It’s about the longevity of the…you’re talking about 10 years. Now we live in…I don’t know these gentleman’s ages. But, you know, well, I turned 57 yesterday. Thank you.
Jimmy: Happy birthday.
Greg: Thank you. So, in my working career, I’ve been through three major recessions. Most of the people in the independent BD channel, the IRA channel, well, we’ve been through three major recessions. So the idea of Opportunity Zone investment to me is, we want to make sure…I hope, I think everybody here thinks…they want to make sure that the investors, they want the same investors on the last day. So we need to look at these from the demographics of the area, demographics of the asset, how long…what is our runway from a capital preservation standpoint? And then you look at the 10% reduction, the fact that…let’s say the return profile, I’ve never looked at it, but Urban Catalysts return profile, U.S. Energy’s return profile, Investors Choice return profile, and let’s say we’ve all come out equal from a risk standpoint. If you look at what the return will be on your money over the next five years and then let’s say it’s a liquidity event near five and a half or six, how much has that return helped your out-of-pocket tax that you would have to pay? In most cases, if the returns at around 8%, 9%, or 10%, the return alone over the next five years will mitigate your out-of-pocket tax by up to 80%, 85%. So it’s not that you have a 10% reduction that’s going off the table but the return that you get over the next five years can almost mitigate, depending on the returns, almost all of your tax liability. To me, that’s the hidden power that’s in front of us whether you get the 10% or not after next year.
Matt: So that loan and then the compounding of the value. The interesting thing is, I think this is where I was mentioning the dislocation of interest distributors versus sponsors and investors. Tax bill that’s going to be owed in 2026 becomes a concern if I’m a broker dealer. There’s a compliance issue around this. And I think that is part of the reason that there’s been a somewhat slower adoption for the BD community than from the RIA or from crack investors. They seem to be a lot more apt to do it than the BD world does. Because they’re very concerned with what happens in 2026 if the broker is not there and the client has a tax event. And what happens if they can’t do a debt refinance distribution in 2026? So there’s this hanging chad out there of how is the client going to come up with a capital if it’s all tied up, right, inside the Opportunity Zone?
It’s another kind of issue there. So the 10%, first and foremost, it’s great. It’s a cherry on top. The other two benefits that you mentioned… And let’s be honest, you’re going to see a lot of fair market value discounts of private and traded securities in 2026 because you can use the lower of the fair market value or the original deferral. So everyone does have to remember that there’s going to be a significant differential there in the market of how you post fair market values in 2026. Just saying, generally, we get a lot of discounts on oil and gas, which work really well, but sort of a lot of other asset classes. So you have those benefits kind of sitting out there…
And I think that’s where the interest becomes of, “How is that tax bill? Are they going to have a liquidity event through debt refinance?” From our perspective, we have all these things called IDCs and depletion and depreciation. What happens is, when you get a stepped up basis…because you have a zero offset basis when you come in, so when you get a stepped up basis in 2026, guess what becomes available? All those IDCs depletion and depreciation.
So any amount of income we pull through is tax free to the investors. They don’t have to pay taxes on the revenue during the first six years. So we do distribute during the first six years because we are revenue right away because we draw the wells and then produce in six months.
So we’re actually paying out 6% a year tax free, technically tax deferred, it’s only tax free if you hold it for all 10 years. And then, any distribution we make in 2026 is also tax free because you’ve also suspended intangible joint costs, depletion allowance, X, Y, Z. So there’s a whole bunch of things that people can do to plan around this, including one of things that we do in our statements, and I’m assuming people…
Normally when you’re coming into an Opportunity Zone, you have a liquidity event. People forget this. When you have a $200,000 sale of your stock, is all of it from 0 to 200 or you have a basis? You have liquidity day one because unlike a 1031, you’re only moving your gain into an… Opp.. you have…
So in case you have $100,000 asset and a $100,000 gain, I get 100,000 liquidity day one. I have another 100,000 that’s going… And people forget that in the Opportunity Zone, right, it’s part of those reasons why in a 1031 exchange people look and say, “If I have a really high basis, a $4 million basis and a $5 million sale, it’s probably better to just put a million in an Op-Zone than it is to put $5 million in a 1031.” Like that would be a case where it just makes a ton of sense where an Op-Zone was a much better option for that client then because he has $4 million liquidity day one. Why are we worried about the taxes on a million dollars in 2026? Or if you only use the boot, it’s still gonna be 25 because recapture rate isn’t changing. So if you only use that in an Op-Zone, you’re still gonna pay 25. I think people put way too much attention on the 10%, they’re not looking at the fair market value. They’re just not doing proper planning.
Erik: You know, Matt, I totally agree with you. I think that the Opportunity Zone program has some significant benefits over 1030 ones, but I stopped trying to convince the BDs and RAs because they’re gonna do 1030 ones all day long.
Matt: I think they’re different. I think they are more of a arrow in the quiver and they only work 30% of the time. But 30% of the time they’re a lot better.
Erik: That’s right. There you go. I definitely agree. Now, back to Jimmy’s, you know, original question, which was how important is 10%? It’s not important at all. And I can say that with absolute certainty. Urban Catalyst, we’re a 506C. So we raise through the BD, IRA channel, but we also raise direct from investors. Over the last two years, I think I’ve talked to somewhere in the neighborhood of 1,500 investors one on one. And I’ve heard their questions, I’ve heard where concerns and what they’re interested in and what they’re not. And really the benefit that they see as the biggest benefit is tax free profits after 10 years. They think the tax-free profits are the end-all be-all. Yeah, they get to defer for a while and it’s okay. And your math is absolutely accurate, it is a huge benefit to be able to defer paying taxes, but they don’t seem to really grasp that as much.
The tax-free profits after 10 years, they can grasp that all day long. So we always tell them every single time, “What really matters isn’t any of the tax benefits associated with our program. But you heard about our program because of the tax benefits.” But to Greg’s point, it’s about the project. It’s about the people that are doing the project, the company that’s doing the project, because if there’s no profits after 10 years, what’s the point of the whole program anyway?
Matt: So make it really simple. This is what I say to clients, think about it this way, if you had a client who had Apple stock right now and he had the option to sell it and buy Apple stock inside of a tax-free account and all you have to do is hold it for 10 years, how many clients would like to take all their returns and make it tax-free after 10 years? The simplest answer on the face of the earth: All of them. Right.
So if you like the underlying asset, which is the key, that you like the underlying asset and the actual investment, who wouldn’t want a tax-free super Roth? It’s nuts. It’s the greatest tax code ever written and nobody gets it.
Erik: We like to say investing into an Opportunity Zone it’s like coming in like a 1031 and exiting like a Roth.
Jimmy: It’s a Super Roth IRA. I like that.
Greg: I just want to make one quick mention, real quick, but I want to dovetail on the 1031. But when we got into the…and people that know me in the audience, in the industry, know that I’ve been on the 1031 side for 30 years, and so I know a little bit about this. And when you look at the 1031, for longest time at the very beginning was always this 1031 versus Opportunity Zone, right? And everybody was kind of going down that path, and I didn’t really buy into that. But if you look at real estate values and you look at the sheer volume of exchanges that are going on right now and the dramatic amount of uncertainty in the marketplace, I’m now starting to get a little bit on board with, “Hey, you really should be looking at Opportunity Zones.”
Because here’s the thing, if you have an exchange, so Dr. and Mrs. Smith, where I’m from, Walnut Creek, California, you know, are going to sell their duplex. Now they have two choices in our world, they can either go sell that…let’s say they go to Oakland, California and buy an apartment building and do an exchange, and they’re still doing it. Or they can do what most people are now doing the 1031 DSTs.
But where are you getting the assets? You’re buying into a market that is overinflated. By the way, I’m not saying they’re bad deals, but you’re looking at generally a market that’s inflated, it’s at the top of the market, you’re in with a group. How long does that sustain? And so, I’ve sort of positioned us to say, “Look, I’m not against it and I think you should look at it. But Opportunity Zone investing makes a very good outlet for…if this goes away, you have longer to invest and it gives you that opportunity to go into an Opportunity Zone.”
I think it’s another arrow in the 1031 exchange quiver, because at the end of the day, it’s about protecting the asset. So what if you got out of paying taxes? But so what if you go into a bad investment? At some point, you have to look at the investment itself versus what your short term value is by not paying taxes. So that’s the only thing I can really add to what these gentlemen are saying.
Jimmy: That’s great. And we’re under 10 minutes to go here. And I did want to save a little bit of time for some audience Q&A, if anybody has any questions. But first, let me pose my question to all three of you. You got a magic wand, you’ve got a wish list of how you would like Opportunity Zones to be improved. How would you improve Opportunity Zones? And, Greg, I’ll start with you.
Greg: Sure, I could do this quickly. Even though we’ve been talking a lot about the 15% and the 10% reduction going away, I think that’s the best place to at least start. The fact of the matter is that it just took the government way too long. If you look at the inflows of money that came into Opportunity Zones, at the very beginning — I kiddingly call them the Scaramucci deals — the big private equity deals were just sucking money into the… Because they were the groups that were willing to take the risk on what the regs had…
Jimmy: What could be…
Greg: Yeah, exactly. They were willing to take that risk. Then you had the multi-asset and single project deals. But when it started to get into where wealth advisors started to get involved, right, now, all of a sudden, you have to due diligence. And that takes some time. You have insurance groups that are getting involved. From the standpoint of, are we going to ensure wealth advisors and our IRAs and the BDs? And you didn’t have any clear regulation until the end of 2019. So they kind of ran the clock out on everybody.
And where the idea…the spirit and intent to the initiative was really made for the average everyday investor. But the Treasury Department put the average everyday investor on its heels at the very beginning for the highest reduction. So I would say, if I had a wish list, two things. Obviously, I love this idea of a rolling 15 or a rolling 10 every 5 years. I think that’s wonderful. But I would hope that they would push this out because if they really do care about the average everyday investor protecting their gains, I think that’s how you do it. And number two is clear, concise instruction on what they’re looking for. Because uncertainty just makes everybody sit still and not do anything.
Matt: I would just wish for $3 billion check so I can go buy the core. For us, the irony is the best reserves in the U.S are in Opportunity Zones. It’s just stupid. The core of the Permian, the five best counties in the U.S. are all Op-Zones. So for me, just sort of strike me a $5 million check so I can go buy from Exxon and Shell and be done. That’d be my answer.
Jimmy: That’s a great one. Erik, finish us off here.
Erik: Well, for me, I just want to see clarity from the Biden ministration to say, “Yeah, we like these programs,” and it’s at least gonna stay the way that it was before and if not, we’ll extend and make it a little bit better. I like the program overall. And I think people are somewhat getting their arms around it, especially in the BDA IRA space. And Opportunity Zones are no longer a new thing. Now we’re the the 5:00 panel on Tuesday, right? We’re here. We’ve arrived.
Matt: Wow, that just said it all.
Jimmy: It was a great interview. I’ll throw in one suggestion, what I’d like to see. We’ve been talking about how the 10% benefit, the 15% benefit didn’t really move the needle very much. What if we made those benefits bigger? What if we made them 25% or 40%, something like that? That might be…
Matt: It sounds like a tax break for the rich to me.
Greg: Jimmy, it’s really easy. It’s called fair market value. You just update the fair market value and then you have a bigger discount.
Jimmy: That’s a good point there.
Greg: It’s an easy way to do it.
Jimmy: That’s a good point. It’s tough to market that though.
Matt: It’s like waving a red flag to the IRS. “Hey, we’re going to use minority and marketability discounts. Look at us.”
Erik: Another thing I would like if I had a magic wand is I’d like everybody to understand what no depreciation recapture means because explaining it over and over again is quite a task.
Jimmy: That’s one of the big hidden benefits of Opportunity Zones, I like to refer to it as. Well, we’ve got under five minutes to go. I do want to open it up for some questions. Yes, sir.
Audience: Just a very simple quick case. We had a client that purchased Home Depot 20 years ago at say 100 grand. It’s appreciated to a sum of 2 to 3 million. So that’s basically 90%, 95% gain. Is this something that would be a good OZ investor?
Matt: It’s like the ideal case study of who our investors are. Seventy-eight percent… But you still have to pay your taxes in ’26. And our different programs have different ways of doing refinance events or distributing capital prior to ’26 so that the investor can pay their taxes. Of course, nothing’s guaranteed and you can read the 80 pages of risk factors in my PPM.
But what I can say for our investors, 78% of our investors in our first fund, you know, we raised $131 million. Seventy-eight percent of our investors, the sale of stock was their capital gain spent. There’s never been like a safe harbor for the sale of stock for folks that don’t want to have to pay taxes like 1031s in real estate. So it’s absolutely…
Erik: So, right, his question was that…
Greg: Yeah, so let me repeat his question to everyone here. So his question is, a client who has a very large disparity between basis and value. So in his example, it was $100,000 basis, $3 million value. And then he’s obviously older, he’s held it for 20 years, we’re gonna assume he’s older. So he’s worried about is that, okay, one he’s going to have a tax bill in 2026.
And two, he’s worried about he would get a step up if he dies, unless Biden gets what he wants and gets rid of the step up when he dies. But is he giving up too much to get that? And the answer is always very simple. It’s, you don’t know the future, right? You don’t know what’s going to happen with this administration… the basis or where a state tax falls at 10 million or at a million. Nobody knows what’s going to happen from that perspective.
To me, it’s never a holistic answer. This is probably a partial solution, … works in a component, right? It’s almost like an installment sale. You’re selling a piece of it now, you’re going to defer that piece until 2026. Some of the programs will have refinance distributions. We provide the cash flow during the lifecycle that you’ll have more than you need for the tax bill, in just cash flow. You don’t even need to have anything else. So there’s just all kinds of answers. Would you sell 100% of Home Depot and put it in oil and gas? No, nuts. Like, period. Sorry. Yes. Yes, you should. No…
Matt: And you never get… three billion with an answer like that.
Erik: Yeah, exactly. I’m not. So I think the answer is it’s a great tax planning, right? You’re trying to move money into the tax free tax-deferred. All these different buckets. Yes, you’re worried a little bit about a step up loss. But you’re not asking for all three million bucks, right. Is it better if you do short-term gain? Of course. Is it better if you did recapture? Of course, because you know you’re at higher tax rates. So then you’re kicking that off for 6 years at 36%. So of course, it’s gonna be a little bit more…it’s easy to say you’re not gonna pay much more, even if rates went up, we’re gonna go from 32.9 or 39. It’s not a big deal.
Greg: And I’m just gonna add one quick thing… because I want to get to another question. But I think this is important to think about as well. We talk in terms of, you can’t do anything with this money for 10 years. So when you’re looking at this, I think you have to look at the program. So if I were in that situation, with what little we know, low basis, huge amount of gain. You need to look at these programs and say…let’s say you put it into seven single project deals, you need to really evaluate when is their liquid…it’s all about the liquidity. And then if he passes away at that time. The lights are really in our eyes so I can’t really see you, I just know you’re over there. I see a silhouette.
So what does that liquidity look like? You might be in seven different opportunities zone deals and in year three, two of them will refi and you’ll get money taken out year four with, let’s say, 3D or whatever the case may be. So you have to look at it from a judging standpoint, what’s the likelihood of him getting enough capital out to pay those taxes? So I don’t know, you could have another six million in the bank.
The other thing to think about is the…and this is really strange because people don’t really talk about it. What is the liquidity of Opportunity Zone fund during the 10 years? A lot of people don’t talk about that because we’re always like, “You have to hold it for 10 years.” But a case can be made that a fund can and should have a stout liquidity provision during the 10 years even though… Because we do have investors that may say in year five…we call it the 2Ds, death or divorce a lot of times, they have to get that cash out. And so you want to make sure…in my opinion, have a liquidity provision even though it triggers their capital gains tax. From a financial planner standpoint, that could make a lot of sense. So I look at it from a performance standpoint, a liquidity standpoint and then a quiddity provision standpoint in my opinion.
Matt: Yeah. In case Trump is reelected, those capital gains is zero. So you don’t want to be totally locked up.
Jimmy: We’ve run out of time. If you do have any other questions, come up and just talk to us. We won’t bite. We’ll hang around for a few more minutes. But wanted to make sure you get to the cocktail hour, and we’ll see you there. Thank you very much. And thanks to our panelists. Thanks guys, appreciate it.