OZ Strategies For High Net Worth Investors, An OZ Pitch Day Panel

In this panel from OZ Pitch Day Spring 2022, a trio of experts discuss the various strategies that investors can use to optimize the tax efficiency of their portfolios.

This episode is the audio version of an OZ Pitch Day Spring 2022 panel titled, “Opportunity Zone Strategies for High Net Worth Investors.” The panel was moderated by OpportunityDb founder Jimmy Atkinson. Panelists: Jay Frank, Rob Johnson, and Scott Hawksworth. Recorded live on March 29, 2022.

Click the play button above to listen to the audio recording of the panel.

Or, for the video recording, click here.

Episode Highlights

  • The ongoing disconnect between housing supply and demand that will likely persist for years to come, and how that creates an opportunity for high net worth investors.
  • The relative merits of 1031 exchanges compared to Qualified Opportunity Funds.
  • Scenarios where Opportunity Zones may be particularly attractive — and other scenarios where the clear preference may be for a 1031 exchange.
  • How depreciation can have a major impact on returns realized in OZ investments.
  • Live Q&A with webinar attendees.

Featured On This Episode

Video Recording

Industry Spotlight: OZ Pitch Day

The OZ Pitch Day Spring 2022 was a live online event designed to match investors who have capitals gains with Qualified Opportunity Funds that are seeking capital. Investing within the 180-day window is of crucial importance for OZ investors.

Learn More About OZ Pitch Day:

About The Opportunity Zones Podcast

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

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Show Transcript

Jimmy: Well, today’s panel is Opportunity Zone investing or Opportunity Zone benefits for high-net-worth investors. My three panelists here today, I’m gonna introduce them very briefly. We only have 20 minutes, so it’s gonna be kind of rapid-fire. But Jay Frank, joining us from Santa Monica, California. He’s president of Cantor Fitzgerald capital and co-head of their real estate investment management business. Scott Hawksworth joining me here today from Chicago, Illinois. He’s co-founder of MultifamilyInvestor.com and host of the “Multifamily Investor” podcast, which is a resource for passive high-net-worth real estate investors. And Rob Johnson also joining us today. He’s here from Austin, Texas. Rob is head of wealth management for Realized. They’re a platform for investment property wealth management, and they specialize in 1031 DSTs and, of course, opportunity zones. So, gentlemen, I wanna start with Scott Hawksworth first.

And Scott, the reason why I wanna start with you is because multifamily is by far and away the most popular sector for Opportunity Zone investing. In fact, 9 of the 12 Qualified Opportunity Funds that are partnering with us on today’s event are multifamily funds, or at least have a very strong multifamily component. So, Scott, why do you like multifamily as an asset class for high-net-worth investors?

Scott: Yeah, thanks, Jimmy. I like multifamily as an asset class for a number of reasons, but I think the biggest reason is we have an ongoing housing shortage in this country. We are underbuilt, and that creates tremendous opportunity for high-net-worth accredited investors. And that kind of underlines what you were just mentioning about the number of funds that have multifamily. And there’s a statistic that I like to point out here, and I have it right here. And this is according to a recent report from the National Association of Realtors. We have an underbuilding gap of 5.5 to 6.8 million housing units. And that has been ongoing since about 2001. So, again, that’s a mismatch between supply and demand. And so there are these funds that are addressing this issue. But even with all of that activity, the demand is not going away, and the supply is just not meeting it. And you see this all over the country. So, I think when we’re talking about the opportunity for return, it’s really tremendous. And that’s why I like multifamily.

Jimmy: Good. Let’s turn to Rob next. A lot of real estate investors traditionally are very familiar with 1031. It’s been a traditional tax advantage vehicle for high-net-worth real estate investors for decades and decades and decades. Can you compare and contrast the section 1031 exchange with Opportunity Zones? What do investors need to know?

Rob: Yeah, no, that’s a great question. So, we get that frequently from clients who could go either way, and they’re gonna evaluate the considerations and upsides of doing one or the other. So, let’s talk about the eligible gains. With a QOZ Fund, any capital gain, regardless of the asset that generated, that gain can go into a QOZ Fund. For a 1031 exchange, it’s limited to gains from real property held for investment or used in a trade or business. So, it’s extremely clear. One is real estate-based. The other one is gonna be any capital gain. The reinvestment of proceeds. What’s nice about the QOZ Fund is you’re only going to reinvest the capital gain. You can reinvest the basis, but it’s not gonna receive the tax benefits. So, quite honestly, we discourage a client from doing that. In the 1031 exchange, you have to reinvest all proceeds, both your basis and the gains. And you have to have the same, or greater amount of debt through the 1031 exchange. So, there are some IRS policies that have to be followed.

The time to reinvestment with the QOZ Fund. You have 180 days, and the gain must be triggered on or before December 31st of 2026. With the 1031 exchange, the time constraints can be very onerous. You’ve got 45 days after the sale of that property to identify what your replacement is gonna be, and then 180 days to reinvest. But you are stuck with what you identify in that 45-day period. So, if you, you know, identify something you don’t close on, it’s gonna blow up your exchange. The replacement asset Qualified Opportunity Zone Funds. You’re gonna invest 90% of the assets in the QOZ property. Real property must be like-kind. So, the IRS is gonna keep a very close eye on what exactly you use to replace that property, and it has to be the real property designation underneath the IRS.

Location of replacement asset. Obviously, the QOZ is in an Opportunity Zone. It has to be designated by the census. With the 1031 exchange, you could pretty much go in any U.S. state and region that you want. Qualified intermediary, or QI, or an exchange accommodator is gonna be required for 1031 exchange. They have to hold the money. If you don’t pass the proceeds onto them from the sale of the property, you’ll blow up your 1031 exchange. You don’t need a QI in a QOZ transaction. Minimum holding period, the QOZ, at least 10 years to achieve the maximum tax benefit. With the 1031 exchange, it’s really gonna be when… You have to have it for a minimum, in most cases due to IRS policy in terms of a hold. But after that, you can exit when you find a potential buyer for the property. And the tax on the gain generated by the replacement asset for the QOZ, it’s eliminated if held for 10 years, maybe eliminated upon the investor’s death. With the 1031 exchange, it’s due upon the sale of the asset, but they also can qualify with the step-up basis. So, those are the main differences with the QOZ versus the 1031.

Jimmy: Yeah, no, that was a great breakdown, Rob, very, very in-depth, very detailed. Jay, kind of want you to kind of take that and keep going here, comparing and contrasting OZs with 1031s. Jay, Cantor Fitzgerald, I know you have a lot of high-net-worth accredited investors that you advise on this situation all the time as well. And, you know, just like Rob does. How often for you do you find that an Opportunity Zone investment is better than a 1031? And when should investors selling real estate really consider OZs as opposed to…or as a replacement for 1031?

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Jay: Yeah. Great. And nice job, Rob. I’m happy to pick up where you left off there. Section 1031 in the tax code has a lot of complexities to it, right? And you should be talking to at first, at a minimum, your CPA or tax attorney, maybe your state planning attorney, and probably a financial advisor. Opportunity Zones to take that complexity to the next level. So, you know, to the nth degree, there should be that team involved in the process because when you are making a decision between one or the other, or don’t forget, you can also invest in both simultaneously. It’s not always opportune, but you can. There’s a lot of different considerations, not just in terms of the investment return, investment time period, horizon, you know, income versus growth when you’re gonna get the returns, etc., like Rob was touching on, but also it has to do with the client’s personal situation. What account that they’re holding it in? The estate planning needs. What tax bracket they’re in? What state do they live in? There’s a whole bunch of, you know, economic considerations, but then there’s a whole bunch of human considerations that go into this.

The general rule that we refer to when you’re kind of comparing a 1031 to an OZ, obviously, only for someone selling investment real estate is when they both are in play. If an OZ tends to be preferred when the client has a basis in the proper they’re selling and/or a little debt. So the more basis they have, the less amount of debt they have, the more the opportunity that it’ll be attractive. So, Jimmy, you bought some land in Dallas, a $ 1 million dollars, it’s land, so you don’t have depreciate it. So, your basis is a $1 million. A few years later, you sell it for a $1.5 million and you have no debt. If you do a 1031 exchange, all $1.5 million would need to go in the exchange to defer a 100% of your taxes. With an Opportunity Zone, you’d be able to take the million dollars of basis out tax-free, put it in your pocket, diversify it. And only the $500,000 of capital gain would need to go into the Opportunity Zone Fund to defer a 100% of your tax liability. So, in that situation, I’d say 90% plus of the time, an investor that’s informed and has good advice, would be looking at an Opportunity Zone.

On the flip side, the other bookend where a 1031 tends to be superior is when the lower the amount of basis the client has, often zero basis, and the more debt they have on the real estate property they’re selling tends to be when the 1031 is superior. And the reason why is, example, Jimmy, you bought a rental property in Dallas for a million bucks, you sold it for a $1.5 million. However, you owed it for 30 years, you’ve depreciated it to zero and you have a million-dollar loan on the property. If you were to put your money in 1031, you simply need to take the $1.5 million and complete the exchange. You defer all your taxes. To do an OZ and defer all your taxes, you’d have to first take your $1.5 million and pay off a million-dollar loan to the bank. You’d have a $500,000 left over to invest in the OZ. Then, you’d have to come up with another $1 million out of pocket to invest in the OZ to address your deferred and recapture depreciation tax. So, it really depends on the client situation, both economic considerations, but also human considerations. And it’s a small amount of time, but there are times when you can use a combination of 1031 exchanges and Opportunity Zones on the same transaction.

Jimmy: Great. I think that was an awesome breakdown that both you gentlemen gave. Jay and Rob, thank you so much for that. I think that’s helpful to a lot of investors on the call today who have familiar with 1031s, maybe they’re starting to learn about OZ. Always good to compare and contrast those two programs. I wanna pulse Scott back in, give him another question about multifamily. That’s his area of expertise. So, Scott, you know, just kind of looking at the world at large over the past 24 months or so, we’ve really been in a period of a lot of economic uncertainty with the COVID pandemic and the resulting recession, the imbalance in the labor market. And now the war in Ukraine is kind of making everybody a little jittery, a little bit more uncertain. Do you still like multifamily during this period of economic uncertainty?

Scott: Absolutely. I think it really gets down to the basic fact that everybody needs a home. They need to live somewhere. And multifamily really addresses this need. And then when you look at it at the real estate sector and where it fits traditionally, multifamily has been among the most resilient. So, does well in terms of generating returns in periods of economic expansion and in times of economic uncertainty, or even recession, multifamily has performed well. And I would also say, as you’re kind of looking back through it, we’re coming out of COVID-19, it’s also created a lot of shifts in lifestyle, and work from home, and all of that. And so that really is attractive to a lot of potential renters and has really driven up the need for that housing and for their expectations on amenities and having quality housing and really having folks really reevaluate the four walls that they’re spending their time in. So, I think, for me, even in a climate of economic uncertainty, multifamily is still something I’m very bullish on.

Jimmy: And regularly tying it back into Opportunity Zones and Opportunity Zone investing, multifamily is where it’s at typically for the types of real estate assets that we see, you know, I think, more than half. According to the most recent Novogradac survey, more than half of the capital raised, data’s been going into funds that have, at least some sort of strong residential or multifamily component. And, you know, bringing it into the Opportunity Zone communities really gives investors a chance to do well by doing good, not only are they providing much-needed housing for this country but also they’re doing it in the areas that need it most, these traditionally underserved economically downtrodden communities.

Jay, let’s bring you back in now. Just one more question for Jay and Rob. We gotta wrap things up here pretty quick. But, Jay, why are we seeing more real estate gains from investment properties going into Opportunity Zones? And in your experience, maybe I’m kind of giving away the answer, I’m leading the witness here a little bit, but does the average financial advisor know enough about Opportunity Zones to properly advise high-net-worth investors their clients on that option of OZ investing?

Jay: No, you got it. And it’s not just the financial advisor, it’s fill in the blank advisor, you know, legal advisor, tax advisor, financial advisor, you know, spousal advisor, whatever it is. Many people just are ignorant to the opportunity. I would also add that people miss one of the key elements that make Opportunity Zone viable for real estate changes, which is, it’s not just the capital gain from this sale of an investment property that can be invested in the OZ in realized the tax benefits. It is also the unrealized depreciation expense. At least the straight-line portion of it, is also eligible. And that key element is what… So, if you had, you know, again, a $500,000 gain and $700,000 depreciation recapture expense, most people think, “Well, I can invest a $500,000 million. I have to pay taxes on the $700,000.” They don’t realize that all $1.2 million could go to get all the tax benefits.

Another thing about depreciation is, remember you’re building brand new properties, which means you have a full depreciable schedule. You can be using, you know, multifamily as a shorter depreciable life than most, again, a bonus there. You can be using cost segregation, component depreciation to really accelerate depreciation, and you can be using bonus depreciation, which was also part of the same Tax Cuts and Jobs Act that created the OZ program. Meaning, said in another simple way is there is so much depreciation that can be passed through in the first 7, 10-year useful life of these assets that the amount of taxable rental income, the investors are gonna be received from these things are probably zero or very close to it. So, there’s two ways that people are unaware of how depreciation plays in and can benefit from the OZ program, A, can be invested in the program, but B, all the appreciation from the program is also gonna be tax-free, assuming you hold it for the required period of time.

Jimmy: Terrific. Yeah, no. Great points there, Jay. Thank you. That’s really interesting about the depreciation as well there. Rob, I’m gonna leave you at the final word here. We gotta cut you guys loose here in a couple minutes. I got my next presenter coming on at 35 after the hour here. But Rob, looking at the future here, I’m gonna turn to you. Opportunity Zones in 2022 and beyond. You know, we’ve gone through that expiration of the 10% basis step-up at the end of last year. So, we’re kind of looking forward to the future program over the next, you know, four-plus years when it is scheduled to sunset. How do you view that opportunity today and going forward, and any additional thoughts or insights you have on opportunity zones?

Rob: Yeah, I mean, I would say that it’s taken too long, in my opinion, for investors to make full use of the Qualified Opportunity Zone opportunity. It got off to a little bit of a slow start. We’re seeing a lot of investors utilize it now for the right reasons, not just for deferral but for planning, long-term planning, retirement, estate planning, things that we normally would use with more traditional investments. They’re benefiting from a Qualified Zone Fund and investment in that manner. So, I hope more individuals are aware of the opportunity that this provides. And my hope is also that the government, as the years go on, understands the benefit of reinvesting in challenged communities, challenged areas, and the benefit that can lead to our society, communities, education growth, you know, the ability to live in a community that’s safe and leads to, you know, better society. So, I hope that the opportunity continues from a legislative purpose.

Jimmy: Agreed. And with any hope, fingers crossed, we’ll get this thing extended at some point. Well, I’m gonna end this session there. Hopefully, that was helpful for you as a high-net-worth investor. Some of the options you have and some of the considerations you should make when contemplating an Opportunity Zone investment, especially with you’re comparing it with a section 1031 exchange, and especially if you’re a multifamily investor. This has been Jay Frank with Cantor Fitzgerald, Scott Hawksworth with multifamilyinvestor.com, and Rob Johnson with Realized. I’m gonna cut you gentlemen loose here and demote you to participants again, but thank you for attending today. Appreciate it.

Scott: Thanks, Jimmy.

Rob: Thanks, Jimmy. Thank you, gentlemen.