Presenting a live 90-minute webinar with interactive Q&A. Today s faculty features:

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1 Presenting a live 90-minute webinar with interactive Q&A Qualified Opportunity Zones and Tax Credits: New IRS Guidance, Capital Gain Deferral Mechanisms Under Section 1400Z IRC 45D(e) Requirements, Step-Up in Basis, Appreciation Exclusion, Tax Planning Strategies for Investors and More WEDNESDAY, JANUARY 23, pm Eastern 12pm Central 11am Mountain 10am Pacific Today s faculty features: Alan M. Blecher, JD, Principal, Marks Paneth, New York Elizabeth C. Crouse, Partner, K&L Gates, Seattle Michael I. Sanders, Partner, Blank Rome, Washington, D.C. The audio portion of the conference may be accessed via the telephone or by using your computer's speakers. Please refer to the instructions ed to registrants for additional information. If you have any questions, please contact Customer Service at ext. 1. NOTE: If you are seeking CPE credit, you must listen via your computer phone listening is no longer permitted.

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5 Qualified Opportunity Zones and Tax Credits Presented by: Michael I. Sanders January 23, :00 2:30 PM ET Strafford Publications 2018 BLANK ROME LLP. ALL RIGHTS RESERVED. PLEASE CONTACT BLANK ROME FOR PERMISSION TO REUSE.

6 INTRODUCTION INTRODUCTION Steven Mnuchin, Treasury Secretary, announced that the OZF legislation will prompt $100 billion in private investment in low income communities to reinvigorate dozens of cities, 8700 designated zones, covering 12 percent of the United States, and 35 million people BLANK ROME LLP. ALL RIGHTS RESERVED. PLEASE CONTACT BLANK ROME FOR PERMISSION TO REUSE.

7 EXAMPLE: Angel investor sells high tech securities generating $10 million in capital gains Tax Act allows individuals and corporate investors to defer capital gains on the sale of stock business assets or other property (wherever located) by investing in a qualified opportunity zone (which must invest at least 90 percent of its assets, directly or indirectly in businesses located in designated opportunity zones (i.e., low income communities). The proceeds must be invested within 180 days beginning from the initial sale or exchange in the amount equal to the gain to be deferred. Moreover, there is partial forgiveness of the deferred capital gain if held for 5 or 7 years until 2026; and furthermore, any future gain on the investment in an opportunity fund may be excluded if the investment is held for 10 years BLANK ROME LLP. ALL RIGHTS RESERVED. PLEASE CONTACT BLANK ROME FOR PERMISSION TO REUSE.

8 The deferred portion of the gain is taxable when the investment in the opportunity fund is sold or, if later, on December 31, 2026 unless the date is subsequently extended by Congress. So if the opportunity fund investment is held for 10 years, the tax basis of the new investment is deemed to be its fair market value on sale. In effect, further appreciation on the investment, but not the deferred gain, is eliminated permanently. It is important to note that the original property sold need not be located in or connected in any way with a qualified census tract BLANK ROME LLP. ALL RIGHTS RESERVED. PLEASE CONTACT BLANK ROME FOR PERMISSION TO REUSE.

9 October, 2018, the Treasury Department issued additional guidance for the Opportunity Zone (OZ) incentive program. Specifically the Treasury Department issued a set of proposed regulations and a revenue ruling, both of which can be relied on by taxpayers. In addition to the proposed regulations and the revenue ruling, the Treasury Department also provided a draft Form 8996, the self-certification form for Qualified Opportunity Funds (QOFs), and corresponding instructions for the form BLANK ROME LLP. ALL RIGHTS RESERVED. PLEASE CONTACT BLANK ROME FOR PERMISSION TO REUSE.

10 Although the additional guidance answers many questions that investors and practitioners have about the OZ incentive program, there are still a number of unanswered questions (some of which the Treasury Department is soliciting additional comments on), which we expect will be addressed in additional tranches of guidance issued from the Treasury Department BLANK ROME LLP. ALL RIGHTS RESERVED. PLEASE CONTACT BLANK ROME FOR PERMISSION TO REUSE.

11 The OZF alternative is a remarkable opportunity for high net worth individuals to defer gain (such as $10 million in the example above) and subsequently exclude further gain based upon the appreciation of their investment in an opportunity zone. Moreover, and most important, it allows and incentivizes investments in qualified census tracts. Another benefit, increased value for real estate located in an Ozone; sales activities have picked up in OZs (See WSJ). Advice: Don t wait on sidelines. But many unanswered questions still remain: BLANK ROME LLP. ALL RIGHTS RESERVED. PLEASE CONTACT BLANK ROME FOR PERMISSION TO REUSE.

12 ADDITIONAL QUESTIONS (SUBJECT TO ISSUANCE OF IRS GUIDELINES) What types of gains are eligible for reinvestment in a QOF? If I invest non-gain capital in a QOF, am I eligible for the ten-year exclusion benefit? Who is the taxpayer eligible for gain deferral? In a partnership context, do the proposed regulations allow flexibility as to the election to exclude gain for the partners? Does a taxpayer have to invest in a QOF by the end of 2019 in order to qualify for the full 15% basis increase? If I hold my QOF interest for ten years, at which point the QOF sells its assets and redeems my investment, is my allocable share of the gain with respect to such sales subject to tax? Or, do I actually have to sell my interest in the QOF in order to receive the ten-year exclusion benefit? BLANK ROME LLP. ALL RIGHTS RESERVED. PLEASE CONTACT BLANK ROME FOR PERMISSION TO REUSE.

13 Is there a grace period for a QOF to invest cash from an investor? Does residential rental property qualify as a qualified opportunity zone business? Is there an objective standard for active conduct of a trade or business? What constitutes a substantial portion of the intangible property used in the active conduct of a trade or business in the qualified opportunity zone? BLANK ROME LLP. ALL RIGHTS RESERVED. PLEASE CONTACT BLANK ROME FOR PERMISSION TO REUSE.

14 How is leased property of a QOZB or QOZBP to be treated? What constitutes a reasonable period for a QOF to reinvest proceeds from the sale of qualifying assets? Can property be aggregated at the QOZB level for purposes of determining whether the QOZB satisfies the substantial improvement test? BLANK ROME LLP. ALL RIGHTS RESERVED. PLEASE CONTACT BLANK ROME FOR PERMISSION TO REUSE.

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16 Opportunity Zones: The Guidance (So Far) Elizabeth Crouse, K&L Gates LLP Copyright 2018 by K&L Gates LLP. All rights reserved.

17 The Guidance Notice : Designations REG : First round of Proposed Regulations Revenue Ruling : Land; substantial improvement Draft Form 8996: QOF election, annual filing December 2018 Executive Order: Order to agencies to facilitate klgates.com 17

18 Topics addressed to date How to become a QOF How to invest in a QOF How a QOF must invest its capital How to dispose of OZ investments The difference between original use and substantial improvement of QOZB property klgates.com 18

19 How to become a QOF Partnership or corporation Organized in the 50 states or DC Organized in possession if investment in possession Election before funding klgates.com 19

20 How to become a QOF klgates.com 20

21 How to invest in a QOF Recognize capital gain and invest it in equity issued by an entity that has already elected to be a QOF. How much gain? Whose gain? An eligible taxpayer is a person that may recognize gains for purposes of Federal income tax accounting. an eligible taxpayer may elect to defer recognition of some or all of its eligible gain Allocations of capital gain from partnership, RIC, REIT klgates.com 21

22 How to invest in a QOF How must the gain be generated? Rollovers When must investment be made? klgates.com 22

23 How to invest in a QOF What does taxpayer get in exchange? Basis Deferred gain portion Additional investment QOF s leverage? Preservation of tax attributes on deferred gain Gain deferral: earlier of sale or 12/31/2026 Deferred gain reduction: 5 or 7 year holds Gain elimination on QOF investment: 10 year hold klgates.com 23

24 How a QOF must invest its capital Substantially all 90% invested in QOZ property QOZB property QOZB equity Partnership or corporation Organized in the 50 states + DC Organized in a possession if investment in possession 70%+ of QOZB property must be qualified Newly issued equity Tax consequences of QOF s disposition of assets? klgates.com 24

25 How a QOF must invest its capital Compliance QOF measurements QOZB measurements Working capital safe harbors 1397C(b) requirements: active trade or business klgates.com 25

26 How to dispose of OZ investments Partial disposition Allocation methods: FIFO or pro rata 100% disposition Rollovers 10 year holding period to eliminate gain Election through 12/31/2047 Mixed investments require tracking klgates.com 26

27 Impact on structuring Opportunities vary by industry Technical impediments Everyone Basis limitations What is QOF/QOZB s basis in its assets? What is an active trade or business? Natural persons: at-risk, PAL Practical impediments Location, location, location Fund management klgates.com 27

28 Structuring opportunities QOF+, QOF++ models Nonrecourse leverage Split the baby Renewables models Creative management solutions klgates.com 28

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30 Section 1400Z-2 Opportunity Zones Selected Tax Accounting Issues January 23, 2019 Al Blecher, JD MARKS PANETH 30

31 Selected Tax Accounting Issues Many of the tax accounting issues in the QOF arena arise due to the uncertain intersection of new Section 1400Z-2 with the long established partnership tax accounting rules The guidance regarding basis adjustments to QOF partnership interests is limited and does not always dovetail neatly with the partnership tax rules Under the general partnership tax accounting rules, a partner s basis in its partnership interest is equal to the partner s initial capital contribution to the partnership, and is subsequently increased by its distributive share of the partnership s income and decreased (but not below zero) by distributions by the partnership to the partner and the partner s distributive share of the losses of the partnership Section 752 provides that if the partnership incurs debt, the partner s share of the debt allocated to it under the special rules pertaining to such allocations is deemed to be a contribution by the partner to the partnership; a decrease in the amount of debt allocated to the partner is deemed to be a distribution by the partnership to the partner 31 MARKS PANETH MARKS PANETH 31

32 Tax Accounting (continued) However, the QOF rules state that except as otherwise provided therein, the taxpayer s basis in its eligible-gain investment shall be zero The statutory otherwise provided exceptions to the zero basis rule are that basis is increased by 5-year, 7-year, December 31, 2026 and 10-year sale adjustments but other basis adjustments otherwise available appear to be excluded The proposed regulations provide that the Section 752 partnership basis increase is not a partner contribution of money that is subject to the mixed investment bifurcation rules for non-gain QOF investments The proposed regulations suggest that the Section 752(a) tax basis increase is allowed for other tax purposes, which may permit a QOF to allocate tax losses to the QOF investors to the extent of said debt 32 MARKS PANETH MARKS PANETH 32

33 Tax Accounting (continued) Under general partnership tax accounting rules, when a partner s basis is increased due to the allocation of partnership debt, and this leveraged basis is used to support the deduction of partnership losses, such cumulative leveraged losses are recaptured into income via the inclusion of the liabilities in the amount realized upon the disposition of the partnership interest Selected Tax Accounting Issues: Does the special rule regarding the exclusion of gain for QOF interests held for at least 10 years exclude not only the gain on the QOF partner s eligible gain interest appreciation but also eliminate the recapture of cumulative leveraged losses? Does the initial zero basis rule also require a zero basis in the eligible-gain QOF investment when the QOF partnership later has undistributed taxable income or incurs debt? Does the initial zero basis rule mean that the QOF takes a zero basis in the assets that the QOF holds? 33 MARKS PANETH MARKS PANETH 33

34 Tax Accounting (continued) How does the single basis rule of Rev. Rul ( a partner has a single basis in a partnership interest ) apply in the context of a mixed-fund investment in a QOF? Can an eligible-gain investor in a QOF partnership be allocated losses if it has no noneligible gain interest and no Section 752-derived debt basis? If a partner purchases an interest in a partnership that has previously made a QOF investment, can the new partner reduce its share of the partnership s gain recognized in 2026 via a Section 743(b) step up? Comparing the tax treatment of a QOF s disposition of a QOZBP vs the sale of an eligible-gain QOF partnership interest, in light of the apparent purpose of the QOZ provisions 34 MARKS PANETH

35 If a sponsor invests gain dollars in a QOF for a 1% interest and has a carried interest in the QOF such that their 1% interest flips to 20% upon a capital event, is the carried interest eligible for forgiveness assuming a 10-year hold? If a QOF or a QOZB partnership were to refinance its property upon stabilization and make a debt financed distribution to a QOF partner that reduces their investment, does the distribution trigger an end to the deferral period? BLANK ROME LLP. ALL RIGHTS RESERVED. PLEASE CONTACT BLANK ROME FOR PERMISSION TO REUSE.

36 With regard to the nonqualified financial property safe harbor, that is, the 31-month working capital rule, how is the taxpayer to designate property? What happens if a taxpayer plans to purchase properties A and B, and instead, purchases property B and C for a similar amount? Is this substantially consistent? Since the new entity doesn t have to be a QOZB at the time the QOF invests and only has to be a QOZB for substantially all of the QOF s holding period, does this imply that a new business has time to become a QOZB? (Treasury should provide a grace period of perhaps 2 years time in order to meet the QOZB test.) BLANK ROME LLP. ALL RIGHTS RESERVED. PLEASE CONTACT BLANK ROME FOR PERMISSION TO REUSE.

37 With regard to the use of intangible property, the requirement with respect to any taxable year is that a substantial portion of the intangible property of a QOZB is used in the active conduct of a trade or business in the qualified opportunity zone. In this context what does substantial mean? A secondary issue concerns whether the intangible property needs to be located in a qualified opportunity zone, i.e., the situs BLANK ROME LLP. ALL RIGHTS RESERVED. PLEASE CONTACT BLANK ROME FOR PERMISSION TO REUSE.

38 Is it better to invest in OZBP directly or Indirectly? I own property located in a QOZ that I purchased in 2017 is there a way to have the property transferred to the QOF that I am sponsoring? If my QOF acquires 10 acres of vacant land and intends to substantially improve it with a single high-rise multifamily tower, will all of the land be deemed substantially improved (assuming the basis addition requirements of the substantial improvement test are otherwise satisfied)? BLANK ROME LLP. ALL RIGHTS RESERVED. PLEASE CONTACT BLANK ROME FOR PERMISSION TO REUSE.

39 If my QOF intends to satisfy the substantial improvement test with respect to property it acquires, does the project need to be placed into service within 30 months after acquisition? I really do not like limited partnerships can I form my QOF as a limited liability company? Is it better to be a corporation or a partnership QOF? I understand that the first measuring date for the 90% asset test is on the last day of the first six-month period of the taxable year of my QOF but what if my QOF is formed after July 1 such that the first sixmonth period after formation straddles into the following taxable year? BLANK ROME LLP. ALL RIGHTS RESERVED. PLEASE CONTACT BLANK ROME FOR PERMISSION TO REUSE.

40 I understand that cash is considered a bad asset for purposes of the 90% asset test how long do I have to deploy cash contributed to my QOF into good assets? If I have a single sale that produces $10m of gain, can I diversify my reinvestment by investing $1m into ten different QOFs, or am I only limited in making the deferral election with respect to one QOF? If I intend to qualify my investment vehicle as a QOF but later determine it is not possible to satisfy the 90% asset test, can I simply withdraw my QOF certification in order to avoid the imposition of monthly penalties? If a QOF investor dies before the end of the deferral period, is the deferred gain exempt from tax? BLANK ROME LLP. ALL RIGHTS RESERVED. PLEASE CONTACT BLANK ROME FOR PERMISSION TO REUSE.

41 If I fail to reinvest gain into a QOF within 180 days of the date of the transaction that produced such gain, is there any relief? I understand a taxpayer has zero basis in their deferred gain invested in a QOF. Does this mean that a Fund or QOZB also have zero basis in the portion of assets sourced with this investment and therefore no depreciation benefits? BLANK ROME LLP. ALL RIGHTS RESERVED. PLEASE CONTACT BLANK ROME FOR PERMISSION TO REUSE.

42 PAIRING OPPORTUNITY ZONE INCENTIVES WITH NMTCS PAIRING OPPORTUNITY ZONE INCENTIVES WITH NMTCS Build on the initial deferral technique by investing in OZF. Through the NMTC structure, the investor can take advantage of the leveraging structure and generate tax credits over a 7 year period. So not only can the capital gains be deferred for a 9 year period, including an increase in basis with partial forgiveness after 5 and 7 year holding period, but the taxpayer can receive incremental benefit through the tax credit regime. Investor likely to be C Corporation in view of the AMT, which was retained as to individuals BLANK ROME LLP. ALL RIGHTS RESERVED. PLEASE CONTACT BLANK ROME FOR PERMISSION TO REUSE.

43 Sufficient basis needed to absorb the required NMTC basis adjustment. Accordingly OZ deferral election will be limited to the QEI less the sub CDE fees and the NMTCs that are generated. It is important to note that QALICB must also be a qualified opportunity zone business (which should be relatively easy to accomplish in view of the similarities of the programs) BLANK ROME LLP. ALL RIGHTS RESERVED. PLEASE CONTACT BLANK ROME FOR PERMISSION TO REUSE.

44 Sub CDEs will need to obtain the status of a QOF, however, may now self-certify. The QLICIs need to be an equity investment under the OZ rules; as a result, the investors may not be able to rely on the reasonable expectation safe harbor test (affects issuance of tax opinions). Existing CDEs may need to get approval from CDFI Fund if the making equity QLICIs is not consistent with their approved business strategy BLANK ROME LLP. ALL RIGHTS RESERVED. PLEASE CONTACT BLANK ROME FOR PERMISSION TO REUSE.

45 USE BY TAX EXEMPT ORGANIZATIONS: WIN-WIN USE BY TAX EXEMPT ORGANIZATIONS: WIN-WIN Opportunity Funds may be purchased and sold similar to mutual funds. A fund could invest in all aspects of mixed use development in designated qualified census tracts beneficial to low income exempt organizations. It incentivizes urban renewal as well as rural development, allowing developers to create and expand communities with new multi-family housing and retail venues. It may also attract angel investors and incubators, along with venture capitalists thereby attracting companies to locate in opportunity zones, where after a 10 year hold, a liquidation may generate millions of dollars in capital gains with permanently exclusion from taxation BLANK ROME LLP. ALL RIGHTS RESERVED. PLEASE CONTACT BLANK ROME FOR PERMISSION TO REUSE.

46 There are many reasons why a nonprofit should form joint ventures or a for-profit subsidiary to directly partner with the OZF, to operate in the designated low income high unemployment zones, consistent with its exempt function. Because the law favors new businesses, new construction, start-ups and incubators may be motivated by the incentives. Thus, an opportunity fund could operate or fund a new technology or healthcare business in the zone. A successful tech start-up could experience significant growth over a decade, allowing the investor a large permanent exclusion from taxation. Community healthcare and food deserts are also sorely needed in many lowincome communities, and walk-in clinics and urgent care facilities, already growing in popularity, may also be attractive projects for opportunity funds BLANK ROME LLP. ALL RIGHTS RESERVED. PLEASE CONTACT BLANK ROME FOR PERMISSION TO REUSE.

47 PRELIMINARY STEPS IN FORMATION OF OPPORTUNITY FUND PRELIMINARY STEPS IN FORMATION OF OPPORTUNITY FUND 1. Formation of Opportunity Zone Fund (OZF) as a corporation or a partnership for purposes of investing in Qualified Opportunity Zone Property ( QOZF ): use of an LP/Query: will an LLC qualify as a OZF? 2. General Partner of the LP: formation of the limited liability company; operations of OZF. 3. Management Company: formation of the limited liability company that will act as a management company; fee structure Terms of the Investment Management Agreement. Confirmation of designation as QCT by Governors, approved by Treasury BLANK ROME LLP. ALL RIGHTS RESERVED. PLEASE CONTACT BLANK ROME FOR PERMISSION TO REUSE.

48 6. Self-certification of OZF based upon IRS Frequently Asked Questions. To self-certify, a taxpayer merely completes a form (to be released in summer of 2018), which is attached to taxpayer s federal income tax return. 7. Preparation of OZF Business Plan (reviewed by counsel), including land and building acquisition, timing. 8. Draft of private placement memorandum. 9. Draft of the Subscription Agreement. 10. Review of exemptions under the Securities Act, state blue sky laws, and the Investment Advisers Act BLANK ROME LLP. ALL RIGHTS RESERVED. PLEASE CONTACT BLANK ROME FOR PERMISSION TO REUSE.