While the government shutdown is holding up the public hearing, we feel it may be instructive to continue to dig into the comment letters submitted on the proposed Qualified Opportunity Zone legislation. One early takeaway was that several real estate industry groups submitted letters, and we wanted to summarize the comments made by those groups because they may be the most relevant to real estate developers as they navigate the evolving regulations regarding Qualified Opportunity Zones and Qualified Opportunity Funds.
The comments submitted by these groups generally supportive of the real estate industry to increase capital flows for investment in Qualified Opportunity Funds, Qualified Opportunity Zone Businesses and Qualified Opportunity Zone real estate development (and redevelopment) projects by easing structural and technical aspects of the proposed regulations and increasing flexibility and requesting clarification in many important key areas.
Here are the key positions shared among the real estate industry:
- Existing owners should not be excluded by forcing them to sell the property they already own to participate. There should be some mechanism for an existing owner of a property inside a Qualified Opportunity Zone to either individually or with investors develop or redevelop an asset to take advantage of the program. At the very least, those who purchased a property prior to 2018 but broke ground after December 31st, 2017 should be able to qualify.
- Properties which have been vacant for more than a year should qualify as long as they are put back into service, whether through demolition or redevelopment. The intent of the program is to reintroduce economic activity to depressed areas, and certain assets may not meet other tests, however simply bringing them back into service is a move in the right direction.
- Qualified Opportunity Funds and their investors should be able to freely transact within the confines of Qualified Opportunity Zones such that selling a Qualified Opportunity Zone asset and investing in another one doesn’t trigger tax consequences for a Qualified Opportunity Fund and likewise investors should be able to sell interests in one Qualified Opportunity Fund and invest in another freely. This creates liquidity in the market and increases the amount of capital that the program can attract.
- There should be some mechanism for the small number of highly complex or very large projects to extend the Working Capital Safe Harbor and Substantial Improvement timelines. Real estate development is an uncertain process and frequently relies upon approvals from multiple governmental entities. It also tends to suffer unforeseen roadblocks throughout the process from any number of stakeholders, not to mention potential environmental surprises or natural disasters.
- Investors sourcing capital gains from structured investments need some way to comply with timing rules. Many investments can be sold mid-year but the allocation between capital gain/loss and ordinary gain/loss are not calculated until the end of the year (or tax year). Therefore investors in these products are almost certainly prevented from investing in Qualified Opportunity Funds because of the timing restrictions.
- Returning the initial invested capital to investors through debt refinancing should not create tax consequences. If returning the initial capital investment to investors disrupts the tax benefits to the investor taking the distribution, other investors in the fund, or the fund itself, it will force the Qualified Opportunity Funds to be unnecessarily complex and overly structured, therefore limiting capital investment. This is especially problematic in 2026, when there is potential for phantom tax payments to be due without any expectation of distributions absent a mass exodus from real estate in 2026 to satisfy the deferred tax payments triggered in that year.
A summary of the individual positions is outlined below and more details are available in the individual letters (see links below).
The National Multifamily Housing Council (NMHC) and National Apartment Association (NAA) submitted a Qualified Opportunity Zone comment letter on December 7th, 2018 signed by Cindy Chetti, SVP of Government Affairs for NMHC and Gregory Brown, SVP of Government Affairs for NAA.
Positions taken by NMHC and NAA on Qualified Opportunity Zones:
- Land itself should not need to be improved to meet Original Use requirement
- Land acquired prior to 2018 should still qualify as long as development consistent with Qualified Opportunity Zone regulations takes place in 2018 or later
- Waiver to the “double the basis” rule should be allowed if a property has been vacant for over a year
- Furniture, fixtures and equipment should be included when calculating the “double the basis” test
- Returns of capital due to debt financing (such as cash-out refinancing) should not trigger tax consequences
- Individual investors in Qualified Opportunity Funds should be able to sell interests in one fund and re-invest in another within 180 days
- Qualified Opportunity Funds should be allowed to sell a property inside a Qualified Opportunity Zone and re-invest the capital from the sale within 30 months without triggering tax consequences for the fund or its investors
- Qualified Opportunity Funds should be allowed to sell individual assets from a portfolio (even if they must split the fund for the transaction) without triggering tax consequences for the remainder of the portfolio
- Provide for penalty relief from the 31-month Working Capital Safe Harbor and the 30-month rule for rehabilitation if there are delays in the development process which are outside the control of the developer
- Allow flexible initial investment timing in the case of REIT capital gain dividends and IRC Section 1231 gains
- Consider infrastructure improvements which are part of a vertical development as Qualified Opportunity Zone investments
- Allow infrastructure improvements that span a Qualified Opportunity Zone to be prorated such that the portion inside the Qualified Opportunity Zone is included
Positions taken by ICSC on Qualified Opportunity Zones:
- Any Section 1231 gains that can be used for loss netting should apply to the invested gains at the conclusion of the deferral period
- The reinvestment window for REIT capital gains should start on January 30th of the year following the declaration of dividend
- Ground-up development in a Qualified Opportunity Zone should satisfy Substantial Improvement or Original Use
- Provide guidance on how the Substantial Improvement test applies for a real estate development involving multiple buildings
- Tangible property used in a trade or business of a Qualified Opportunity Fund should include all rental real estate and all types of leases
- Allow pre-2018 owners of property inside a Qualified Opportunity Zone to co-invest with a Qualified Opportunity Fund on the existing property
- Qualified Opportunity Funds should be allowed to return capital to investors through the use of debt financing (such as cash-out refinancing) without triggering tax consequences
- Allow Qualified Opportunity Fund investors to receive a comparable basis step-up if Qualified Opportunity Fund assets are sold after the investor makes their basis step-up election
- Provide guidance on how the Working Capital Safe Harbor works in a blind fund
- Allow an extension of the 31-month Working Capital Safe Harbor for delays beyond the control of a Qualified Opportunity Fund
Positions taken by The Real Estate Roundtable on Qualified Opportunity Zones:
- Allow Qualified Opportunity Funds to split into multiple individual funds to sell individual properties from a larger portfolio
- Permit the sale of individual property tracking interests for Qualified Opportunity Zone assets
- Allow basis step-up inside a Qualified Opportunity Fund subsidiary upon the sale of an individual property as long as the investor in the Qualified Opportunity Fund has held their interest for 10 years
- Permit intermediary entities, or “feeder funds”, to aggregate deferred capital gain from individual investors and subsequently invest in one or more Qualified Opportunity Funds
- Land should be Qualified Opportunity Zone business property provided the building built on the land is Qualified Opportunity Zone business property
- Land should qualify for purposes of the 90% fund asset test and 70% business test even if acquired before 2018 or if acquired from a related party, as long as it is substantially improved
- Require improvements to buildings on land exceed 2x the value of the land for it to qualify as Qualified Opportunity Zone business property
- Exclude land underlying a Qualified Opportunity Zone property from the 90% fund asset and 70% business tests
- Improvement to an existing structure that was valued at 20% or less than the improvements should meet the Original Use test
- Substantial improvements should qualify when the improvements are 4x the value of the used or retained property, even if ownership begain prior to 2018
- A building which is vacant for one year or more should be treated as Original Use when placed into service by a Qualified Opportunity Fund
- Allow Qualified Opportunity Funds to distribute debt proceeds from refinancing without triggering recognition of deferred gain, provided the fair value of equity in the Qualified Opportunity Fund does not drop below the original deferred gain
- Allow Qualified Opportunity Funds to facilitation refinancing transactions to facilitate investors’ payment of deferred capital gains which come due at the end of 2026
- Investors should be able to sell Qualified Opportunity Fund interests and re-invest in another Qualified Opportunity Fund within 12 months and include both holding periods for the purposes of the 5/7/10 year rules
- Qualified Opportunity Funds should be permitted to sell property and re-invest in another Qualified Opportunity Zone property within 12 months without triggering tax consequences or affecting the investor’s hold periods
- Allow for extension of the 31-month Working Capital Safe Harbor and the 30-month Substantial Improvement period for circumstances beyond the developer’s control
- Ensure the Working Capital Safe Harbor extends to a Qualified Opportunity Fund, not just a Qualified Opportunity Zone Business
- The Working Capital Safe Harbor should apply to all projects expected to qualify as a Qualified Opportunity Zone Business, regardless of how the schedule begins, such that the land cannot prevent the Qualified Opportunity Zone Business from qualifying during the 31-month Working Capital Safe Harbor
- Qualified Opportunity Funds should be allowed to make reasonable changes to development plans, consistent with the complexity experienced in real estate development projects
- Consider aggregate impact of investments as sufficient reporting for purposes of gauging success of the program
- Qualified Opportunity Zone investments should qualify for credit under the Community Reinvestment Act
- All gains, including those gains attributable to depreciation and losses allocated over the holding period should be excluded upon sale of the Qualified Opportunity Zone interest, not just the appreciation of the asset
- Section 1231 gain should be eligible for investment in Qualified Opportunity Funds
- Allow flexible initial investment timing in the case of REIT capital gain dividends
- Apply New Markets Tax Credit standards to the Active Trade or Business requirement
- Allow self-constructed property acquired prior to 2018, but put into service in 2018 or later qualify as Qualified Opportunity Zone property
- Clarify that customary Section 752 and Section 704 rules apply to Qualified Opportunity Funds and their investors
- Recipients of Qualified Opportunity Zone interests in non-recognition transactions may receive Qualified Opportunity Zone benefits
- Clarify rules revolving around transfers of Qualified Opportunity Fund interests between investors
- Capital gains (including Section 1231 gains) should be eligible, even in the presence of offsetting capital losses, netting should not be required
- Leased property should be classified as an intangible asset for purposes of the Qualified Opportunity Zone Business tests
- Construction of a building on leased land should be permitted as Qualified Opportunity Zone property
- Investors should be able to contribute non-rollover amounts and later replace them with deferred gain contributions
- Clarify non-US investor rules
- Gains received in conjunction with an installment sale should be allowed to be invested as they are received
- Partnerships that distribute proceeds from an installment sale should have 180 days after the end of the partnership’s tax year to make an election
- Full-service spa facilities should be specifically excluded from “sin businesses”
The National Association of Real Estate Investment Trusts (Nareit) submitted a Qualified Opportunity Zone comment letter on December 26th, 2018 signed by Tony Edwards, EVP and General Counsel
Positions taken by Nareit on Qualified Opportunity Zones:
- Allow REIT Section 1374 “built-in” gains and Section 1231 gains to be eligible for deferral
- Allow flexibile initial investment timing for Section 1231 gains