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Three Tips For Navigating Opportunity Zones - Tiedemann Advisors

Kent Insley and Anisa Dougherty, May 13, 2019

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These zones have their appeal but beware of letting the tax tail wag the investment dog. There are risks to consider, the authors of this article say.

The package of US tax measures enacted by the current administration in late 2017 were mainly covered for corporate and personal tax changes, such as caps on state and local income tax deductions, the one-off levy on firms repatriating overseas earnings, and the corporate tax cut from 35 to 21 per cent. A less salient reform was the Qualified Opportunity Zone idea, with the notion of letting investors get reliefs from capital gains if they put money into designated areas of the US deemed to be in need. All US states are included in the QOZ plan. Already, some firms have commented on these zones, such as Abbot Downing. In a way, the zones gel with the rising theme of impact investing, in that people who want to do “good” in some way get a financial return, although practitioners might debate how close such a term really fits.

In this article, Kent Insley, chief investment officer, and Anisa Dougherty, associate, at Tiedemann Advisors, give some ideas about how people should approach using these zones. This publication is pleased to share such views with investors and invites responses. It does not necessarily endorse all views of guest writers. Email the editor at tom.burroughes@wealthbriefing.com


Opportunity Zones are attracting significant interest across the investor community. But just like with any new investment or market, it’s important to understand both the opportunity and potential areas of caution. To help guide that discussion with clients, here are our current thoughts on how to navigate this new market. 

What are the benefits?
Much has been written about Opportunity Zones, a new tax incentive that was introduced in December 2017 as part of the Tax Cuts and Jobs Act to help spur investments into low-income communities across the US. The program, which was billed as a response to the uneven economic recovery that followed the 2008 Financial Crisis, allows investors to defer and reduce their capital gains tax by investing those gains in designated low-income census tracts, called Opportunity Zones. Today, there are over 8,700 Qualified Opportunity Zones within the US and its territories.

You can get a more detailed breakdown of how the Opportunity Zones program works by visiting the IRS website or accessing the resources created by Novogradac & Co, an accounting and consulting firm specializing in Opportunity Zones. 

One of the biggest tax benefits of investing in Opportunity Zones is the exclusion of the capital gains tax on new gains, provided it is invested by 2026 and is held for at least 10 years. In effect, the policy rewards long-term investors that are committed to investing in low-income communities. Given that there are strict deadlines for taking advantage of the various benefits, we believe that Opportunity Zones can and should be an aspect of ongoing tax planning. 

What are the risks of investing in the zones?
While investors are right to be intrigued about Opportunity Zones, we want to highlight three potential risks that investors should be aware of as they explore this new market.

1. Navigating Regulatory Uncertainty. The IRS recently released a second tranche of regulations for Opportunity Zones to help clarify specific questions about how and where to invest. But it’s important to remember that regulatory discussions are still ongoing, so we believe investors should favor investment strategies with minimal regulatory uncertainty. For example, potential investors should consider Opportunity Zone Funds that plan to invest in real estate, as this sub-sector of the market is already well understood. In contrast, market players are still working to interpret rules about investing in operating businesses located within Opportunity Zones. 

2.  Sizing Risk. An increasing number of Opportunity Zone Funds are entering the market. According to Novogradac & Co, there are now more than 100 funds in the market seeking a total of $23 billion in capital, with several funds targeting $500 million or more. When navigating this market, potential investors should be careful to invest with Opportunity Zone Funds that are appropriately sized to the market opportunity, keeping in mind that Opportunity Zone Funds have a limited amount of time to deploy investor capital. For example, an excessive influx of capital has the potential to increase competition for deals and distort prices. To preserve flexibility, investors should consider Opportunity Zone Funds that are large enough to be diversified across geographies and small enough to be nimble and price-disciplined.

3. Conflicts of Interest. For Opportunity Zone Funds, there is always the potential for a conflict of interest because the tax benefits only accrue to the investor, not the fund’s GP. To illustrate this challenge, consider the requirement that Opportunity Zone Funds must invest 90 per cent of their assets in designated Opportunity Zones for at least 10 years. But if the fund receives an attractive offer and decides to sell an asset before the 10-year holding period is up, thereby dipping below the 90 per cent threshold, the GP would receive a performance fee but the LP would forfeit their tax incentive. In talking to a number of Opportunity Zone Funds, we have yet to find one that has adopted legally binding language that would obligate them to protect the investor’s tax benefit. 

Closing thoughts
The Opportunity Zone program offers a compelling tax incentive for high net worth investors. That said, the program is not without its risks. Chief among these risks is a potential for conflicts of interest, regulatory uncertainty and distorted pricing. While these complexities are addressable, they require a thoughtful and measured approach. At Tiedemann, we are in the process of designing a standalone solution for clients that can preserve the tremendous tax advantages while navigating these complexities.

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