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Opportunity zone funds - how do they work?

12/12/2018

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An Qualified Opportunity Zone Fund ("QOF") is mechanically very similar to a private equity fund. The various regulations under the SEC and IRS will still apply. However, there are few more restrictions to how a QOF can operate in order to stay qualified. 

From what I have seen there are really three types of people interested in starting a QOF:

1) Fund Managers - Many general partners of various funds have been intrigued by the opportunity zone regulations and have already set up the various entities to create a QOF. These structures are a lot more complex than the opportunity zone regulations make it seem and it is highly recommended that a professional is consulted in structuring it properly. This is where the various SEC and IRS regulations apply. 

2) Taxpayers - Some people are interested in selling properties and are looking for various ways to maximize their tax benefits by investing their capital gains into a QOF. The structure for this is relatively straight forward because the IRS recently said that a QOF could just be an LLC. However, the various restrictions in the new tax code applies. More will be discussed below. 

3) Real Estate Developers and Business Owners - This is where many attorneys are having to tell their clients that starting a QOF may be difficult unless they are willing to get creative. Many real estate developers own properties in opportunity zones and are interested using their own capital gains to fund projects. The real problem here is the "related persons" rule and its restriction on allowing a QOF to invest in a property where over 20% of its ownership is by a common partner or even a relative. Without further guidance from the IRS, a QOF would only make sense for a real estate developer if they are interested in investing their capital gains into a project they don't own or they are willing to accept outside investors where they own at least 80% of the project. Business owners can also enjoy the benefits of a QOF because they could potentially invest capital gains into their business an enjoy tax-free income after 10 years. However, there are some hurdles that would need to be dealt with before a QOF can be deemed a correct strategy. 

How is a QOF structured?

Many QOFs are being structured similar to how a private equity fund would. The QOF is structured as a Limited Partnership in order to easily accept investors as limited partners. The General Partner of the QOF would be an LLC. The QOF would then invest into one or more portfolio companies structured as Limited Partnerships. The portfolio companies would technically be a Qualified Opportunity Zone Business. The benefit to investing funds into portfolio companies is that the QOF will have 31 months to utilize the funds instead of only 6 months if they were to invest directly from the QOF into a property. This gives the QOF more flexibility when their investments include construction projects that are typically lengthy in duration. 

A QOF could be started as a simple LLC. However, such a simple set up could lead to a failure to maintain a QOF status and may result in large fees and penalties. It is important to consult a professional before starting a QOF. ​
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    Sasha Zabihi is a practicing securities attorney. He provides articles written on current investment issues. 

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