OPPORTUNITYZONE REPORT

CRITERIA FOR EVALUATING

FEB 2019

AN OPPORTUNITY ZONE

KEY TAKEAWAYSCRITERIA FOR EVALUATING

AN OPPORTUNITY ZONEOpportunity Funds have several ingredients likely to make them more successful than Enterprise Zones and other programs designed to spur investment in distressed areas.

The window is closing. 2019 is the last calendar year in which investors can get into a fund and take full advantage of the program’s generous long-term tax incentives.

There are now more resources than ever to find the right zone for your fund and to see how well that zone is performing (and conforming).

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Cross St & NorthCENSUS TRACT 437

Wall St & West AveCENSUS TRACT 434

South NorwalkCENSUS TRACT 441

Smart GrowthPotential

Qualified Norwalk, CT Opportunity Zones

While some wrinkles remain to be ironed out, the federal Opportunity Zones program—a byprod-uct of the landmark 2017 Tax Cuts and Jobs Act (TCJA)—could go down as the largest and most significant federal community development initiative in U.S. history. Economic Innovation Group, (EIG) an organization that advocates for policies that promote entrepreneurship and investment, says U.S. taxpayers hold more than $6 trillion in unrealized capital gains in stocks, funds, real estate, artwork and other alternative assets and collectibles. A sizeable chunk of that private investment trove could start flowing into pre-designated low-income communities around the country, both urban and rural.

Just remember that 2019 is the last calendar year for opportunity zone investors to take full advantage of the program’s generous long-term tax incentives. Don’t wait until year-end to decide whether investing in any of the nation’s 8,700 designated Qualified Opportunity Zones (QOZs) makes sense for you and your fund.

As with any investment opportunity or tax deferral strategy, it’s imperative to do your due diligence before signing on the dotted line.

That includes carefully reviewing the location, property type, market demand, operator, oper-ator’s track record and whether or not they have de- veloped projects in an area similar to the des-ignated opportunity zone you are considering.

“Most clients who have experienced a financial windfall aren’t going to ask you, ‘Hey, can you get me into an Opportunity Zone Fund?’ explained Anthony Glomski, founder of Los Angeles-based AG Asset Advisory. “They’re looking for ways to minimize their tax hit. And, that’s where you come in — knowing your clients well enough to suggest a solution that most tax preparers and other advi-sors would not have considered.”

To that end, we’re pleased to announce that Connecticut is among the 28 U.S. states to have adopted the federal OZ program. As of press time, there were 72 approved opportunities in Connecticut and three of the top 10 rated zones for “Smart Growth Potential” are located in Fair-field County, including two nestled right here in the city of Norwalk.

Opportunity zones are better positioned than earlier efforts to spur investment in disadvantaged communities.

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Opportunity ZonesPositioned to Spur Investment

Most clients are looking for ways to minimize their tax hit. And, that’s where you come in.”

”

Anthony Glomski,founder of Los Angeles-based AG Asset Advisory

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Many experts believe opportunity zones will be more successful than Urban Enterprise Zones and other earlier federal tax programs that were designed to spur investment in distressed areas. For starters, the tax benefit that investors in

Qualified Opportunity Funds (QOFs) receive will not be capped as it was under earlier programs. Plus the QOZ initiative touches far more commu-nities than previous programs and investors only receive their full tax benefits if they stay commit-ted to a fund for the long haul.

“Unlike prior programs, opportunity zones reward taxpayers for exiting from existing investments and redirecting their capital to low-income communities, explained Real Estate Roundtable’s

Ryan McCormick in a GlobeSt.com report. “Unlike the New Markets Tax Credit program, in-vestors do not have to compete with one another for a limited number of tax credits in a costly, centralized process,” McCormick added.

McCormick said opportunity zones also promote the pooling of capital through QOFs,” which could be “transformative in terms of mobilizing capital from disparate sources to support jobs and growth.” According to McCormick, the fund structure that underlies the program may result in a business model in which “local entrepreneurs with knowledge and expertise partner with out-side investors, creating a new cadre of business leaders and lasting benefits for the community.”

Brief Historyof Opportunity Zones

How to FindQualified Opp Zones

Opportunity Zones are a bipartisan community development program established in the Tax Cuts and Jobs Act of 2017 to incentivize investments in low-income communities across the country. The Opportunity Zones program is based on the bipartisan Investing in Opportunity Act, which was cham-pioned by Senators Tim Scott (R-SC) and Cory Booker (D-NJ) and Representatives Pat Tiberi (R-OH) and Ron Kind (D-WI), who led a regionally and politically diverse coalition of nearly 100 congressional cosponsors. Opportunity Zones represent a subset of census tracts with an individual poverty rate of at least 20 percent and a median family income no greater than 80 percent of the area median. Each state’s governor nominates the zones for approval by the U.S. Treasury Secretary as a qualified zone within 30 days of their submission. 

The program provides deferred capital gains taxes or tax breaks to incentivize patient capital equity investments in Opportunity Funds to seed new business investments, expand existing businesses, or fund real estate development in Opportunity Zones. Unlike 1031 Like Kind exchanges, QOFs are not limited to comparable real estate. Funds can also invest in other qualifying local initiatives, such as existing busi-nesses and start-up businesses as long as those businesses derive at least 50 percent of their revenue within a designated opportunity zone and are not “sin” businesses such as golf courses, liquor stores, massage parlors and casinos. However, many experts argue that it can be challenging to find real estate deals that can “locate well” in economically depressed areas.

You can find a list of designated Qualified Opportunity Zones at Opportunity Zones Resources and in the Federal Register at IRB Notice 2018-48.  You can also find a visual map of the census tracts designated as Qualified Opportunity Zones at Opportunity Zones Resources.

The numbers are the population census tracts designated as Qualified Opportunity Zones.

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What do the numbers mean on the Qualified Opportunity Zones list, Notice 2018-48?

Selecting the RightInvestment AreasOpportunity360 and the EIG’s Distressed Community Index (DCI) are two good tools that have been highlighted for opportunity zone evaluation. Enterprise Community Partners created Opportunity360, which evaluates opportunities within a census tract across housing stability, education, health and well-being, economic security, and mobility and was used by several states in nominating their Opportunity Zones. 

Look at the existing plans of the city in which the QOZ is located

What is the demand of the property type?

What kind of property type is best for the location?

What is the experience of the developer

What is the track record of the developer

How much of their own money is the developer putting in

. . . .and what is their plan to protect the downside if the area doesn’t take off like they think it will — if or the investment doesn’t do as well as the devel-oper had hoped?

One of the important factors to weigh is neighbor-hood appeal: Will the neighborhood, and the mul-tifamily properties within it, appeal to millennials or baby boomers? “Younger workers are much more inclined to walk or use public transportation to get to their jobs, so proximity to schools, shopping areas and employers will yield a premium on rents,” according to Blake Christian, CPA, a tax partner of HCVT, LLP in Long Beach, CA.

As for Boomers, many of them are downsizing and migrating from the suburbs to close-in areas out-side big cities, experts say. According to the Tax Policy Center, multifamily properties are eligible for Opportunity Zone investments. In previous fed-eral programs designed to spur economic devel-opment, multifamily properties were NOT eligible.

Class-B and class-C multifamily assets are ex-pected to keep performing well as vacancy rates remain low, according to Randy Hubschmidt, managing partner of Fortis Wealth, King of Prussia, Pa. For 2018, vacancy rates for class-B and class-C categories were projected to be 6% or lower, compared with a 9% rate for class-A properties. And a National Real Estate Investor report noted

Get a Handle onThe Neighborhood

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that that class-B and class-C multifamily assets are “super attractive” during down cycles, adding that both classes held their own during the Great Recession.

“Class-A apartments are the most competitive sector and have the highest likelihood of generat-ing substandard returns over the next few years,” Hubschmidt added. “Properties in prime loca-tions with high-end finishes and amenities, while desirable, are also facing the most competition for tenants,” Hubschmidt said.

Your fund could purchase real estate and do heavy rehab on it, or it could purchase a parcel of land and build a commercial building there, noted Glomski. “It could also start a bakery, dry cleaner or any other local business that’s needed in a community, to name just a few.”

7Median Income Ratio

Poverty rate

Prime-age adultswho are not working

HousingVacancy Rate

Change inemployment

Change inestablishments

Adults without ahigh school diploma

EVALUATINGMETRICS

12

34

56

7

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UnderutilizedLand & Buildings

Pipeline of Development Projects

Finding the Census TractNumber for a Specific Address 

Experts say you want to look for zones in which there are multiple backers already on board.

“It’s not likely a single investor can make an opportunity zone project succeed and many contributors may be needed, wrote Darryl Jacobs, of Chicago-based law firm Ginsberg Jacobs LLC, in National Real Estate Investor. “The key will be staying diversified while still taking advantage of the capital gains tax relief available through the program.”

The IRS rules specify that funds don’t have to include the value of the land when calculating how much the law requires them to spend renovating or refurbishing property. For ex-ample, if a fund were to pay $10 million for a warehouse and land, with the building valued at $4 million, the fund has to spend at least $4 million in renovations, (i.e. what the building is valued at) — but not the $10 million total purchase price. That’s a big benefit to investors in urban areas where land can be a significant portion of a project’s cost. Developers can spend less to meet requirements for “substan-tially improving” a building under the law. For some projects, such as affordable housing, investors could have been forced to pay more to improve the building than they would have been able to recoup in rental income.

You can find 11-digit census tract numbers, also known as GEOIDs, using the U.S. Census Bureau’s Geocoder. After entering the street address, select ACS2015_Current in the Vintage drop-down menu and click Find. In the Census Tracts section, you’ll find the number after GEOID.

According to EIG, the housing stock in the average opportunity zone has a median age of 50 years, more than 10 years past the U.S. median—“a sign that many of these neighbor-hoods urgently need reinvestment.” Larry Kosmont, CEO of Kosmont Companies told commercial real estate site Bisnow that the fear of gentrification forcing out longtime residents and businesses is always a concern. “The only way to get through that tension is to [reach out] to that community effectively and speak to them; find project amenities that improve the quality of life along with the return on investments. Then you are viewed as a long-term player ready to invest money and bring jobs to that area.” That’s a much better alternative, he said, than being a “single one-hit wonder that wants to win and leave.” It does not completely ameliorate the fear of gentrification, but certainly “softens that blow,” Kosmont related.

That being said, if a business that receives an investment from a QOF later decides to move its headquarters to somewhere outside an Opportunity Zone — that business still counts as a qualified investment for that fund for 5 years.

Transformative Effect

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Side by side comparison

From Fundrise

1031 Like-Kind Exchange Opportunity Fund InvestmentRollover

Property eligiblefor deferralupon sale

QualifiedAssets

Capital GainsTax Deferral

An investor must reinvest the principal and capital gain within 180 days of sale. This transaction must be conducted through a qualified intermediary in many instances.

An investor must reinvest capital gains only within 180 days of sale to qualify for capital gains tax advantages. An investor is not required to roll over the entire gain, but only the rolled over portion is eligible for tax advantages. An investor may place Opportu-nity Fund investments directly, and no intermediary is required.

Real estate only can qualify for a 1031 Exchange.

Capital gains from sale of real estate or another investment can qualify for an Opportunity Fund

InvestmentStructure

This is designed for single asset swaps. Multiple properties can be supported through certain structures, but this option usually comes with high costs, fees, and general inflexibility.

This can support a pooled fund that invests in multiple assets.

Capital gains tax payments for the initial investment may be deferred indefinitely.

Tax payment on capital gains of the initial investment may be deferred until April 2027.

Capital GainsTax Reduction

No capital gains reduction is available except through a step up in basis upon death.

Capital gains tax on the initial investment is reduced by 10% after 5 years and by another 5% after 7 years through step up in basis. In total, a 15% reduction is possible (as long as an investor invests by Decem-ber 31, 2019).

Capital GainsTax on Final Sale

An investor owes capital gains tax on final sale of the asset.

If the investment is held for at least 10 years, the investor can expect to owe no capital gains tax on any appreciation of the initial opportunity fund investment upon sale of such investment

The 90% Test &Your Compliance StructureRemember, a QOF is an investment vehicle (cor-poration or partnership) that is required to hold at least 90 percent of its assets in QOZ property. The 90 percent requirement is determined each year by averaging the percentage of QOZ held by the QOF at six-month intervals (i.e. June 30th and December 31st for a calendar year taxpay-er). Penalties for failing to meet the 90 percent requirement can be stiff.

Also make sure you are working with good auditors. CPAs and others who advise taxpayers with sizeable capital gains will look closely at each QOF’s compliance and structure. “They will look at the general partners who are running your fund and who is doing the audit,” noted Glomski. “Make sure your auditor is a firm with ‘bench strength’ and a long-standing history of auditing funds,” Glomski added.

If an Opportunity Fund fails to keep an average of 90 percent of its assets invested in qualified Opportunity Zone property (the “Minimum Investment Standard”), then the Opportunity Fund must pay a monthly penalty for each month in which it fails to meet this requirement. The penalty is calculated by multiplying the underpayment rate established under Section 6621 (a)(2) for the applicable month by an amount equal to the excess of 1) 90 percent of the Opportunity Fund’s aggregate assets over 2) the aggregate amount of qualified Oppor-tunity Zone property it holds. Notwithstanding the foregoing, no penalty is to be imposed with respect to any failure if it’s shown that the failure is due to reasonable cause. Because there is no explanation of “reasonable cause,” this will presumably need to be addressed in forth- coming guidance.

Make sure your auditor is a firm with ‘bench strength’ and a long-standing history of auditing funds.

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Current FinancialIncentivesInvestors that hold a property for at least five years in an opportunity zone receive a 10 per-cent break; those who hold it for seven years receive a 15 percent break. As a separate ben-efit, an investor can forgo paying capital gains taxes on the appreciation of an investment in Opportunity Zones if the asset is held for at least 10 years.

As Brad Alexander, a senior advisor at Mc-GuireWoods Consulting, explained recently in Commercial Property Executive, opportunity zone law provides tax advantages that make private capital “more willing to accept lower re-turns on a long-term lease or build to suit for a government use.” Put differently, one of the big obstacles to pubic private partnership deal for-mation using private capital is the higher return it seeks, relative to public revenue or general obligation debt. Under this scenario, said Al-exander, “the opportunity zone tax advantages enhance the return on capital, making rates compare more favorably to the cost of funds from other public sources.”

While still a fairly new program, the window of “opportunity” is closing for investors who want to take full advantage of the 15 percent concession. That’s because the capital gains deferment ends on Dec. 31, 2026. So, inves-tors have until Dec. 31, 2019, if they want to reap the benefits of the entire seven-year tax break—a cumulative 15 percent basis step-up with respect to the invested gains.

Why Now?

Norwalk is a fast growing, business-friendly city with a sizable population of 90,000+. It is a vibrant destination with a proud populace and progressive city officials. We have a historic downtown, beautiful harbor, and plenty of access to transportation. We have emerging growth in the fields of health, retail, science and technology. The city has an actionable plan to modernize infrastructure, improve walkabili-ty, create jobs, add housing and enhance innovation and technology. A major neighborhood revitaliza-tion effort is already underway with major investors and developers involved. Blending mixed-use project density and transportation enhancements has uniquely positioned Norwalk for continuing in-vestment. Your fund should be a part of our success as the future unfolds.

opportunityzone-invest.com

norwalkredevelopmentagency.com

norwalkct.org

Norwalk Redevelopment Agency125 East Ave, Norwalk, CT 06851(203) 854-7810

All expressions of opinion within this article are subject to change as rules and regulations pertaining to this subject matter are continually evolving. Content should not be viewed as personalized investment advice or as an offer to buy or sell any securities discussed. A professional adviser should be consulted before implementing any of the strategies discussed. All investment strategies have the potential for profit or loss. Content should not be construed as legal or tax advice. Always consult an attorney or tax professional regarding your specific legal or tax situation. The City of Norwalk is not engaged in the practice of law, accounting or consulting.

©2019 — City of Norwalk, CT

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