Traditional Deal Financing Sources...Traditional Deal Financing Sources 2 Owner Equity • Return expectation (leveraged): 15% plus • First loss position • Day-to-day control •

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ICSC MichiganOpportunity Zones – Unbelievable Tax Shelter or Trap for the Unwary

Presented by Gordon Goldie and Valerie Grunduski, Plante & Moran, PLLC

and Nicholas Maloof, Associated Environmental Services, LLC

February 14, 20191

Traditional Deal Financing Sources

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Owner Equity• Return expectation (leveraged): 15% plus

• First loss position

• Day-to-day control

• Unlimited upside potential

Mezzanine• Return expectation: 10-18%

• Term – 18 months to 5 years

• Current return of 5% to 9%

• Share of appreciation

• Second loss position

• Influence over major capital events and performance standards for the operator

• Collateral: Pledge of equity of owner or second mortgage position

• The capital tier between 70% to 90% LTV

1st Mortgage• First lien on property

• Term – 7-10 years

• Last loss position

• Return expectation: 4-8%

• No upside potential

• The capital tier up to 75% LTV

• Limited controls

Owner Equity

Mezzanine Loan/Preferred Equity.

1st Mortgage

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Tax Incentive Deal Financing SourcesOwner Equity

• Return expectation (leveraged): 15% plus

• First loss position/Unlimited upside potential

• Day‐to‐day control

Tax Incentives

• Temporary or permanent equity

• Subsidized by federal, state or local government

• Used to fill funding gaps

Mezzanine

• Return expectation: 10‐18%

• Term – 18 months to 5 years

• Current return of 5% to 9%

• Share of appreciation

• Second loss position

• Influence over major capital events and performance standards for the operator

• Collateral: Pledge of equity of owner or second mortgage position

• The capital tier between 70% to 90% LTV

1st Mortgage

• First lien on property

• Term – 7‐10 years

• Last loss position/No upside potential

• Return expectation: 4‐8%

• The capital tier up to 75% LTV

• Limited controls

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Owner Equity

Mezzanine Loan/Preferred Equity.

1st Mortgage

Tax Incentives

Overview of Available Incentives

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Development Incentives include numerous Local, State and Federal tax incentives to support development of a given project in a specific location, whether residential, commercial or industrial, or a mixed-use development. Most are tied directly to Job Creation and the total Real and Personal Property Investment.

These incentives can include tax abatements, job creation grants, infrastructure matching funds, job training grants and other incentives. Common Federal Government examples include:

• New Market Tax Credits (NMTC)• Federal Historic Tax Credits (HTC)• USEPA Grants and Loans• Housing and Urban Development (HUD) Financing

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Common State and Local Government examples include:

• Property Tax Abatements

• Commercial Rehabilitation Act (PA 210)

• Obsolete Property Rehabilitation Act (OPRA)

• Personal Property Tax Relief in Distressed Communities (PA 328)

• Industrial Facilities Tax (IFT) Abatements (PA 198)

• MEDC Business Development Program Grants for Job Creation

• Michigan Department of Transportation (MDOT) Transportation Economic Development Fund (TEDF) Grants


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Common State and Local Government examples (Cont.):

• MEDC Community Revitalization Program (CRP)

• Tax Increment Financing (TIF)

• Transformational Brownfield Plan (TBP)

• MDEQ Grants and Loans

• Revolving Loan Funds (USEPA, MDEQ & Local BRA)

• Site Assessment Grant and Loan Funds

• MSHDA Low Income Housing Tax Credits (LIHTC)

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Overview of Available IncentivesOpportunity Zones

A brand new Federal Tax Incentive (Opportunity Zones) is now available to investors, business owners and real estate developers that is a direct creation of the recent Tax Cuts and Jobs Act of 2017, approved by Congress, signed by President Trump and became law on December 22, 2017 (Public Law No: 115‐97).

What is an “Opportunity Zone” you may ask?According to the IRS, “An Opportunity Zone is an economically‐distressed community where new investments, under certain conditions, may be eligible for preferential tax treatment. Localities qualify as Opportunity Zones if they have been nominated for that designation by the state and that nomination has been certified by the Secretary of the U.S. Treasury via his delegation of authority to the Internal Revenue Service.”

We will now discuss Opportunity Zones in more detail.

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Overview of Opportunity Zone Program

• Goal: Incentivize investment into low income census tracts

• Benefits: Deferral of Capital Gain until 12/31/26 – To the extent gain is invested in

Qualified Opportunity Fund (QOF) in 180 days

Exclusion of 10% or 15% of Capital Gain – Investment in QOF must be held 5 or 7 years

No tax on gain from sale of QOF – Investment must be held 10 years

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Overview of Opportunity Zone Process

• Qualified Opportunity Zone (QOZ) designation and certification

• QOF certification

• Investors reinvest capital gains into QOFs

• QOF acquires QOZ business property (directly or indirectly through a partnership or corporation)

• Deferred gain recognized upon earlier of QOF sale or 12/31/26

• Election to step up basis in QOF to fair market value upon QOF sale

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Overview of Opportunity Zone Process(continued)

Investor

Realizes capital gain

Reinvests gain within 180 days

Gain deferred until earlier of sale of QOF or 12/31/26

Opportunity Zone Fund Self

certification

90%+ of assets must be QOZ Property

Opportunity Zone Business Substantially

all (70%) of tangible property must be QOZ Business Property

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Designated Qualified Opportunity Zones (Metro Detroit)

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Opportunity Zone Program Details

• Michigan Opportunity Zone information available at http://www.michigan.gov/mshda/0,4641,7‐141‐5587_85624‐‐‐,00.html

• Plante & Moran Opportunity Zone resources available at: https://www.plantemoran.com/explore‐our‐thinking/areas‐of‐focus/opportunity‐zones

• Taxpayers self‐certify their QOF by attaching Form 8996 to their timely filed tax return

• 90% of QOF’s assets must be QOZ property QOZ stock

QOZ partnership interest

QOZ business property

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Opportunity Zone Business Property

• Tangible property used in trade or business of QOF

• Acquired by purchase after 12/31/17

• Cannot be acquired from a related party

• Original use or substantial improvement test Original use of property commences with QOF or

QOF substantially improves the property.

• Substantial improvement test Additions to basis during any 30 month period after acquisition exceeds

Adjusted basis at the beginning of such 30 month period

• Substantially all of the use of such property was in a QOZ during substantially all of the QOF’s holding period

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Qualified Opportunity Zone Business

• Substantially all (70%) of the tangible property owned and leased by the taxpayer is QOZ Business Property

• At least 50% of gross income is derived from active conduct of business using QOZ Business Property in QOZ

• Nonqualified financial property must be less than 5%

• Cannot engage in sin businesses (e.g., country club, massage parlor, hot tub facility, suntan facility, gambling facility, or liquor store)

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Opportunity Zone Gain Deferral

• Type of gain eligible for deferral Long‐term capital gain = Yes

Short‐term capital gain = Yes

Other gain = If taxed as capital

Section 1231 gain = Depends

Ordinary gains = No

• 180 day reinvestment deadline

• Investment must be made before 12/31/26

• No escrow requirement

• Only required to reinvest gain (not proceeds)

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Opportunity Zone Gain Deferral (continued)

• Timing difference reverses on earlier of: Sale of QOF

December 31, 2026

• Phantom income recognized on 12/31/26 if QOF not yet sold

• Partial permanent exclusion with 5+ or 7+ year QOF holding period 10% permanent exclusion with 5+ year holding period (N/A for QOF

investments after 12/31/21)

15% permanent exclusion with 7+ year holding period (N/A for QOF investments after 12/31/19)

• Deferral of related party gains is not allowed

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Opportunity Zone Gain Exclusion

• Investment in QOF must be held 10 years

• Exclusion applies to gain on sale of QOF

• Exclusion is elective – Results in basis step up in QOF to fair market value upon sale

• Only available if investment in QOF was funded with deferred gain

• Deferred gain will be recognized during 10 year holding period (phantom income)

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Example 1: Gain Deferral with No Basis Increase

Capital gain sale

» Sale price = $1,500,000

» Basis = $500,000

» Capital gain = $1,000,000

» Sale date = May 1, 2019

Reinvestment

» Deferred gain = Amount invested up to $1,000,000

» Deadline for investment = October 28, 2019

QOF sale

» Sale date = October 31, 2022 (< 5 year holding period)

» Sale price = $1,500,000

» Basis = $0

$1,000,000 investment

‐ $1,000,000 deferred gain

» Gain = $1,500,000

$1,500,000 sale price

‐ $0 basis

» Breakdown of gain

• $1,000,000 original

• $500,000 appreciation

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Example 2: Gain Deferral with 10% Basis Increase

Capital gain sale

» Sale price = $1,500,000

» Basis = $500,000



Reinvestment



QOF sale

» Sale date = October 31, 2024 (> 5 year holding period)

» Sale price = $1,500,000

» Basis = $100,000


‐ $900,000 90% of deferred gain

» Gain = $1,400,000


‐ $100,000 basis


• $900,000 original


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Example 3: Gain Deferral with 15% Basis Increase

Capital gain sale

» Sale price = $1,500,000

» Basis = $500,000



Reinvestment



QOF sale

» Sale date = October 31, 2026 (> 7year holding period)

» Sale price = $1,500,000

» Basis = $150,000


‐ $850,000 85% of deferred gain

» Gain = $1,350,000


‐ $150,000 basis


• $850,000 original


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Example 4: Phantom Income on Gain Deferral

Capital gain sale

» Sale price = $1,500,000

» Basis = $500,000



Reinvestment



Phantom Income

» Deadline for deferred gain recognition = December 31, 2026 (> 7 year holding period)

» Sale price = N/A (no sale)

» Amount of deferred gain recognized = $850,000

$1,000,000 deferred gain

‐ $150,000 15% basis increase

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Example 5: Exclusion with 10 Year Holding Period

Capital gain sale

» Sale price = $1,500,000

» Basis = $500,000



Reinvestment



QOF sale

» Sale date = October 31, 2029 (> 10 year holding period)

» Sale price = $1,500,000

» Basis = $1,500,000

$850,000 phantom income recognized 12/31/2026

+ $150,000 step up after 7 years

+ $500,000 election to step up to fair market value

» Gain = $0


‐ $1,500,000 basis

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Opportunity Zones vs. 1031 Exchanges

• Opportunity Zone Advantages Greater range of property eligible for gain deferral

Greater range of property eligible for investment

Eliminates intermediate step of identifying replacement property.

Allows more time for purchase of replacement property

Allows the taxpayer to use proceeds allocated to basis without restriction

Taxpayer has access to proceeds for up to 180 days before investing in a Qualified Opportunity Fund

Permanently eliminate up to 15 percent of initial capital gain.

Permanently exclude gain from sale of Qualified Opportunity Fund investment from tax

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Opportunity Zones vs. 1031 Exchanges

• 1031 Exchange Advantages Allows deferral of unrecaptured depreciation

Geographic flexibility within the U.S (not restricted to distressed areas)

Replacement property can be existing property without substantial improvements

Options available to identify and acquire replacement property before sale of existing property

Longer potential gain deferral

No phantom income

Ability to continue to defer gain (e.g., via a subsequent 1031 exchange)

Original gain can be excluded upon death of taxpayer

More flexibility in structuring sale of replacement property

Can defer gain on sale to a related party

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Thank you!

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Gordon Goldie

248.375.7430

[email protected]

Valerie Grunduski

313.496.7240

[email protected]

Nicholas G. Maloof, RPG

248.203.9898

[email protected]

Documents

Traditional Deal Financing Sources...Traditional Deal Financing Sources 2 Owner Equity • Return expectation (leveraged): 15% plus • First loss position • Day-to-day control •