Can you GP equity gain with Opportunity Zone funding?

Answers

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  Forrest Milder

  Nixon Peabody

  July 10, 2019

  You can certainly refinance your project, and at any time, but note: Distributions in excess of an investor's basis will be an "inclusion event" that will accelerate recognition of the gain that was supposed to be delayed until Dec. 31, 2026. If the borrowing is non-recourse, then the investor should be able to include its percentage share of the QOF multiplied by the amount of the debt in basis, thereby addressing the "distribution in excess of basis" rule that I identified above. If the OZ investor guarantees the debt, then it should be able to include the amount guaranteed in basis, also addressing the distribution in excess of basis rule. For example, QOF has a $10-million investment from an investor who gets a 70% interest; the QOF acquires a property for $10 million (in compliance with the applicable OZ rules), and then borrows $1 million, secured by the property on a non-recourse basis. Although the investor starts with a $0 basis in its $10 million investment, that basis is increased by the investor's share of the debt, i.e., 70% of $1 million or $700,000. So, in general, $700,000 could be distributed to the investor without screwing up the OZ treatment of its investment. Regardless, distributions in the first two years after the investor invests will be subject to very heightened scrutiny, and are not recommended. They might actually cause the original investment to not be respected as an OZ investment. This rule trumps the previous rule. Even though non-recourse borrowing, followed by a distribution generally works, it will be subject to great scrutiny (and probably doesn't work) if it happens in the first two years. So, if you refinance within the first two years, it would be better to roll the money into more QOZB property, as opposed to distributing the cash. Don't forget that a QOF can only have 10% "bad" assets, so it can't sit on all that much cash. Similarly, a lower tier "subsidiary entity" can only have 5% "nonqualified financial property," so it can sit on even less cash. Bottom line: You should have a plan in advance for what you will do with cash from a refinancing. You shouldn't try to refinance first and figure that you will solve the 5%/10%/two-year rules afterward.

• 

  Matthew Rappaport

  Falcon Rappaport & Berkman

  July 15, 2019

  Need more details to answer the question. There are multiple issues at play here, including whether the recap is an inclusion event, whether the GP equity is a carried interest, and the business reasons for the recap.

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  Brad Cohen

  Jeffer Mangels Butler & Mitchell

  July 18, 2019

  You can do it after 24 months. No impact to other partners.

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  Guy Nicio

  Windes

  July 10, 2019

  I'm a little unclear on your scenario and questions, but I'll give a shot at a reply. There should not be any limitations to recapitalize on an OZ-funded project. The key to the OZ benefits lies in the OZ entity itself. There are some basic rules (and some complications within the rules) for an entity to qualify as a Qualified Opportunity Fund. The most fundamental of these rules is that 90% of the assets must be qualified Opportunity Zone Business Property (QOZBP) and that this 90% rule is test twice per year. As you likely know, based on your scenario, an OZ fund can invest into another entity. And that entity itself would qualify as QOZBP (for purposes of the 90% test at the fund level) if that other entity holds at least 70% of its assets as QOZBP plus a few other complicated rules regarding limitations on type of business (not a sin busines), limitation on financial and intangible property. So as long as the fund does not run afoul of the 90% of QOZBP test, I don't see any issues. There would be no impact to the OZ-funded LP equity. There are a few caveats of related parties become involved, for example. I hope this helps for high-level analysis. Obviously, interpreting and applying tax law to a specific set of facts and circumstances can be extremely complicated. Therefore, I would not recommend anyone attempt to handle the tax planning and compliance for OZ matters without engaging a qualified attorney and CPA.

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