This is a rather complex question with a number of structural alternatives, with potential leasing or sale as to which you would need to meet the 20% limitation.
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How and when can I take advantage of owning a commercial property in an Opportunity Zone?
I bought an apartment complex five years ago in Florida, where I have 120 tenants. I just found out that it is located in an Opportunity Zone. Do I have to sell it to take advantage of being located in an Opportunity Zone? Can I transfer it into another entity that I start now to make it an Opportunity Zone business? I have plans to make substantial improvements to the building, so I would like to know what I can do to better use the location.
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If you plan on meeting the substantial improvement requirement in the statute, a master lease is the only way you can accomplish this.
Very doable, but for existing property, if you want to retain more than a 20% equity interest, you will have to structure the fund as a tenant as a ground lease, including improvements
All those are great questions that need to be carefully analyzed before answering. It seems that you have an ongoing business. Therefore, careful analysis of the rules applicable must be done in order to determine compliance with the ongoing business requirements: tangible property investment, gross income, etc. If these are met, you may be able to attract a QOF to invest in your business.
In general, for property to be Qualified Opportunity Zone property, it has to be purchased from an unrelated party after Dec. 31, 2017. The threshold for related party status has been defined as 20%. Theoretically, you may be able to sell your building to a partnership of which you own less than 20%.
The combination of the original-use requirement and the mandate that QOZBP be purchased after Dec. 31, 2017, by a QOF from an unrelated party poses a problem in your project. To take advantage of the law, the taxpayer would sell the property to a QOF for the taxpayer to defer any gain on the sale, and for the QOF to be able to count the property as QOZBP. The taxpayer and the QOF cannot be related, and as a result, the taxpayer cannot own more than 20% of the QOF after the sale. Giving up this much equity may not be attractive. The recent proposed regulations provide that a QOF and QOZB may now lease property if the lease is entered into after Dec. 31, 2017 and its terms are at arms-length. A lease structure may work depending on your situation. There are a number of rules concerning the lease of property in a QOF.
Selling it will not get you any benefits under the Opportunity Zone other than the fact that the value may be somewhat higher to an interested buyer, but that premium is limited to whatever a willing buyer will pay, obviously. No, you can't transfer it to another entity if you are the owner of said entity due to the related-party rules which prohibit such transactions with related parties for purposes of the Opportunity Zone benefits. Related parties are defined as owning 20% or more interest in the relevant entities. There may still be ways to benefit, but it is not evident from your intended plans. I think you would have to completely dilute your ownership in the Opportunity Zone entity to get around the related party rules.
No need to sell the building, which would not work anyway if you sell it to a QOF in which you own a big enough share of (20%, I think). However, you can lease the building to the QOF and then have the QOF make the substantial improvements as tenant improvements. Just have to make sure the numbers work for the value of the improvements vs. value of the building.
The QOF must acquire the property by a purchase from an unrelated party to qualify for QOF benefits with related party status having a low 20 percent relationship threshold.
You really need to consult a professional to do get the best guidance for your situation. However, here are two options that you should discuss with a qualified attorney or tax professional. One, you can lease your property to a Qualified Opportunity Fund and gain an interest in the fund. Then you will get the 10 year tax-free advantage on any gain from the sale of interest in the fund. Two, the other option is to sell your property to a Qualified Opportunity Fund. Then any capital gain will be eligible to defer by investing in any Qualified Opportunity Fund. If you invest the gain into the fund you sold the property to, you can not have an interest of more than 20%. This will take away all the tax benefits of an Opportunity Zone investment.
This presents a number of issues and is difficult to fully explore and answer via email. Simply transferring to a new entity will not automatically turn it into a qualified OZ business, plus the OZ rules require a "purchase" after 2017 to qualify as OZ property. Selling the property to a Qualified Opportunity Fund (QOF) also presents issues if you retain more than a 20% ownership interest. Keep in mind you must fund the QOF with cash or property AND have eligible capital gain income reportable in the prior 180 days. It may be possible to set up a QOF that invests in the rehab of your property and then gets an allocation of rent, but you will also need to have a fact pattern to support that the QOF conducts an active business, which may be difficult under your facts pattern. If you have sufficient land to build a second tower, that would be the ideal situation to place the new building in a QOF, but I suspect that is not an option. While it may be possible to establish a structure that qualifies, your fact pattern illustrates that it is very challenging to convert an existing OZ property or business into a QOZ business without having a new owner (80% or more) purchase it.
In general, you cannot take Opportunity Zone tax advantages on a property you already own, nor can you simply transfer or sell it to a new entity that you own. There are several advantages that you can take, however. The property is potentially worth more because it is in an Opportunity Zone, should you choose to sell it. You may be able to sell it to a new entity of which you control or own no more than 20% of the interest. Check with a CPA or tax attorney regarding this. Depending on the value and the way you structure it, you could retain managerial control over the property, bring in new investors who will own 80% of the property, and you could retain the 20%. You could then use the funds from the sale to purchase and improve another Opportunity Zone property. (I am looking to do exactly this with a property that I own with a partner in Colorado.) It is not something that you want to deal with an inexperienced broker on.
There are a couple of issues you would face. First, the incentive will only apply with respect to capital gains invested in the entity that is to be the Qualified Opportunity Fund within 180 days of the realization event. So only investors with gains they are willing to invest to make your substantial improvements could be eligible for the incentive benefits. Second, since you owned the property prior to Dec. 31, 2017, your ability to make the property qualify as a "good asset" (i.e., Qualified Opportunity Zone business property) is at a minimum more difficult. Recent proposed regulations may give you an avenue to do this through a lease of the property to the new entity that will be the Qualified Opportunity Fund or its subsidiary partnership or corporation. But if it’s a related party lease, which is seems like this would be, there are other details to be aware of, including that the lessee will have to pay the lessor FMV for the lease, among other things. You'll need to consult with an experienced Opportunity Zone lawyer to navigate these issues.
One of the fundamentals of the Opportunity Zone incentive relates to the acquisition of the property or business after 2017, in a transaction that involves unrelated parties. So you are essentially correct. The most efficient structure is for you to sell the complex to a new LLC or partnership of which you own not more than 20%, and then go from there. There are likely ample opportunities for you to be paid fees and sales price to get the benefit of the built-in value of the property now and going forward. Of course, you should work with a professional to assure that the fees that you earn are not recharacterized as profit shares that might blow the not-more-than-20% related party test. You could either form a QOF (Qualified Opportunity Fund) to become the investor partner in the LLC that acquires the building you now own (remembering to pay attention to the 20% test) or seek an investment from one of the many, many QOFs that have been formed and are looking for properties in which to invest. And don't forget the potential incidental benefit when you sell the property, you will have a Section 1231 gain that will likely qualify for investment in a QOF (even this one, provided you stay at or below 20%).
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