What is an Opportunity Zone?
Introduced by the Tax Cut and Jobs Act of 2017, “Opportunity Zones” are low-income census tracts designated by state and federal government. Qualifying investments in these tracts may be eligible for preferential tax treatment if made through existing capital gains.
(Read: Guide to Opportunity Zones.)
What is the purpose of Opportunity Zones?
Opportunity Zones are an economic development tool — that is, they are designed to spur economic development and job creation in distressed communities.
(See: IRS FAQ)
What is a Qualified Opportunity Fund?
An investment vehicle that invests a certain percentage of its assets in Qualified Opportunity Zones (percentage threshold varies depending on how investments are structured, but generally 70%+). Investors that reinvest capital gains into a Qualified Opportunity Fund can receive meaningful tax breaks including capital gains deferral, a substantial step up in tax basis, and tax abatement of all post-investment appreciation. Unlike the 1031 exchange program that has long been used to defer real estate-related taxable gains, eligible capital gains are not limited to real estate and can include gains from stocks and business or personal assets.
What types of investments can be made through a Qualified Opportunity Fund?
Investments are required to be equity investments in businesses or real estate in within an Opportunity Zone. Most real estate investments will be subject to a “substantial improvement” requirement within 30 months of the purchase date. As a result, real estate Qualified Opportunity Funds are expected to target development and rehabilitation projects. For example, a Qualified Opportunity Fund could invest in a ground-up development of a mixed-use project that includes new retail and workforce housing.
Do I need to fund my investment with capital gains?
No. Investments into a Qualified Opportunity Fund do not need to be made with capital gains and a Qualified Opportunity Fund can pool eligible capital gains and “other capital.” However, only investments of qualifying capital gains are eligible for the Opportunity Zone tax benefits.
Do I need to rollover my entire capital gain into the Qualified Opportunity Fund?
No. The regulations also clarify that you can choose to rollover only a portion of the gain. Also, investors may divide a single gain to be invested into multiple Qualified Opportunity Funds.
How do I know if my capital gains are “eligible”?
There are two key things to consider when determining eligibility of gains. First, only gain treated as a capital gain for U.S. federal income tax purposes is eligible. Ordinary income/gains such as depreciation recapture are not eligible.
Second, to defer a gain through a Qualified Opportunity Fund investment, a taxpayer must generally invest in the Qualified Opportunity Fund during the 180-day period beginning on the date of the sale or exchange giving rise to the gain. Where the gain is earned through a partnership or joint venture that does not choose to roll the gain into a Qualified Opportunity Fund, an individual partner’s 180-day clock starts at the end of the tax year of that venture. (However, if you know the date of sale for gain earned in a venture, you can choose the earlier date if you need to invest earlier.)
How do I get my investment certified by the IRS?
Qualified Opportunity Funds will self-certify using Form 8996 as a part of their tax return. Given the self-certification, there is no initial approval process by the IRS. Cadre, as the manager of the Qualified Opportunity Fund, will need to file IRS Form 8996 every year to report compliance with the 90% asset test and other matters required by the IRS. When filing tax returns, investors will elect a deferral using Form 8949. All investors should consult their tax advisers regarding their individual reporting requirements.
How is this reinvestment different to a 1031 exchange?
Unlike a 1031, the Opportunity Zone rules allow you to reinvest any gain, not just gain from the sale of “like-kind” real estate assets. Moreover, Opportunity Zone investment requires no intermediaries. You can hold your gain on your own and still benefit on any part of it you invest in a Qualified Opportunity Fund within 180 days. Please reach out to us for a more comprehensive side-by-side between 1031s and Opportunity Zones.
I am sitting on substantial capital gains and my 180-day clock expires soon. Can I place this gain in a Qualified Opportunity Fund even if the Qualified Opportunity Fund is not ready to invest all the gains immediately? If I invested all my gain with Cadre today, how long would Cadre have to invest it?
The Proposed Regulations allow you to invest in a Qualified Opportunity Fund immediately. For that Qualified Opportunity Fund to qualify prior to undertaking a development/investment, the manager must produce a written schedule that describes the planned expenditure of the cash (and other working capital).
This schedule must be produced prior to the end of the first 6 month period of the Qualified Opportunity Fund (and in all events by December 31 of the Qualified Opportunity Fund’s first year) and must generally contemplate the expenditure of the Qualified Opportunity Fund assets within a 31-month period, thereby providing the flexibility to extend the window between gain recognition and capital deployment to as much as three years.
Advisers have told us that a best practice is to have your written plan correspond to an identified asset for purchase. Our structure follows that advice and we avoid the potential risks associated with basing your Qualified Opportunity Fund on a written plan that requires the future identification of assets, even within a pipeline. Please reach out to us to discuss specifics related to your situation in order to arrive at an optimal funding strategy.
Do I still have to pay state tax?
One practitioner has stated that “Investors in states that do conform with the federal opportunity zones provisions may receive state tax incentives similar to those available at the federal level. Conversely, investors residing in nonconforming states may be unable to defer and reduce state taxation on the initial gains invested in Opportunity Zones. Investors in these non-conforming states may also be required to recognize gain for state tax purposes on their eventual sale of the opportunity fund investment.”
A list of conforming and non-conforming states prepared by a national firm may be found here. All investors should consult their tax advisers to confirm their local requirements.
Is Cadre creating a Qualified Opportunity Fund?
Cadre’s Opportunity Zones program is not a single fund, but a series of single-asset Qualified Opportunity Fund that investors can access. In other words, each Qualified Opportunity Fund offering on Cadre’s platform will be held within its own investment vehicle. Since inception, we’ve focused on structuring single-asset funds, which we believe is the optimal structure for Opportunity Zone investing. Leading law firms have noted that “a traditional [commingled] fund structure with multiple properties is not a straightforward fit for the Opportunity Zone Program” and that instead, fund managers “may wish to create a separate fund for each property.”
How can I participate in the Cadre program?
Investors can participate in the Opportunity Zones program in the same way they participate in non-Opportunity Zone deals. Once a transaction is available for subscription, we will open that deal for allocation requests on the Cadre platform. Investors can then select investments they want to invest in. Subject to set asides for managed accounts or institutional commitments, allocation requests are accepted on a first-come, first-serve basis with an investment minimum of $50k.
If I participate, can I achieve diversification, or will I be choosing one asset?
Our approach is intended to provide investors the opportunity to achieve multi-asset diversification, as well as the structural simplicity and regulatory clarity associated with holding each deal through a separate Qualified Opportunity Fund vehicle. While subject to market conditions, Cadre expects to have 3-4 single asset funds available for allocation within an investor’s 180-day window. Investors who have the ability to manage their capital gains and commit to a two-year drawdown period can also participate through Cadre’s Managed Account structure, which will give investors programmatic access to each of Cadre’s Opportunity Zone eligible deals. Please contact us for more information on the Managed Account solution.
Cadre has indicated that it intends its Opportunity Zone program to hold deals for at least 10 years to take maximum advantage of the potential tax savings. Will I be able to dispose of my interest in the Qualified Opportunity Fund prior to the 10-year hold period?
Achieving liquidity prior to the full hold period will not necessarily negate the tax benefits to you – the rules permit further rollover of gains realized upon a sale of your interest in the Qualified Opportunity Fund. (It’s important to note that the purchaser of your interest may not be able to receive any of the Opportunity Zone tax benefits.)
To this point, we do intend to offer investors the ability to list their interests on our Secondary Market during our hold period. The availability and use of the Secondary Market are subject to the terms of that feature and there is no guarantee that a buyer will be found if you do list interests. Investors should therefore plan to hold the asset for the full life of the Qualified Opportunity Fund.
What is Cadre’s exit strategy?
The Opportunity Zones Rules stipulate that investors must sell their Qualified Opportunity Fund interests in order to claim the benefit of eliminating capital gains tax on investment appreciation. The requirement to sell fund interests is a key reason Cadre has chosen to set up single-asset funds as opposed to mixed-asset funds where managers may need to execute a portfolio sale across assets. Generally, each Cadre Qualified Opportunity Fund will be structured as a 15-year partnership, subject to customary extension options. We expect to seek to optimize a sale between years 10 and 15. The terms of each Cadre Qualified Opportunity Fund can vary, and investors should review the terms of each investment before deciding to invest.
Next Steps for Interested Investors
The views expressed above are presented only for educational and informational purposes and are subject to change in the future. No specific securities or services are being promoted or offered herein.
This communication is not to be construed as investment, tax, or legal advice in relation to the relevant subject matter; investors must seek their own legal or other professional advice.
Performance Not Guaranteed
Past performance is no guarantee of future results. Any historical returns, expected returns, or probability projections are not guaranteed and may not reflect actual future performance.
Risk of Loss
All securities involve a high degree of risk and may result in partial or total loss of your investment.
Liquidity Not Guaranteed
Investments offered by Cadre are illiquid and there is never any guarantee that you will be able to exit your investments on the Secondary Market or at what price an exit (if any) will be achieved.
Not a Public Exchange
The Cadre Secondary Market is NOT a stock exchange or public securities exchange, there is no guarantee of liquidity and no guarantee that the Cadre Secondary Market will continue to operate or remain available to investors.
Opportunity Zones Disclosure
Any discussion regarding “Opportunity Zones” — including the viability of recycling proceeds from a sale or buyout — is based on advice received regarding the interpretation of provisions of the Tax Cut and Jobs Act of 2017 (the “Jobs Act”) and relevant guidances, including, among other things, two sets of proposed regulations and the final regulations issued by the IRS and Treasury Department in December of 2019. A number of unanswered questions still exist and various uncertainties remain as to the interpretation of the Jobs Act and the rules related to Opportunity Zones investments. We cannot predict what impact, if any, additional guidance, including future legislation, administrative rulings, or court decisions will have and there is risk that any investment marketed as an Opportunity Zone investment will not qualify for, and investors will not realize the benefits they expect from, an Opportunity Zone investment. We also cannot guarantee any specific benefit or outcome of any investment made in reliance upon the above.
Cadre makes no representations, express or implied, regarding the accuracy or completeness of this information, and the reader accepts all risks in relying on the above information for any purpose whatsoever. Any actual transactions described herein are for illustrative purposes only and, unless otherwise stated in the presentation, are presented as of underwriting and may not be indicative of actual performance. Transactions presented may have been selected based on a number of factors such as asset type, geography, or transaction date, among others. Certain information presented or relied upon in this presentation may have been obtained from third-party sources believed to be reliable, however, we do not guarantee the accuracy, completeness or fairness of the information presented.