What is an Opportunity Zone (“O-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 Cadre’s 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 for more information.)
What is a Qualified Opportunity Fund (“O-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 an O-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 an Opportunity Fund?
Investments are required to be equity investments in businesses or real estate 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 O-Funds are expected to target development and rehabilitation projects. For example, an O-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 an O-Fund do not need to be made with capital gains and an O-Fund can pool eligible capital gains and “other capital.” However, only investments of qualifying capital gains are eligible for the O-Zone tax benefits.
Do I need to rollover my entire capital gain into the O-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 O-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 an O-Fund investment, a taxpayer must generally invest in the O-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 an O-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?
O-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 O-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.
(To learn more about certifying your investment, see Cadre’s Opportunity Zones How-To Guide.)
How is this reinvestment different to a 1031 exchange?
Unlike a 1031, the O-Zone rules allow you to reinvest any gain, not just gain from the sale of “like-kind” real estate assets. Moreover, O-Zone investment requires no intermediaries. You can hold your gain on your own and still benefit on any part of it you invest in an O-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 an O-Fund even if the O-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 an O-Fund immediately. For that O-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 O-Fund (and in all events by December 31 of the O-Fund’s first year) and must generally contemplate the expenditure of the O-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 O-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 an Opportunity Zone Fund?
Cadre’s Opportunity Zones program is not a single fund, but a series of single-asset O-Funds that investors can access. In other words, each O-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 Zones investing. Leading law firms have noted that “a traditional [commingled] fund structure with multiple properties is not a straightforward fit for the OZ Program”1 and that instead, fund managers “may wish to create a separate fund for each property.”2
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 O-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 O-Zone eligible deals. Please contact us for more information on the Managed Account solution.
Cadre has indicated that it intends its O-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 O-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 O-Fund. (It’s important to note that the purchaser of your interest may not be able to receive any of the O-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 O-Fund.
(See our Secondary Market FAQ for more information.)
What is Cadre’s exit strategy?
The O-Zones Rules stipulate that investors must sell their O-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 O-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 O-Fund can vary, and investors should review the terms of each investment before deciding to invest.