OPPORTUNITY ZONES: Demystified

1. OPPORTUNITY ZONES: Demystified Robert C. Guth

2. A Disclaimer • This is where I normally put the typical disclaimer: • This is not legal advice. • This is not meant to be used as legal advice. • This is not a substitute for paying, I mean talking to, your lawyer. • Seriously, do not assume that the information here is even accurate. • If you are about to invest any significant amount of time, energy, or money in reliance on something you heard or read in this short presentation . . . don’t! First invest a little more time, energy, and money in getting real legal advice, tailored to your real situation. • But in addition to all of that, please note that the Opportunity Zone legislation discussed here is very new and full of uncertainty and unanswered questions. • The purpose of this presentation is to give you a sense of the topic, so that you know better what questions to ask. To better fit that purpose, this presentation favors simplicity and clarity over thoroughness and accuracy. • Also, the views expressed herein – particularly with respect to the effects of Opportunity Zones – are my own and may not reflect the views of my firm or other attorneys within the firm.

3. INTRODUCTION

4. Opportunity Zones in a Nutshell • A tax incentive • For investors with prior capital gains • To fund new business and development • In “Qualified Opportunity Zones” (QOZs)

5. A Tax Incentive • Created by the “Tax Cuts and Jobs Act” • P.L. 115-97 • I.R.C. §§ 1400Z-1, 1400Z-2. • How it works • If you have capital gains ≤ 180 days old • And you invest in a qualified OZ fund • You get some great tax benefits

6. The Benefits • Deferred tax on rolled-over gains Gains rolled over into a qualifying OZ fund aren’t taxed until 2027 (or until OZ fund interest is sold) • Discounted tax on rolled-over gains If you hold your OZ fund investment for at least . . . • 5 years  10% reduced tax • 7 years  15% reduced tax • 10+ years of tax-free gain No tax on gains from sale of OZ fund interest if • Held for 10+ years, and • Sold before Jan. 1, 2048

7. Example of Tax Benefits in Action • Awhile ago you bought land for $2MM • August 1, 2018 –you sell for $3MM, realize $1MM capital gain • You “realize” a $1MM capital gain • You have until Jan. 28, 2019 to rollover into qualified OZ fund • Jan. 1, 2019 – you buy $1MM of OZ fund stock • April 15, 2019 – TAX TIME – Deferral • You report the land sale and $1MM gain • Ordinarily, you might owe as much as $200k in capital gains tax • But you also report the OZ fund purchase and defer paying anything on the rolled over gain • Jan 1, 2024 – you’ve held your OZ fund investment for 5 years (10% discount) • If you sold now, you’d owe • $180k on rolled-over gains • Tax on any gain on sale of OZ fund • Jan. 1, 2026 – you’ve held your OZ fund investment for 7 years (15% discount) • If you sold now, you’d owe • $170k on rolled-over gains • Tax on any gain on sale of OZ fund • December 31, 2026 – deferral period ends for everybody • April 15, 2027 – TAX TIME – must pay tax on deferred gains (if you haven’t already) • You now mustpay $170k tax on rolled-over $1MM gain – whether or not you sell • Jan. 1, 2029 – you’ve held your OZ fund investment for 10 years (no tax on sale) • If you sell now, or anytime before Jan. 1, 2048, you owe no tax on the sale.

8. Two Investments, Three Benefits Prior Gains rolled into OZ Fund Investment in OZ Fund OZ Fund interest bought with rolled-over gains Taxed as any ordinary investment, except . . . Benefit #3: No Tax If you hold for 10+ years, and Sell before Jan. 1, 2048 No tax on gains from sale of OZ Fund investment • Capital gains from prior investment • Would be taxable/taxed in year you invest in OZ Fund • Benefit #1: Deferral • No tax until • you sell OZ fund interest, or • Dec. 31, 2027 tax year • Benefit #2: Discount • 5 years  10% • 7 years  15%

9. Nuts & Bolts Three Basic Components: • Qualified Opportunity Zones (“QOZs”) The tracts of land designated to benefit from the program • Qualified Opportunity Zone Business Property (“QOZBP”) Actual investment needed to qualify for tax benefits • Qualified Opportunity Funds (“QOFs”) Investment vehicle used to access tax benefits

10. A note on jargon . . . • QOZs, QOFs, QOZBs, QOZBPs The prevailing lingo is hard on the tongue, the ears, and the brain. • I prefer: • “OZ Zones” = qualified opportunity zones Yes, I know, ATM Machine. Grammar foul, but it works. • “OZ Fund” = qualified opportunity funds Or just “Fund” when we all know we’re taking about OZs. • “OZ Assets” = the actual stuff OZ funds invest in to qualify for tax benefits May be direct through OZ fund or first-tier operating sub.

11. oz Zones

12. Qualified Opportunity Zones • Tracts of land nominated by governors (and D.C.’s mayor), certified by U.S. Treasury Dep’t • Had to meet certain “low-income community” standards, but flexibility has allowed expansion into already developing or developed regions • Ship has sailed. • All OZ Zones have been set. • It’d take an act of Congress to change them. • Literally.

13. QOZs – Tennessee

14. QOZs – Davidson County

15. QOZs – Urban Nashville

16. oz Funds

17. Qualified Opportunity Funds • Tax incentive is built around a new investment vehicle: Qualified Opportunity Fund (or “QOF”) • To get the tax benefits, investors need only . . . • Have eligible gains (i.e., capital gains, less than 180 days old) • Buy QOF equity interest (with cash) • File simple form with personal tax return • The Funds • Find and invest in qualifying OZ assets • Certify compliance to the IRS • Pay penalties for noncompliance

18. OZ Fund Requirements • Three basic requirements: • Must be a corporation or partnership (for federal income tax purposes) • C-Corps, LPs, LLPs, LLCs taxed as corporations, LLCs taxed as partnerships – all clearly qualify. • S-Corps? Probably, but not as clear. • Disregarded LLCs? No, must be a regarded entity. • Must be formed in U.S. Entities formed in possessions, territories may only invest in those areas. • Must be at least 90% invested in OZ Businesses

19. Fund it and forget it? • Funds are meant to carry most of the burden and risk • But what happens to investors if/when their Fund fails? • Best case: penalties reduce the Fund’s value • Worst case: IRS de-certifies Fund entirely • Do investors lose their right to • Deferral? • Discounts? • 10+ years untaxed gain? • Not yet clear • These uncertainties could be handled by agreement between a fund and its investors, but power dynamics and other business realities could make that impractical. • Best advice: investor beware

20. OZ Assets

21. Qualifying Opportunity Zone Business Property (“QOZBP”) • Under the law, OZ funds must invest 90% of their total assets in something called “qualified opportunity zone business property” • But the official definition of “QOZBP” is so bad, it’s best to ignore it. • Instead, I like to start with an unofficial term I call “OZ Assets”

22. OZ Assets • An OZ Asset is • Tangible property • Bought on/after Jan. 1, 2018 • Bought new or “substantially improved” • *Used in a trade or business • *Used mostly within an OZ Zone *Still awaiting guidance on these

23. Tangible Property • Generally, includes anything you can touch • Manufacturing Equipment • Buildings/structures • Office equipment, furnishings • Generally, does not include • Land • Cash • Intellectual property • Financial investments

24. New or Substantially Improved • New • “The original use of the tangible property in the qualified opportunity zone commences with the [current owner.]” • Prop. Reg. §1.1400Z-2(d)-1(c)(4)(2) – further guidance is expected • Substantially Improved • Owner doubles its cost basis over 30 months

25. Simplest Example • Facts: • You buy vacant land in OZ Zone on 1/1/2018. • You build a factory (completed before 7/1/2020) and buy a bunch of new equipment. • You use the factory and equipment in an active manufacturing business. • Analysis: • The factory and equipment are all OZ Assets. • The land is not.

26. A little more nuanced . . . • Facts: • You buy an existing factory in OZ Zone on 1/1/2018. • You renovate the structure (completed before 7/1/2020) and buy a bunch of new equipment. • You use the factory and equipment in an active manufacturing business. • Analysis: • The equipment is still all OZ Assets. • The land still is not. • The factory? Depends. Did you double your cost basis? Does the IRS agree with your calculations?

27. Real world, real complicated • Facts: • You buy an existing factory in OZ Zone on 1/1/2018 • Demo the factory • Build new mixed-use residential and commercial space (substantially complete before 7/1/2020) • You and your tenants fill the space with a whole bunch of new, refurbished, and unimproved tangible assets. • Analysis: • The land is not an OZ Asset. • The rest? Call an attorney. • And brace for some uncertainty – until more guidance is issued.

28. Putting it all together Typical oz deal structure

29. Basic Opportunity Zone Structure Investors OZ Fund OZ Assets

30. OZ Fund’s 90% Requirement • 90% of an OZ fund’s total assets must be qualified OZ assets • Tested twice annually • Fiscal six-month end • Fiscal year end • If average of sixth-month and year-end tests is < 90%, fund faces penalties (disqualification?) Investors OZ Fund OZ Assets

31. Investing through First-Tier Subsidiary • Generally, investments in other companies are not OZ Assets • But equity in a first-tier operating subsidiaries may be counted as an OZ Asset if • 70% of sub’s tangible assets are OZ assets; and • Other requirements, limitations are met, e.g., • 5% cap on “nonqualified financial property” • 50% income from OZ business • Intangibles largely used in OZ First-Tier Subsidiary OZ Fund OZ Assets OZ Assets

32. Working Capital • “Substantial improvement” doesn’t happen overnight. • What about expected improvements? • Or cash held in reserve? • Not strictly OZ Assets • But Proposed Regs give us a safe harbor for working capital First-Tier Subsidiary OZ Fund New OZ Assets Improved OZ Assets New Assets Working Capital? Improved Assets

33. Working Capital Safe Harbor “31-Month Plans” • Working Capital • Cash, cash equivalents • Earmarked to buy, improve OZ Assets • Per written plan • Must be commercially reasonable • Within 31 months of receipt of cash • Subs with 31-month plan may count as OZ Assets: • Working Capital • Assets to be improved per working capital plan First-Tier Subsidiary OZ Fund New OZ Assets Improved OZ Assets New Assets Working Capital Improved Assets To-be Improved

34. Mixed Investors • REMEMBER • To get tax benefits, investors must rollover capital gains • Otherwise, an investment in an OZ fund is just an ordinary investment • But OZ Funds are allowed to have both qualified and non-qualified investors • And investors are allowed to have both qualified and nonqualified interests Investor(s) Eligible Gains Anything Else Ordinary Interests Qualified OZ Interests OZ Fund

35. Complete Opportunity Zone Structure • Tax Benefits • Deferred tax on rolled-over capital gains • 5 yrs, 10% basis ↑ • 7 yrs, 15% basis ↑ • 10+yrs, no tax on sale of OZ Fund interest • No Benefit • Taxed as usual Ordinary Interests Qualified OZ Interests First-Tier Subsidiary OZ Fund 90% Test 90% of Fund’s total assets should be qualified OZ assets New OZ Assets Improved OZ Assets 70% Test 70% of sub’s tangible assets should be qualified OZ assets, working capital, and/or assets to-be improved by working capital. New Assets Working Capital Improved Assets To-be Improved

36. Timeline of Opportunity Zone Development Project Fund buys/forms first-tier sub Sub sets working capital plan Working capital is expended Sub acquires property Capital Gains Realized Sub constructs, improves Purchase OZ fund equity 180d 6mos* 31mos *Actual timeline may vary depending on Fund’s start month and fiscal year. Fund should form sub and commence working capital plan as soon as commercially reasonable and practicable.

37. Frequently Asked Questions • Who can invest in an OZ fund? • Anyone! • But only shares bought with rolled-over gains get tax benefits • And watch out for securities laws! • Who can start an OZ fund? • Anyone! • You do not need to have capital gains to start an OZ fund and offer the tax benefits to other investors who do have the gains to rollover • How many investors do you need? • Technically, just one. • No minimum. • No maximum. • Who certifies or polices OZ funds? • Funds “self certify” when filing their federal tax return • IRS will police to ensure funds meet the statutory/regulatory requirements

38. QUESTIONS?