Opportunity Zones: Basic Overview & Key Concepts

Opportunity Zones: Basic Overview & Key Concepts Erik Rickard(614) 628-1444 erik.rickard@btlaw.com

Opportunity Zones: Basics • Legal Authority: • Added to Federal Tax Code as part of the Tax Cut and Jobs Act (P.L. 115-97, December 22, 2017) • Qualified Opportunity Zones (“QOZ’s”) have 10-Year Life (est. in 2018, therefore expire on December 31, 2028) • Initial IRS Regulations (released October 2018), but more to follow • Purpose: • QOZ’s were created to serve as a tool to spur economic development and job creation in distressedcommunities • Unlike federal NMTC and other programs for deferral of capital gains, there is no national limitation on the amount of gain that can be deferred or excluded under this program

Opportunity Zones: Basics, cont’d • Purpose: • Provides tax incentives to encourage investors to re-direct gain from prior investments into new investments in Qualified Opportunity Zones • Incentives: • Long-term taxdeferraland partial tax exclusion on capital gains invested in QOZ’s • Eligible for tax exclusion from new capital gains achieved from those QOZ investments • Desired Outcome? Encourage equity share in business expansions and development projects in QOZ that would likely not otherwise occur

Opportunity Zones: Basics, cont’d • Key Concepts: • “Qualified Opportunity Zone” (“QOZ”) • “Qualified Opportunity Fund” (“QOF”) • “Qualified Opportunity Zone Business” • “Qualified Opportunity Zone Property” • Equity share in QOZ Business (so either “Qualified Opportunity Zone Stock” or “Qualified Opportunity Zone Partnership Interests”), or • QOZ Business Property

Opportunity Zones: Basics, cont’d • What is a “Qualified Opportunity Zone”? • Population census tract that is a low-income community, nominated by a State’s governor, and designated by the Secretary of U.S. Treasury • Chief executive of each U.S. state, territory and D.C. was authorized to nominate up to 25% of its low-income community census tracts (by April, 2018) • Gov. Holcomb nominated maximum 25% of Indiana’s low-income census tracts as “Opportunity Zones”, all of which were certified by Secretary of U.S. Treasury • 156 OZ’s selected based on combination of factors

Opportunity Zones: Basics, cont’d • Where are the “Qualified Opportunity Zones”? • Indiana: For a map showing all 156 QOZ’s, tract number and county in which it’s located, please visit https://www.in.gov/gov/2979.htm • Nationwide: For a list of all QOZ’s, maps and additional resources, please visit https://www.cdfifund.gov/Pages/Opportunity-Zones.aspx

Opportunity Zones: Mechanics, cont’d • How does it work? • Investors can defer paying taxes on any prior capital gain (e.g., sale or exchange of stock, partnership interests, real estate, etc.) • General Rule for Timing of Investment: Must re-invest the gain in a “Qualified Opportunity Fund” within 180-days of the sale or exchange of property producing the gain, and elect to defer the gain

Opportunity Zones: Mechanics, cont’d • Exception to the General Rule: If a partnership incurred the gain and the partnership did not make the election, a partner could elect to have the 180 days start on the last day of the partnership’s taxable year • Basis in QOF investment is initially $0

Opportunity Zones: Mechanics, cont’d • Tax Benefit #1: Temporary Deferral of Taxes • Taxpayer can defer paying taxes on prior capital gains reinvested in a QOF until the earlier of: • The date on which the QOF investment in the QOF is sold or exchanged, or • December 31, 2026 • Taxpayer’s basis in QOF investment is increased by the amount of gain recognized at end of deferral period

Opportunity Zones: Mechanics, cont’d • Tax Benefit #1: Temporary Deferral of Taxes • All tax attributes of deferred gains are preserved through deferral period and taken into account when the gain is included in the taxpayer’s income

Opportunity Zones: Mechanics, cont’d • Tax Benefit #2: Deferral & Exclusion • 5 Years: If taxpayer holds QOF investment for at least 5 years, basis of the taxpayer’s QOF investment is increased by 10% of gain rolled into the QOF • Recognition Amount: At end of deferral period, taxpayer must include in income the excess of: • Lesser of (1) capital gains rolled-over, or (2) the FMV of taxpayer’s QOF investment as of end of deferral period, over • Taxpayer’s basis for the QOF investment • Effective Result: 10% of the deferred gain is permanently excluded from taxation

Opportunity Zones: Mechanics, cont’d • Tax Benefit #2: Deferral & Exclusion • 7 Years: If taxpayer holds QOF investment for at least 7 years, basis of the taxpayer’s QOF investment is increased by 15% of gain rolled into the QOF • Recognition Amount: At end of deferral period, taxpayer must include in income the excess of: • Lesser of (1) capital gains rolled-over, or (2) the FMV of taxpayer’s QOF investment as of end of deferral period, over • Taxpayer’s basis for the QOF investment

Opportunity Zones: Mechanics, cont’d • Effective Result: 15% of the deferred gain is permanently excluded from taxation • Important Reminder Notes: • In order to realize the full 15% deferral, investment in a QOF must be made no later than December 31, 2019 • In order to realize the 10% deferral, investment in a QOF must be made no later than December 31, 2021 • The last date to invest in a QOF is December 31, 2028 (i.e., the date when all Opportunity Zone designations expire)

Opportunity Zones: Mechanics, cont’d • Tax Benefit #3: Exclusion of Additional Gains • Taxpayer’s basis in QOF investment is increased by the amount of gain recognized at end of deferral period • 10 Years: If taxpayer holds QOF investment for at least 10 years and taxpayer makes election, the basis of its QOF investment is increased to the FMV of the investment on date that the QOF investment is sold or exchanged • Result: No federal tax on appreciation of QOF investment

Opportunity Zones: Mechanics, cont’d Source: Forum on Affordable Housing and Community Development Law

Opportunity Zone Funds: Basics • What is a “Qualified Opportunity Fund”? • An investment vehicle created for purpose of investing in “Qualified Opportunity Zone Property” (other than another QOF) • Can be a corporation, LLC or partnership • Must be created or organized in one of the 50 U.S. States, D.C., or a U.S. territory • Self-Certify as a QOF by filing IRS Form 8996 • QOF’s will own full assets or shared ownership position in real estate and operating businesses located in QOZ’s • Note: A direct investment in Qualified Opportunity Zone Property or an investment vehicle not certified as a QOF will not be eligible for the tax incentives described above

Opportunity Zone Funds: Basics, cont’d • Requirements for QOF’s: • Must hold 90% of its assets in “Qualified Opportunity Zone Property”, as measured by average percentage held at last day of first 6-month period of the QOF’s taxable year, and the last day of the QOF’s taxable year • The QOF can specify the taxable year and month in which it first becomes a QOF; investments before such first month do not qualify for benefits • If QOF fails the 90%-asset test, must pay penalty for each month it fails to meet requirement • 90%-asset test uses values reported on QOF’s certified audited financial statements or costs of assets if such financial statements unavailable

Opportunity Zone Funds: Basics, cont’d Even though QOZ designations expire December 31, 2028, taxpayers may continue to hold QOF interests invested in those QOZ’s and are still eligible for stepped-up basis of their QOF investments to FMV if they hold investment for 10 years Per IRS proposed regs, an investment made as late as June 30, 2027 and sold as late as the end of 2047 will qualify for full basis step-up Treasury provided the additional 10-year period (through 2047) to avoid tax-inducted sales as soon as 10-year holding requirement met

“Qualified Opportunity Zone Property” • #1) Equity interest in an entity that is a U.S. corporation, partnership or LLC that is organized to be “Qualified Opportunity Zone Business” • Must be acquired after December 31, 2017, at original issuance, and solely for cash • During “substantially all” of the time that QOF holds the equity interest, the entity must satisfy requirements as a “Qualified Opportunity Zone Business”

“Qualified Opportunity Zone Property”, cont’d • #2) Qualified Opportunity Zone Business Property • Tangible property used in trade or business of the QOF if: • acquired by purchase after December 31, 2017; • original use of the property in the QOF commences with the QOF or the QOF “substantially improves” the property; and • during time QOF owns the property, “substantially all” of the use of such property was in a QOZ • Property treated as “substantially improved” by QOF if capital improvements made with respect to the property in 30 months after acquisition by QOF exceed the QOF’s purchase price of the property • Rev. Ruling: Improvements need only double owner’s basis in a building and not the basis in land as well (encourages re-purposing of buildings)

“Qualified Opportunity Zone Business” “Substantially all” (i.e., 70%) of the tangible property owned or leased by the business is “Qualified Opportunity Zone Business Property” (see definition above) At least 50% of the business’ gross income must be derived from the active conduct of a trade or business within a QOZ, and a substantial portion of the business’ intangible property is used in the active conduct of a trade or business within a QOZ Excluded Businesses: Commercial golf courses, country clubs, massage parlors, hot tub facilities, suntan facilities, racetracks or other facilities used for gambling, or any stores the principal business of which is sale of alcoholic beverages for consumption off premises

“Qualified Opportunity Zone Business”, cont’d • Intended Result? If a QOF directly operates a disqualified business in an opportunity zone, the property of the disqualified business can qualify as Qualified Opportunity Zone Property, but if the QOF operates the disqualified business through a subsidiary corporation or partnership, the subsidiary stock or partnership interest would not qualify as Qualified Opportunity Zone Property • Less than 5% of the aggregate unadjusted bases of the entity’s property is nonqualified financial property (“NQFP”) • NQFP includes debt, stock, partnership interests, options, futures contracts, forward contracts, warrants, notional principal contracts, annuities, and other similar property specified in regulations • Excludes (a) reasonable amounts of working capital held in cash, cash equivalents, or short-term debt (≤18 months), and (b) trade receivables

“Qualified Opportunity Zone Business”, cont’d • The proposed regs provide for a 31 month working capital safe harbor which provides that qualified working capital assets are reasonable if three requirements are satisfied • The assets are designated in writing for the acquisition, construction, and/or substantial improvement of tangible property in an opportunity zone (the “written designation”) • There is a written schedule consistent with the ordinary start-up of a trade or business for the expenditure of the working capital assets within 31 months of the receipt by the business (the “written schedule”)

“Qualified Opportunity Zone Business”, cont’d • The working capital assets are actually used in a manner that is substantially consistent with the written designation and schedule (the “consistent use”) • Practical Note: The proposed regs do not provide such a safe harbor for a QOF. For a QOF, testing dates govern investment window

One or Two Tiered Investments • Factors favoring direct investment by the QOF • No prohibition on disqualified business • Simple (for investments that easily meet the Qualified Opportunity Zone Business Property test) • Factors favoring two tier investment (i.e., QOF investments in a corporation, partnership or LLC) • 70% tangible property test (versus 90% assets test) • Working capital safe harbor, including 31-month investment period

Opportunity Zones: Additional Resources • IRS Frequently Asked Questions: • https://www.irs.gov/newsroom/opportunity-zones-frequently-asked-questions • Text of Legislation • https://www.congress.gov/115/bills/hr1/BILLS-115hr1enr.pdf • Proposed IRS Regulations • https://www.irs.gov/pub/irs-drop/reg-115420-18.pdf • IRS Guidance (Revenue Ruling): • https://www.irs.gov/pub/irs-drop/rr-18-29.pdf

Disclaimer This document is not intended to provide advice on any specific legal matter or factual situation, and should not be relied upon without consultation with qualified professional advisors Any tax advice contained in this document and any attachments was not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties that may be imposed under applicable tax laws, or (ii) promoting, marketing, or recommending to another party any transaction or tax-related matter

Opportunity Zones: Basic Overview & Key Concepts