Opportunity Zone Magazine Opportunity Zone Magazine Volume 1, Issue 1 | Page 12
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OPPORTUNITY ZONE MAGAZINE | VOLUME 1
•
ISSUE 1
ADDITIONAL TIPS FOR QOZ INVESTMENTS
& ASSET ACQUISITIONS
While awaiting additional guidance, certain best practice tips
include:
Due Diligence: QOF sponsors are encouraged to
undertake meticulous due diligence of each potential
investment, whose merits must be reviewed in a manner
that is independent of the suite of QOZ tax benefits
that will apply to investors. QOFs can rely on the QOZ
tax benefits to enhance each investment’s return (ROI)
and thus enhance the “pitch” to potential investors.
However, securities laws and duties of care still apply
and require thorough due diligence to avoid surprises
that were discoverable. ROI can be further enhanced by
adding other public incentives in the capital stack, which
are compatible with the QOZ Program (e.g., LIHTCs,
NMTCs, EB-5, etc.) that encourage socially responsible
investing that benefits communities.
Post-Closing Assistance with Data Collection:
In the course of negotiating term sheets and definitive
purchase agreements related to acquire QOZ assets,
partnership interests and stock, QOZ fund sponsors
should consider inserting language to require the QOZB
to cull operations data to ease the QOFs compliance
burden. The data requested would be tailored to the size
and nature of the asset but should reveal how much of
its income was derived from within a QOZ during the
reporting period. Venture capital QOFs are particularly
cautioned to procure this assistance from QOZB in
which they invest.
Representations and Warranties: If the QOF fails to
meet the 90-percent asset test, a penalty will generally
apply in an amount equal to the product of: the excess of
the amount equal to 90 percent of the QOF’s aggregate
assets, over the aggregate amount of QOZ property
held by the QOF, multiplied by the underpayment
rate. QOF sponsors should consider whether to insert a
representation in the definitive purchase agreement that
if the QOF fails the 90-percent asset test because of the
QOZB’s lack of cooperation to produce data or related
breach of representations in definitive agreements, the
QOZB might be required to indemnify the QOF. An
additional QOZB representation to consider includes a
covenant to remain within a QOZ and continue primary
operations therein during the compliance period (subject
to allowed exceptions).
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Representations and Warranties Insurance: The
widespread acceptance of representation and warranty
insurance to underwrite the risk of loss associated
with breaches of representations and warranties in the
definitive agreements might be useful on many QOZ
investments. A closing condition of the QOF could
require the QOZB to obtain a representation and
warranty insurance policy.
The proposed regulations clarify many of the questions
relating to investments and compliance by a QOF. QOF
sponsors, investors and developers have since communicated
constructive feedback and it appears that the IRS and
Treasury are listening. Hope is warranted that the final
regulations will fine tune the program to encourage
investment in the QOFs with lessened compliance and
qualification standards. Meanwhile, QOF sponsors are
encouraged to be steadfast in their adherence to all applicable
guidance and proceed with the high standards of care.
D ebbie A. K lis has a broad financial practice focused on
securities and private fund formation, including Opportunity
Zones, venture capital, hedge funds, private equity, real estate
funds/syndications, EB-5 and international master-feeder funds.
Klis frequently speaks and writes regarding private equity, fund
formation, Opportunity Zones and crowdfunding. Her experience
includes structuring debt and equity investments with alternative
sources of income, including private equity, EB-5 financing, HUD
loans, LIHTC, tax credits, bonds, energy credits and crowdfunding.
Klis is part of Polsinelli’s multidisciplinary team representing
developers, fund sponsors and investors regarding QOFs.
Sources:
1
An operating business may qualify as a QOZB if, among other requirements, at least 70
percent of its tangible property (owned or leased by its trade or business) is QOZB property
and the business is not a golf course, country club, massage parlor, hot tub or suntan facility,
racetrack or gambling facility or a store that sells alcoholic beverages for consumption off
premises.
2
A substantial improvement means that the additions to the basis of the property during the
30-month period commencing on the acquisition date must exceed the adjusted basis of the
property as of the acquisition date.
3
The New Market Tax Credits (NMTC) regulations allow an entity to meet the gross income
requirement if 50 percent of the use of its tangible property is within a low-income community.
IRS and Treasury are being urged to interpret the QOZBs gross income requirement as it does
with NMTC.
4
However, if the calendar-year QOF chooses July or later as its first compliance month, the
QOF will have just one testing date f
5
However, if the capital generated is not derived from capital gains, negative tax consequences
could result. i
6
See https://blogs.cfainstitute.org/investor/2018/05/07/growing-trends-in-private-equity-
secondary-market-investing/
7
This penalty will not apply if the failure is due to “reasonable cause.”
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