April 16, 2019
The Opportunity Zone program has spurred a great deal of interest within the commercial real estate industry, especially among developers. Qualified Opportunity Funds are being created, geared to funnel income from capital gains into ground-up building development, as well as renovations of already existing structures.
Mary Burke Baker, with K&L Gates LLP, stepped in with a reminder that the program isn’t just about building or redevelopment, however. The program is also in place to assist any active trade or business within those Opportunity Zones, including manufacturing, retail, hospitality, medical practice, research facilities, energy plants and grocery stores. In fact, fostering new businesses in lower-income areas was an important driver behind the legislation, as the goal is to create long-term, sustainable economic growth which would, in turn, lead to well-paying jobs.
Baker pointed out that, while investing directly in a building makes sense for real estate developers, “holding an equity interest in a qualified industrial, retail or technology business allows an investor to have a stake in an entire company.” That stake, by the way, includes tangible assets such as production lines, machinery and buildings. Also included in this type of property are patents and the existing workforce.
One main advantage for business investment is that only 70% of tangible property held by a qualifying Opportunity Zone business is required to be qualifying Opportunity Zone business property. Meanwhile, when it comes to real estate, the QO is required to hold 100% of tangible property. Baker noted that the 70% rule benefits investors, because more businesses will meet the requirements for program incentives.
Much like the asset test for Opportunity Zone commercial real estate, Opportunity Zone businesses also face tests.
- More than 50% of gross receipts must be derived from active conduct of the business in the zone.
- A substantial amount of any intangibles held by the business must be used in the business.
- Less than 5% of the assets may be held in nonqualifying, intangible property. These include ownership in another business and certain passive assets.
Baker closed her article by pointing out that regardless of which investment approach is used, investors need to conduct their due diligence to avoid costly mistakes that might, in turn, mean disqualification for preferential treatment of capital gains.
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Tags: Opportunity Zones