We hear from people for whom the pace of clarity around Opportunity Funds is too slow. Maybe they sold an asset and have gains they want to shelter; or they are holding an asset they want to sell, but only if they can roll the gain into an Opportunity Fund. There aren’t any generally-available Opportunity Funds yet, so they ask, “Can I create my own Opportunity Fund today?”
Theoretically Yes: As it stands today, the law allows for Opportunity Funds to be created, and for capital gains to be deferred through investment in the new Opportunity Funds.
Practically, Not a Great Idea: It seems a great risk to start an Opportunity Fund now because we don’t have draft regulations from the IRS yet. The IRS has wide discretion to adopt regulations under the Opportunity Fund statute, and those regulations could have some surprises in them. There is a good chance it will be difficult, expensive and/or impossible to conform an Opportunity Fund created today, to regulations that are issued at a later date. (We anticipate seeing draft regulations in the next month or two, and final regulations sometime toward Fall of this year.)
But Maybe: A very simple approach might work today, without uncomfortable exposure to regulatory risk. It would look like this: (i) Taxpayer sells an appreciated asset and rolls some or all of the gain into a new corporation/partnership (the Opportunity Fund) that is limited in purpose to investing in qualified opportunity zone property; (ii) the Opportunity Fund uses all of the invested gain (plus 3rd party debt if desired) to purchase an asset in an Opportunity Zone. In addition to being located in an Opportunity Zone, the asset must satisfy either the “original use test” or the “substantial improvement test.”
“Original Use Test”. To satisfy the Original Use Test, the original use of the property in the Opportunity Zone must commence with the Opportunity Fund. For example, the business of the Opportunity Fund is food processing, and the Opportunity Fund purchases a new food processing line and installs it in a leased building within an Opportunity Zone.
“Substantial Improvement Test”. To satisfy the Substantial Improvement Test, the Opportunity Fund must invest (within 30 months after acquisition) an amount equal to the Opportunity Fund’s basis in the property on the date of acquisition. For example, the Opportunity Fund acquires an old building for $3m, and invests an additional $3.1 m to retrofit it to a new use.
The anticipated lifespan of the investment should exceed 10 years due to existing ambiguity about interim-realization of gains by an Opportunity Fund. And there are of course other considerations that must be taken into account; you will need competent and adventurous counsel onboard.
If anyone out there has already created an Opportunity Fund, we would love to hear about it, and we will share your story if you let us. You can email us at info@Opportunity-Funds.com.