By James Holleman, Vice President of Capital Formation
Opportunity Zones offer unique advantages for both communities and investors, incentivizing development in underserved areas through tax benefits for investors. But all Opportunity Zone funds are not created equal.
At Grubb Properties, we structured the Link Apartments Opportunity Zone REIT to maximize the benefits of the program. By utilizing a REIT structure, we offer investors significant advantages that would not be attainable under the traditional private fund structure, while enabling greater flexibility for the fund manager to optimize returns.
By structuring the fund as a REIT, taxes are reported on Form 1099-DIV and only in years where we make distributions. In a commingled limited partnership, investors receive a K-1 and must complete state-level tax filings in each of the states in which a fund has invested, creating a significant tax-reporting burden. 1099s are only reported for federal purposes and for state purposes only in the investor’s state of residency.
If a partnership-based QOF invests in a state which is a “non-conforming” state, meaning that its state tax laws do not provide for the QOZ benefits, investors will generally be required to pay state taxes to that state, even on the post-10-year realization. By limiting our reporting to a 1099-DIV, investors are required to pay taxes only in the state in which they reside. Therefore, if an investor lives in a non-tax state or a “conforming” state, they will not be required to recognize taxes in non-conforming states in which our QOF invests (California, New York, and North Carolina).
One of the primary benefits of opportunity zone investing is to minimize capital gains taxes. The REIT structure enables us to internalize depreciation with the intent of offsetting revenue to reduce the requirement to produce net income distributions, instead favoring tax-advantaged return of capital distributions. Every dollar distributed to fund investors as taxable income, regardless of structure, reduces the tax-free growth potential of the fund. Additionally, internally captured depreciation within the fund enables us to ensure that more investment dollars receive the full benefit of the 10-year capital gains exclusions.
The REIT structure also enables us to better manage the tax implications of our investments. A prevalent misconception in opportunity zone investing is that all properties in a QOF must be held for ten years to achieve the tax benefits. This is inaccurate, as the actual restriction lies with the investor holding interests in the QOF itself. In a QOF structured as a partnership, any sale of assets must be passed through to investors, which, if done prior to year ten, will eliminate some tax benefits. Therefore, the only option for a partnership to sell a property and preserve the benefits for investors is through a 1031 exchange, which can be complicated and difficult to pull off in a QOF due to the requirements of the program. With the REIT structure, we can sell a property and execute a 1031, as well, but we also have the additional option to pay taxes on the gain generated by the disposition asset and reinvest the balance, giving the capital another chance to grow inside the fund, ultimately creating a larger back-end benefit.
Visit our Link Apartments OZ REIT page here to learn more about our Qualified Opportunity Fund program.
Vice President of Capital Formation