by Benjamin Paltiel
Baker Tilly Virchow Krausse, LLP is an IMA Member
Opportunity zones were devised for the benefit of investors to encourage them to take their capital out of stagnation and place it into underdeveloped areas. But investors don’t have to be the sole recipients of the program’s goodwill.
Through careful design of operating agreements, real estate developers can also join in on tax benefits from OZs. If they pay attention to investment structure and other incentives beyond the opportunity program, developers can increase their capital stack, reduce the total cost of their projects and create higher returns for themselves and their investors.
“A carefully structured operating agreement can be a classic win-win,” Baker Tilly partner Randy Barrus said. “Different investors have different tax profiles — they may be able to provide capital and see returns in different ways. It’s not about taking a slice of the pie and allocating it elsewhere, it’s really just expanding the pie for everyone.”
Much of the focus of the opportunity zone program has been on the investor-backed funds that can reap tax benefits by deferring capital gain payments. But the capital stack for an opportunity zone project goes far beyond opportunity funds. Developers can also source capital from institutional sources, which can take advantage of tax write-offs through depreciation losses, Barrus said, or even not-for-profit programs and grants that are tax-exempt. Beyond an opportunity fund, a general partner could provide cash for a project, and take advantage of passive losses that OZ investors cannot reap.
Barrus said that there is no strict formula: Each opportunity zone developer needs to carefully assess their capital stack to make sure that they are approaching it in the most tax-advantageous way.
“Baker Tilly consults with developers to model the benefits they can pass on to their potential investors, through the entire life cycle of the OZ,” Barrus said. “We even offer a matchmaking service between sellers and buyers, and build custom solutions for OZ projects.”
By carefully parsing which investors see which returns, developers can grow their capital stack and ensure that investors are not overpaying on any taxes. Developers can also take advantage of numerous other tax programs to reduce the overall cost of a project, bringing everyone higher returns. Many opportunity zone tracts overlap with areas that are eligible for New Market Tax Credits — a government program that promotes investment in underserved areas around the nation.
Unlike the opportunity zone programs, NMTC provides actual tax credits, rather than tax deferral, so the two programs are mutually beneficial. Developers can also earn credits for creating jobs and even receive historic tax credits for preserving and developing historic spaces.
“The OZ benefit is really just one tool in a very big toolbox,” Barrus said. “Our job is to make sure that developers are taking advantage of all the programs that make sense for them, to reduce the overall cost for them and their investors.”
Barrus said he has also counseled developers on other financing programs that can supplement their capital stack, including PACE financing, which can help pay for green upgrades to buildings, and tax increment financing, by which developers can partner with local agencies to receive property tax abatements in return for their work.
“We’re coming to clients and saying, ‘Here are all the opportunities at your fingertips, let us help you craft the best solution for you and your investors,’” Barrus said. “These additional tax benefits and opportunities should be considered when determining the total after-tax internal rate of return available to potential investors.”
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