Q: I am purchasing property in an Opportunity Zone with owner financing. Does this eliminate your ability to enjoy the benefits that are provided by this incentive? –--Kenyatta
A: Great question, Kenyatta, and thanks for thinking of us to provide an answer! Opportunity zones (OZ), of course, are pretty new with best practices still developing, so we turned to an expert to provide some insight.
Here's what he had to say:
In general, can I use financing to purchase property in an opportunity zone?
Yes, the tax benefits of the opportunity zone for investors are based on the qualified opportunity fund (QOF) invested in the qualified opportunity zone business (QOZB). An investor invests capital gains into a QOF and invests that money in a QOZB, and those invested funds receive the beneficial treatment. For example, if the investor wished to purchase a QOZB whose purchase price was $500,000 but only had $100,000 in capital gains, the investor could use the $100,000 as a down payment and finance the remaining purchase price.
Can I purchase a QOZB through seller financing?
Yes, so long as the seller sells the QOZB and retains no more than 20% of the QOZB. Seller financing occurs when the seller holds a note or other debt instrument on the property sold. In the same scenario above, if the investor purchased the property by putting $100,000 down and utilizing seller financing for the remaining $400,000 of the $500,000 purchase price, it would satisfy the QOZB requirements. Remember, the QOF benefits only apply to the QOF investing in the QOZB, so 100% seller financing would not benefit the investor.
What businesses can I invest in?
The property has to be vacant, new, or substantially improved. You may invest in a business when more than 50% of its gross income from the active conduct of a trade or business is in an opportunity zone and when it uses a substantial portion of its intangible assets in such trade or business
What businesses qualify? How about start-up businesses?
Anything except "sin businesses," such as casinos, golf courses, liquor stores, and massage parlors. And yes to start-ups. In that same scenario above, the investor could invest the $100,000 in the start-up company pursuant to the private offering documents provided by the start-up company, assuming the start-up company is a QOZB.
I have represented a client where the building, located within an opportunity zone, the client wished to acquire would not satisfy the substantial improvement test to qualify as a QOZB, but the investor utilized a 1031 exchange to acquire the building.
The client then used its QOF to fund the start-up business that will be the tenant in that building. The gain on that $100,000 invested in the start-up will grow capital gain tax-free so long as the investment is held no less than 10 years.
If you have a question, please email email@example.com to be featured in an upcoming column.
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