<p>Recently, I have spoken with a number of taxpayers who have heard about Opportunity Zones and want to know if they are a viable alternative to a 1031 exchange. My answer is usually “it depends.” Here, I provide an overview of opportunity zones and their differences from 1031 exchanges.</p>

<h2>Qualified Opportunity Funds</h2>

<p>An investment under the O-Zone code provision and proposed regulations has to be into a qualified opportunity zone listed by the Community Development Financial Institutions Fund. Typically, the zones are areas where most of the population live well below the poverty level and the O-Zone provisions are obviously designed to encourage investment into Qualified Opportunity Funds (QOF) that have, in turn, invested in qualifying new or used property or qualified businesses after December 31, 2017. These investments may not fit the taxpayer’s property investment goals.</p>

<p>Much like Section 1031, the reinvestment window for a QOF investment is 180 days after the sale. However, unlike Section 1031, the taxpayer has to purchase shares of stock or partnership interest in a QOF invested in the O-Zone. The upside for the taxpayer is that unlike the typical 1031 exchange, which requires a reinvestment of 100% of exchange value for 100% gain deferral, the investor in an O-Zone only has to reinvest the capital gain portion and can draw out the basis on the sale of the relinquished asset. The trade-off for being able to pull out the cash is the obligation to comply with the myriad of rules designed to ensure that the QOF meets the O-Zone requirements.</p>

<h2>Partial Ownership of Real Estate</h2>

<p>When a taxpayer invests into a qualified opportunity zone, they are not purchasing a discrete, solely-owned real property interest (although the taxpayer could conceivably create their own QOF). Most often the investment will comprise ownership of stock or partnership interest in the QOF. This may be an issue for most taxpayers who are used to sole control of their investments. These are the same investors who are uncomfortable with <a href="/blog/fractional-ownership-real-estate">TIC or DST ownership interests</a>.</p>

<h2>Potential for Capital Gains Deferral</h2>

<p>Investing in an O-Zone results in something different than the potential 100% deferral of capital gains achieved with Section 1031 exchanges over the course of ownership of investment or business use property. With an O-Zone investment, the taxpayer can obtain a potential exclusion of capital gain up to 15% between the acquisition of the property during the 2018-2019 window and the end of 2026 (or the earlier sale of the QOF interest). The taxpayer may also achieve 100% capital gain exclusion if the investment is held for 10 years and sale occurs before 2047. Realistically, the gain will probably only be deferred for eight years or the end of 2026, and the gain will have to be reported on the taxpayer’s 2026 return.</p>

<h2>Opportunity Zone Regulations</h2>

<p>Finally, the proposed regulations for O-Zones are complicated and are still a work in progress. For example, there is still no clear definition of what “substantially all” means for purposes of the holdings of the QOF within the qualified O-Zone. There are ongoing annual certification requirements, strict timetables for reinvestment if a QOF investment is sold, a new set of forms for election of deferral and certification, minimum investment requirements for property types, etc.</p>

<h2>Summary</h2>

<p>While O-Zone investments are not a replacement for 1031 real property exchanges, they afford benefits to taxpayers who are willing to invest in the types of properties present in the designated zones and limit their gain deferral to less than the potential 100% deferral available in a 1031 exchange. Certainly, the Treasury will continue to refine the O-Zone regulations, and most likely a whole industry will emerge around these kinds of investments. The key for taxpayers is to learn of the pitfalls and the potential benefits, find advisors who know the rules, perform their due diligence and not to get lost in the O-Zone.</p>

<p>This week, Accruit CEO Brent Abrahm joins fellow business leaders as part of the Colorado Succeeds Education &amp; Business Delegation to California's Bay Area.</p>

<p>Dubbed "The Agility Tour," the trip is an opportunity for Colorado business and community leaders to learn from national experts and visit world-class learning providers in Silicon Valley, where the culture of innovation and entrepreneurism is being successfully integrated into the area's educational ecosystem.</p>

<p>Delegation members will connect with philanthropists, transportation experts and design-thinking specialists supporting education in the area, tour diverse and engaging learning environments, and have the opportunity to visit Apple and Khan Lab School, both of which are driving innovation in education.</p>

<p><a href="https://coloradosucceeds.org/&quot; target="_blank">Colorado Succeeds</a> is a nonprofit, nonpartisan organization that brings business leaders across the state together to ensure all of Colorado's children are educated to their greatest potential.</p>

<p>Accruit CEO Brent Abrahm and Vice President Matt Medlock join other executives and corporate practitioners at the Commercial Equipment Marketplace Council's East Coast Roundtable, "a unique interactive roundtable designed to help disruptive industry leaders embrace innovation to transform their business in today’s digitalized world."</p>

<p>This year the Roundtable brings together leaders in the FinTech, Capital Markets, Technology, Equipment Purchasing, and Equipment Financing industries in a one-day event comprised of keynote speakers, interactive dicussions and peer collaboration.</p>

<p><a href="https://cemcouncil.com/&quot; target="_blank">Read more about the CEMC and its Events</a>.</p>

<p>Jordan Born, Accruit's associate general counsel, will be a panel speaker in a Careers in Real Estate Law program at The John Marshall Law School in Chicago. During the event, "Let's Taco Bout Real Estate Law," alumni of the LL.M. Real Estate program discussed their career paths and practice in Real Estate Law to both J.D. and LL.M. students.&nbsp;</p>

<p>"This event is a great opportunity for students to gain insight into various aspects of real estate law and the careers ahead of them," said Born. "I appreciated it when I was a student and enjoy being a part of the discussions with students and other alumni."</p>

<p>The safe harbor transactions fit within the parameters of the safe harbor created in September 2000 by Revenue Procedure 2000-37 and governs those transactions in which the property is parked no longer than 180 days. However, there are instances in which, for a number of reasons, the replacement property must be parked for longer than 180 days.&nbsp; Common examples are those in which the relinquished property will take longer to market and sell than 180 days or in which construction of improvements are required on the replacement property.</p>

<p>While Revenue Procedure 2000-37 does not cover so-called non-safe harbor transactions, it takes the position of no negative inference merely because certain structures are pre-approved due to the safe harbor:</p>

<blockquote>
<p>Further, the Service recognizes that 'parking' transactions can be accomplished outside of the safe harbor provided in this revenue procedure. Accordingly, no inference is intended with respect to the federal income tax treatment of 'parking' transactions that do not satisfy the terms of the safe harbor provided in this revenue procedure, whether entered into prior to or after the effective date of this revenue procedure.</p>
</blockquote>

<p>Some exchangers mistakenly believe that if a parking period extends past the 180-day deadline they can somehow allow the transaction to keep running and simply conclude their exchange without any adverse consequences. This approach to “blown” safe harbor deals has apparently found some support in a recent court case, <a href="/blog/bartell-decision-non-safe-harbor-parking-exchanges-have-just-become-safer">Bartell v. Commissioner, 147 T.C. No. 5</a>,&nbsp;&nbsp; decided August 10, 2016.&nbsp; In Bartell, the U.S. Tax Court ruled, among other things, that even though the taxpayer entered into what was essentially a safe harbor transaction on August 1, 2000 and the parking period lasted until December 31, 2001, the taxpayer’s <a href="/services/1031-exchange">1031 exchange</a> should not have been disallowed by the IRS. &nbsp;</p>

<p>In Bartell, the court overlooked the 17-month timeline even though the property was purchased by an exchange facilitator with loan funds secured by the taxpayer, the taxpayer managed the construction portion of the deal and the taxpayer was in possession of the property during the parking period.&nbsp; It is clear the parking entity did not really have any true benefits and burdens of ownership.&nbsp; Accruit believes the Bartell case should not be relied on in current similar situations for a number of reasons including the facts that the parking transaction was commenced prior to the issuance of Rev. Proc. 2000-37, it originated in the taxpayer friendly 9th Circuit and, most importantly, the IRS has since made it clear they will not acquiesce to the decision as precedent in other cases.</p>

<p>When, for any number of reasons, more than 180 days is required, the best approach may be to utilize what is referred to as a non-safe harbor reverse exchange which is specifically structured to last longer than 180 days and create true benefits and burdens of ownership in the parking entity.&nbsp; Since these are not typical parking arrangements, each transaction must be structured differently based upon the facts presented.&nbsp; The taxpayer’s CPA’s, attorneys and other advisors working for the taxpayer need to be involved in the process.&nbsp; Accruit has the necessary experience and expertise to assist the taxpayer and all of the other essential parties to the exchange process in navigating transactions outside the safe harbor.</p>

<h2>View the entire <a aria-label="10 Steps of Reverse Exchange" href="/sites/default/files/files/Reverse%201031%20infographic.pdf" title="10 Steps of Reverse Exchange">10 Steps of a Reverse Exchange Infographic</a>.</h2>

<p>Accruit, LLC is a national provider of <a aria-label="1031 Exchange Qualified Intermediary" href="https://www.accruit.com/blog/how-choose-qualified-intermediary-your-103…; title="1031 Exchange Qualified Intermediary">1031 Exchange Qualified Intermediary</a> (QI) and Exchange Accommodation Titleholder (EAT) services for simple and complex exchanges. Accruit handles all types of real property like-kind exchanges. Specialized EAT services are provided by Accruit Exchange Accommodation Services LLC.</p>

<p>A reverse exchange is a tax-deferred exchange that enables the purchase of new (replacement) property prior to the sale of the old (relinquished) property.</p>

<h2>Step One</h2>

<p><img alt="Reverse Exchange Step One" src="/sites/default/files/files/Reverse%201031-Step%201.png" style="width: 704px; height: 348px;" /></p>

<p>The taxpayer enters into a contract to purchase the replacement property, assuring the contract has no restriction against assigning the contract to a third party. In the unlikely event that it is so restricted, the contract should be negotiated to allow the contract to be assigned to the reverse exchange accommodator, Accruit Exchange Accommodation Services (AEAS) or a special purpose entity (SPE), typically an LLC, owned by AEAS to hold title to the property. Under IRS vernacular, the SPE is known as an Exchange Accommodation Titleholder (EAT).</p>

<h2>Step Two</h2>

<p><img alt="Reverse Exchange Step Two" src="/sites/default/files/files/Reverse%201031-Step%202.png" style="width: 704px; height: 533px;" /></p>

<p>The taxpayer or their advisor contacts Accruit to start an exchange and obtain a reverse exchange document package. The taxpayer and AEAS, enter into a Qualified Exchange Accommodation Agreement (QEAA) for replacement property whereby the SPE, as the EAT, will take title on the date of closing to the replacement property. The SPE is set up with AEAS&nbsp;as its sole member.</p>

<h2>Step Three</h2>

<p><img alt="Reverse Exchange Step Three" src="/sites/default/files/files/Reverse%201031-Step%203.png" style="width: 704px; height: 415px;" /></p>

<p>The taxpayer assigns the replacement property purchase contract to the EAT.</p>

<h2>Step Four</h2>

<p><img alt="Reverse Exchange Step Four" src="/sites/default/files/files/Reverse%201031-Step%204.png" style="width: 704px; height: 409px;" /></p>

<p>Unless the taxpayer is providing 100% of the necessary funds, a taxpayer selected lending bank loans the funds required for the purchase to the EAT to enable it to acquire the replacement property. The EAT signs any applicable loan documents as the borrower, however, the taxpayer signs as the guarantor of any such loan. In the event the bank does not make a 100% loan-to-value loan, the taxpayer makes a second loan for the balance needed, which should include any earnest money that may have been previously advanced. The documents required for any taxpayer loan are furnished by Accruit and typically include a Non-Recourse Promissory Note and a Pledge Agreement of Membership Interest to secure the loan.</p>

<h2>Step Five</h2>

<p><img alt="Reverse Exchange Step Five" src="/sites/default/files/files/Reverse%201031-Step%205.png" style="width: 704px; height: 481px;" /></p>

<p>The taxpayer and the EAT enter into a contract for the sale of the replacement property from the SPE to the taxpayer as well as a triple net Master Lease, which allows the taxpayer to oversee the day-to-day management of the property while it is held by the EAT. The lease provides that, in lieu of rent, the taxpayer will pay all debt service to the lender and/or the taxpayer, assuming a secondary loan from the taxpayer. Accruit may request that the taxpayer execute an Environmental Indemnity Agreement.</p>

<h2>Step Six</h2>

<p><img alt="Reverse Exchange Step Six" src="/sites/default/files/files/Reverse%201031-Step%206.png" style="width: 704px; height: 364px;" /></p>

<p>Funds are sent directly to the closing by the lender and/or the taxpayer. The closing takes place and the SPE takes title to the property. Evidence of liability insurance must be furnished to Accruit showing the SPE as the insured party, while the lender and the taxpayer may appear as additional insureds.</p>

<h2>Step Seven</h2>

<p><img alt="Reverse Exchange Step Seven" src="/sites/default/files/files/Reverse%201031-Step%207.png" style="width: 626px; height: 600px;" /></p>

<p>Within six months (180 days) of the replacement property closing, the taxpayer enters into a contract for the sale of the relinquished property and enters into a standard Tax Deferred Exchange Agreement with Accruit, who serves as the QI. The taxpayer assigns its rights (but not its obligations) under the contract for the sale of the relinquished property to the QI and gives to the buyer(s) written notice of this assignment on or before the closing. The closing must take place within the 180-day period and the net proceeds of the sale are paid to the QI.</p>

<h2>Step Eight</h2>

<p><img alt="Reverse Exchange Step Eight" src="/sites/default/files/files/Reverse%201031-Step%208.png" style="width: 704px; height: 391px;" /></p>

<p>The taxpayer assigns its rights under the contract for the purchase of the replacement property (which is now being acquired from the EAT) to the QI and gives written notice of this assignment to the EAT, on or before the closing.</p>

<h2>Step Nine</h2>

<p><img alt="Reverse Exchange Step Nine" src="/sites/default/files/files/Reverse%201031-Step%209.png" style="width: 704px; height: 535px;" /></p>

<p>The taxpayer directs the QI to disburse the exchange proceeds to the EAT as part, or all, of the purchase price. The EAT receives the funds and immediately wires those funds to the lending bank and/or to the taxpayer to pay down all or part of the debt.</p>

<h2>Step Ten</h2>

<p><img alt="Reverse Exchange Step Ten" src="/sites/default/files/files/Reverse%201031-Step%2010.png" style="width: 704px; height: 339px;" /></p>

<p>The taxpayer takes ownership of the replacement property via an assignment of the membership interest in the EAT which transfers the LLC, and the property it holds, from the member (AEAS) to the taxpayer. Alternatively, a deed may be issued to the taxpayer by the EAT and the LLC may be dissolved. The taxpayer takes the membership interest or the deed relating to the replacement property subject to the balance of any debt.</p>

<p><em>Note: The foregoing suggested procedural outline is made available by Accruit to interested parties and to licensed attorneys and it is intended to be used as a guideline. It is not intended to be relied upon, or viewed in any way, as legal advice, and is furnished for purposes of convenience only. As a qualified intermediary, Accruit is prohibited from providing tax or legal advice. Taxpayers must seek such counsel from their advisors.</em></p>

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