The Opportunity for OZs and Historic Buildings

Novogradac Journal of Tax Credits | April 2019 | Volume X - Issue IV
By: Albert Rex

Shortly after the 2017 tax reform legislation was enacted, questions began about historic buildings in newly realized opportunity zones (OZs).

Look no further than this issue of the Journal of Tax Credits to read the many conversations about the use of OZs. While those in our field rely on the tax experts to explain how the program really works, we can offer insight on how this may generate additional equity for historic tax credit (HTCs) projects when combined with state and federal HTCs.

You probably know the basics. There are approximately 8,800 designated OZs across the United States. Each state selected its own through a variety of processes with the only requirement being that they were in census tracts that were already designated low income communities (LICs) and no more than 25 percent of LICs could be labeled OZs. The OZs are not part of a program, such as the New Market Tax Credits (NMTC) program, but are in a statute that has the incentive benefit sunsetting in 2026. That means there may be a little less long-term predictability for OZs and there is less procedural information than with the NMTCs that have been renewed every several years. This lack of guidance has created a situation where a lot of people are talking about OZs, setting up qualified opportunity funds (QOFs) and are prepared to make investments, but it is unclear how quickly those investments will come and exactly what they will look like.

The good news is that OZs exist and that they are bringing new investors from family offices, high net-worth individuals and some banks that are reallocating gains in in order to create QOFs. More good news is that real estate, and in particular historic buildings, are well suited for these types of investments, with OZs potentially creating a new pool of equity for HTC deals. OZ investments require that assets must be purchased after 2017 and that the entity acquiring the real estate must be at least 80 percent unrelated  sellers. There is also a requirement that if the investment is in already used property (essentially a rehab project) then the investment must exceed the investor’s basis in the building in any 30-month period. This last requirement is much like the substantial rehabilitation test requirement for the federal HTC and many state HTC programs.

According to the National Trust for Historic Preservation’s Leadership Forum, “Of the 1,035 historic tax credit (HTC) projects completed nationwide in 2017, 46 percent were in Opportunity Zones. And 48 percent of designated Main Street communities are in Opportunity Zones as well.” It is only natural for OZs to contain an array of historic buildings, since they were selected at the state level and they were required to be in LICs; most states want to see investment in areas that already have the infrastructure and people in place– such as aging industrial cities or underserved main street areas. The percentage of HTC projects in OZs is likely to increase as QOFs start making investments.

The above statistics appear to be a positive sign that QOFs should see HTC deals as a great investment opportunity, but what does that really mean? We have established that the rules for real estate investment align well with HTC projects; we have established that a large number of HTC developments should be found in OZs; but what is the ultimate attraction of this investment? The answer to that question lies in the goal of the OZ investor as allowed by the statute.

Some in the real estate industry feel the QOFs can be a new vehicle for real estate owners that typically participate in Internal Revenue Code (IRC) Section 1031 exchanges, which allows an investor to sell a property to reinvest the proceeds in another property and to defer all capital gains taxes. Like the IRC Section 1031, the gains are deferred to a later date in OZs. The deferring of these gains in OZs is a benefit to the investor, although there is some risk as the deferral will be at the tax rate in the year in which the gains are paid, in this case 2026, and capital gains tax may increase between now and then.

It would seem that just deferring the capital gain is not the ultimate reason for OZ investment. Another component of the statute is the forgiveness of additional gains depending on the type and timing of the investment and sale of the asset in which the investment has been made. In this case, not only will the investor in the OZ defer tax payment on capital gain for multiple years, they may pay a reduced tax or potentially no tax on gains they realize during their participation in an OZ. This could generate some strong returns for OZ investors that pick the right project and timing.

At the recent National Housing & Rehabilitation annual meeting, Ricky Novak, co-managing partner at the Strategic Group Atlanta, discussed the OZ market based on his experience with family office and private equity investors. He sees HTCs as the primary program that will get attention from OZ investors, as they are just not looking to shelter capital gains but want to see residual value with the least amount of investment. He noted the de-levering of historic deals by stacking state and federal HTCs creates an attractive investment opportunity in historic downtown markets and other OZs.

States with historic assets in OZs and strong state HTC programs will likely see interest from OZ investors. If the state has other mechanisms for adding funds to the capital stack and reducing investment risk, like an incentive for workforce housing, then that would further interest on the part of OZ investors, since multifamily housing continues to be a big focus for this investor pool.

Unlike the NMTC program and other mature tax credits, there is simply not enough experience or guidance to fully anticipate the impact of OZs on HTC developments. What exists are a lot of experienced lawyers, CPAs and investment consultants trying to figure out how to make this all work. Even more importantly, QOFs are already established and investors are looking for ways to put their money into these transactions. Finding ways to apply both OZ funding and HTCs will create a path to more historic rehabilitations as more is known about the new incentive.

More equity looking for more and better historic projects? That sounds like a great opportunity. ;

 This article first appeared in the April 2019 issue of the Novogradac Journal of Tax Credits.

© Novogradac & Company LLP 2019 - All Rights Reserved

Notice pursuant to IRS regulations: Any U.S. federal tax advice contained in this article is not intended to be used, and cannot be used, by any taxpayer for the purpose of avoiding penalties under the Internal Revenue Code; nor is any such advice intended to be used to support the promotion or marketing of a transaction. Any advice expressed in this article is limited to the federal tax issues addressed in it. Additional issues may exist outside the limited scope of any advice provided – any such advice does not consider or provide a conclusion with respect to any additional issues. Taxpayers contemplating undertaking a transaction should seek advice based on their particular circumstances.

This editorial material is for informational purposes only and should not be construed otherwise. Advice and interpretation regarding property compliance or any other material covered in this article can only be obtained from your tax advisor. For further information visit