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Opportunity Zones—A New Decade of Potential
February 07, 2020

During 2019, one of the hottest tax incentives in commercial real estate was the opportunity zone/fund tax incentive (OZ  incentive). Novogradac reports that as of Jan. 8, 2019, $6.72 billion in capital was raised for 502 separate qualified opportunity funds. The New York Times described the incentive in August as a “Trump Tax Break That Became a Windfall for the Rich.”  Several pieces of legislation were introduced to refine the program, and on the eve of 2019, the Treasury Department issued Final Regulations explaining and finalizing the interworking of the incentive. That gave your friendly neighborhood* tax and real estate attorney just enough time to refresh his operating agreements before the end of the year.    

Now that 2019 is closed, here are some major takeaways from our OZ structuring work and the Final Regulations as we look ahead to the next decade of OZ deals. 

As background, the OZ incentive allows for investors in projects or businesses located in certain designated census tracts to defer invested capital gain, that would otherwise be required to be recognized, until 2026, if the capital gain is reinvested in an OZ and the OZ investment is held for 10 years, investors can avoid paying taxes on gain from the sale of the OZ investment. Most deals are structured with one entity, known as the qualifying opportunity zone business (QOZB), conducting the business or project and a second entity, the qualified opportunity fund (QOF), investing in the QOZB as an equity member.

The Final Regulations provide a clear road map about how to organize many OZ deals and generally follow prior guidance from Proposed Regulations issued by the Treasury Department. The Final Regulations reinforce the program’s accessibility for nearly any scale project.  The OZ incentive is relevant for at least the next three years with benefits being phased out over time. 

The major takeaways from Parsons Behle and Latimer’s 2019 OZ structuring work are:

--The OZ incentive makes good projects better, but it is not a windfall. A project that can’t provide cash flow and is financed with 100 percent debt is not going to become viable simply by integrating the OZ incentive. 

--The OZ incentive’s value to the investor is a function of their optimism about the zone’s overall future growth. As such, OZ projects benefit from coordinated development.  A project that is not anticipated to appreciate substantially over the next 10 to 20 years will not benefit greatly from OZ incentives.

--Every OZ deal requires the same three ingredients:  capital gains that would otherwise be recognized; a site (leased or purchased) in an opportunity zone acquired from an unrelated party; and a project that will qualify as a QOZB.    

--The QOZB is typically developed before funds are solicited or QOFs created.

--Although deferred capital gains that were placed in OZ Funds before Dec. 31, 2019, will enjoy an additional five-percent-basis step-up, this does not fundamentally change the OZ incentive.  Many of our clients chose to delay realizing gains believing the market return would exceed the opportunity cost of tying up money in an OZ fund.**

Two major takeaways from the Final Regulations for OZ investors and projects are:

The Final Regulations provide a water mark as to what it means to be engaged in a “trade or business” to qualify as a QOZB. In both the first and second tranche of initial regulations, the Treasury Department indicated that the underlying QOZB must be something more than a passive activity. The requirement serves both as an anti-abuse rule and investment motivation to spur additional economic activity in the zone. The Final Regulations provide that only entities that are “engaged in a trade or business within the meaning of section 162” will be a QOZB. That generally means the taxpayer must be involved in the activity with “continuity and regularity and that the taxpayer’s primary purpose for engaging in the activity must be for income or profit.” (citing Commissioner v. Groezinger, 480 U.S. 23, 25 (1987)). 

The Final Regulations appreciate that the section 162 requirement will be most applicable to real estate investments, a primary source of OZ projects. Fortunately, the Treasury Department provided the following specific guidance:

  • Solely for the OZ incentive “the ownership and operation (including leasing) of real property is the active conduct of a trade or business.”
  • However, “merely entering into a triple-net-lease with respect to real property owned by a taxpayer does not constitute the active conduct of a trade or business.”

The Final Regulations include an example that effectively defines a triple-net-lease as one under which the tenant pays taxes, insurance and maintenance expenses in addition to rent. The existence of a property manager or staff member of the landlord does not remedy the situation, per the example. 

The Final Regulation also includes an example describing a mixed-use office set up, with one triple-net-lease tenant that would qualify as a QOZB. The example suggests that for real property leasing to qualify as a QOZB, two-thirds of the building must be leased with non-triple-net-lease arrangements and  the owner must staff and maintain an office in the building which is “regularly” used by employees to carry out managerial activities. 

Shareholder/Partners/Members of Pass-Throughs can still invest 2019 gains.  Section 1400Z-2(a)(1)(A) requires investments in a QOF to occur within 180 days of the date of such sale or exchange.  With the Final Regulations, the Treasury Department further extended the window for pass-through entities (partnerships, S corporations and decedents’ estate) to investment.   

Under the Final Regulations, the 180-day period for partners or a shareholder of a pass-through entity that elects not to defer gain begins on the due date of the entity’s tax return, not including extensions so long as the pass-through entity did not notify its partners/shareholders. So, for a partnership that realizes capital gains on Jan. 1, 2020, partners would have until Sept. 10, 2021, to invest the capital gain in a QOF. Partnerships and shareholders that realized gain anytime during 2019 can still invest in a QOF in 2020, if the entity does not defer under the provision.   

--Ross P. Keogh practices in Parsons Behle & Latimer’s Missoula, Mont. office and focuses his practice on opportunity zones, tax, corporate and real estate transactions, energy, environmental and natural resource matters and estate planning.  To discuss this article or other related matters, contact Ross at (406) 206-9710 or by sending an email to

*On Nov. 1, I joined the regional law firm Parsons Behle and Latimer as part of its Missoula, Mont. office.   

** The additional five percent incentive for a Montana investor reduced total taxes by only about one percent. The Dow Jones Industrial Average has returned nearly two percent since Dec. 31, 2019.