Opportunity Zones: FAQs from MIE's Webinar

Question

Answer

What are implications for funds, investors, and investees when an investor wants to exit a fund?

Ruth: Individual fund agreements generally will specify when/how investors may exit the fund and the terms/conditions may vary. Because of the additional tax benefits for holding fund interests for at least 10 years, some funds may be structured based on an assumption that investors will stay in the fund for 10 years.

How flexible is the fund creation for individual taxpayers? Can an individual taxpayer create a fund where they’re the sole owner? 

Ruth: Opportunity Funds (O Funds) are flexible investment vehicles.  I am not aware of any tax provision that would prevent an individual from creating a fund and investing in that fund, nor are there any requirements that investors be unrelated.  However, there are some related party rules in the statute. For example, in order for a capital gain to qualify for deferral, it must arise from a sale/exchange with an unrelated person. In addition, Qualified OZ Business Property must be acquired from an unrelated person.  Also, Treasury has broad authority to issue regulations to address any perceived abuses.

Will the CDFI Fund be involved in terms of tracking type / level of investment? And can NMTC, QSBS, LIHTC, etc. work in concert with OZs?

Ruth: There is no prohibition on using NMTC, LIHTC, or other programs in concert with OZs - although it may not be easy to fit the different requirements of the different provisions together.  It is not clear yet what sort of reporting will be required of O Funds or whether Treasury will actively track the funds.

Outside of real estate, what other kinds of projects can OZs fund? What about disaster recovery and climate resilience?

Aaron: The only way to answer this question is to invert it. O Funds can fund any active trade or business that is not a federal sin business. This is not a traditional federal program so there is guidance on what can be funded and how. It is up to market participants to create structures that accomplish community needs (like disaster recovery and resilience) and are attractive to investors. As in every market, what is attractive is relative to the other alternatives available in the market. The central questions to ask are, “what is the expected risk adjusted return of the investment I’m offering and how does that compare to the alternatives that are in the marketplace?”  and, "if my investment requires an investor to care about the social impact, who is that investor and how much yield will they trade for that impact?” No one can answer those questions for investors as it relates to any given project or initiative. We all need to figure it out for ourselves in this new market.

Have fund managers expressed willingness to make multiple, small investments into low-margin small businesses?

Aaron: It’s unclear whether O Funds will deliver low cost equity into small community businesses at scale. I’m sure there will be some isolated examples of local funds delivering some volume of capital in this space. I’m skeptical these funds will change the landscape much, at least in the near term. Our research is telling us that most managers operating at scale do not intend to provide low cost capital or change their business model in any significant way. The behavior change may be that these managers will look to apply their existing business model to new geographic markets once they are convinced they can’t deploy the capital in their existing footprint. That will take time. If the competition between managers is strong enough, over time we may see a loosening of terms and a change in practices. Impossible to know how long that behavior change might take, if ever.  

Can Kresge Foundation share examples of good fund management/ administration with multiple investors with different objectives?

Aaron: Not yet. We are in the middle of negotiating with fund managers now. We are attempting to extract certain social impact and responsible investing commitments in exchange for our support. We don’t know if these managers will be willing to make that trade.  More to come.

Can you provide more information on the support offered by Kresge Foundation?

What action steps do you want to see coming from foundations?

How can we engage OZ residents and connect them with potential investors?