Introduction:
Find out everything about the holding period of a Qualified Opportunity Zone Fund. Come join me.
Economically disadvantaged areas called Qualified Opportunity Zones (QOZ) may be eligible for special tax treatment for new investments under specific criteria. Because the Secretary of the Treasury has delegated his authority to the Internal Revenue Service, localities nominated for Qualified Opportunity Zone status by a state or territory are eligible for such designation (IRS).
Do Qualified Opportunity Zones have a lengthy history?
No, there isn’t. On April 9, 2018, the first set of Qualified Opportunity Zone designations, encompassing parts of 18 states, was announced. All 50 states and US territories have been recognized as Qualified Opportunity Zones.
Since being established as part of the Tax Cuts and Jobs Act in 2017, Qualified Opportunity Zone (QOZ) investing has gained increased attention and momentum. While investment capital in Qualified Opportunity Zone funds has expanded significantly every year since the program’s inception, one crucial aspect of the Qualified Opportunity Zone legislation is that the investment must be held for a minimum of 10 years.
Understandably, we’ve discussed investment redemption with nearly all of our 600 Qualified Opportunity Zone Fund investment partners, as cautious due diligence is required before making a 10-year commitment in an illiquid investment. In this article, we’ll explain what happens if you need to sell your Qualified Opportunity Zone Fund investment during the mandated 10-year hold period, what occurs after the hold period, and how and when we value our Fund.
Our Opportunity Zone Fund seeks an investment minimum of ten years to ensure compliance with Qualified Opportunity Zone program legislation. While we cannot amend the Qualified Opportunity Zone program’s minimum 10-year hold period, we have added a provision in our Qualified Opportunity Zone Fund that allows investors to redeem before the 10-year hold period expires in an emergency. Redemptions made before the conclusion of the hold period must be paid for with cash flow and refinancing proceeds, as selling assets before December 31, 2031, would cause the Fund to be out of compliance. Every investment must wait at least one year before requesting a redemption.
The assets of the Qualified Opportunity Zone Fund are valued quarterly, and any redemption between years one and ten is priced at the current net asset value (“NAV”), less a discount that burns off each year. The redemption window is open for the first year, and the discount is 10% of NAV, which is lowered by 1% every year until it reaches zero.
While this may appear to some to be a punishment, keep in mind that this liquidity provision is just for emergency usage and is a deviation from the specified hold duration. Furthermore, redemption before completing a 10-year-old will result in the loss of some tax benefits associated with the Qualified Opportunity Zone program.
It should be noted that giving liquidity to one individual reduces cash flow to all other investors in the Fund; yet, the Fund’s discount to the NAV benefits all other partners in the Fund. The Fund purchases the position at a somewhat lower than fair market value, compensating the other investors for the cash flow disturbance.
We plan to examine who may be considering requesting a redemption after their 10-year mandated hold around two years before December 31, 2031 (10 years after the Fund’s final closing). Understanding demand early allows us to reserve funds, sell assets, refinance properties, or use other measures to meet those needs.
Following the 10-year hold period, redemptions will be limited to 5% of the Fund’s NAV per calendar quarter. This will be a best-efforts approach, with pro-rata payments depending on an investor’s contributed capital if a tender offer is oversubscribed. If redemption requests exceed 20% of the Fund’s NAV for two consecutive calendar quarters, the Fund may choose to leverage, sell, or otherwise monetize assets to meet the redemption requests.
Investors do not have to redeem their Fund shares after ten years. After ten years, investors can continue to produce cash flow and benefit from long-term tax-free appreciation. Investors may withdraw from the Fund at any time after year ten throughout the Fund.
Qualified Opportunity Zone Fund Appraisal
Requests for Qualified Opportunity Zone Fund redemption will be assessed on the first day of each calendar quarter for those who submitted them on or before that date. We plan to redeem an investor’s stake at the prevailing NAV as of the most recent valuation date within 90 days of receiving a request for liquidation. For example, investors who want to redeem their interest on January 1, 2032, will be redeemed at the value as of December 31, 2031, with the request completed by April 1, 2032. Only investors who request liquidation on or before January 1, 2032, will be eligible for the redemption period in the first quarter of 2032.
Our asset management team will appraise the Fund’s assets using best practice valuation procedures, including the fair market value of each property owned by the Fund. The team considers broker valuations, appraisals, the cost of new development, and similar sales and leases. The Fund will be audited each calendar year by a third-party accounting firm. The audit will look at how we perform our appraisal and the valuation itself.
As a reminder, our projected returns are net of our fee structure and do not include any Qualified Opportunity Zone tax benefits. Our initiatives must make sense on their own merits, regardless of tax benefits, because we are investing in assets we believe in and want to own for the long term. In addition, there are no disposition or redemption fees. Based on our forecasts, a $500,000 investment in the Fund today will rise to $1.25 million following a 10-year holding period.
Why Is a 10-Year Hold Worth It?
The Qualified Opportunity Zone program offers considerable benefits to individuals who have capital gains. While ten years may seem long, we expect the Fund’s assets to produce regular income flow while also increasing in value. In short, we have substantial personal wealth invested alongside Qualified Opportunity Zone Fund clients. They did the arithmetic and discovered that a traditional investment would require a 3.7 net equity multiple to obtain the same anticipated after-tax return as the Qualified Opportunity Zone Fund.
Over a ten-year investment horizon, institutional real estate has a consistent history of rising in value, and not being taxed on the way out is icing on the cake.
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Come join us! Email me at mark@dolphinpi.us to find out more about our next real estate investment.