Thread by @DallasAptGP

Opportunity Zone investing is VERY tax advantaged. It has been called a tax shelter...

I've seen some people have 💡💡moments about this but not enough people “get it” yet. The 10-year basis step up combined with cost seg and bonus depreciation is wild.

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Beginning steps that I'll gloss over for this thread which I’ve written about previously:

**You had a short/long term capital gain
**You created a “Captive OZ Fund” and contributed all/part of the gain
**Your OZ Fund invested directly into RE or into a GP’s QOZB

Before you jump into OZ investing please check with a CPA and/or tax attorney (I am neither). It is complicated and you need good advice.

I am going to use some of the examples and language that @sweatystartup introduced last week since it was clear/concise.

Let’s say your QOF bought a $1mm value add apartment building at a 7% UYOC. It generates $70k in net operating income (before debt service but after value add)

$300k down and the other $700k from a bank

OZ Fund paid for 30% but gets to enjoy the tax benefits on all of it

This example is a “value-add” deal in an OZ. The adj. tax basis of the building has to 2x.

We’ll assume that land value is $200k, building at acquisition was $400k, and post-closing improvements were $400k.

New depreciable basis (since you can’t depreciate the land) is $800k

Let’s say you straight line depreciate over 27.5 years (multifamily). 3.6%/year

Depreciation isn’t a real expense that comes out of your checking account.

It’s a form of tax deferment and is written off as an expense on your taxes. It lowers your tax liability.

3.6% on $300k equity check wouldn’t be much. Only $11k. But the depreciation write-off includes the part the bank paid for as well.

That’s a cheat code!

3.6% on the $800k is $29k. That’s 10% of your initial cash investment and you get to write this off every year.

There’s more. Not every part of the building you buy is depreciated on a 27.5 yr schedule. The windows, doors, HVAC, cabinets, appliances, etc are on a 5, 7, or 15 year schedule

You can pay a firm to do a cost segregation for you and assign values to all of these things

There’s a piece of tax code to incentivize buying and holding assets

Bonus depreciation

It comes and goes based on political administration but it allows you to write off everything under a 15 yr life in year one. The first year the property is put in service!

In many cases you'll get 30%+ of the total depreciable basis assigned to this shorter lifespan and depreciated in year 1

30% of $800k is $240k
$240k is 80% of YOUR $300k investment!!

In a 30% tax bracket, this is worth $72k

If you or your spouse is a “real estate professional” (IRS designation) this can offset your active income from W2

Even for non-REPro, the depreciation write offs become suspended losses and when property is sold (hopefully a gain) then your taxable gain will be reduced.

In a non-OZ deal, depreciation writeoffs are generally looked at as an interest free loan from the IRS.

When you sell the property you have to “recapture” the benefit of the writeoff and pay the forgone taxes.

Opportunity Zone deals ARE DIFFERENT.

In the OZ structure, depreciation is no longer an interest free loan from the IRS, it is much more like a tax credit.

If you hold for 10+ years then you get to step up the value of the assets to fair market value.

For REPro, if you’ve been using the OZ Fund’s K-1 to offset active income for 10+ years then you won’t have to recapture that.

For non-REPro, after step-up, the suspended losses will become NOL Carryforwards.

The NOL Carryforwards will be available to offset wages, retirement account distributions, or other investment income.

For non-RE pros this is something new and powerful.

Remember that we bought this deal for $1mm at a 7% UYOC. It generates $70k in NOI (before debt service but after value add)

We invested well. After rehab/lease up are complete, value is $1.33mm at a 5.25% cap rate. Selling would ruin all of your OZ tax benefits.

Refinancing is the smart move:
• $1mm loan amount
• 3.5% rate and 30 year am
• 1.35x DSCR

The $300k in cashout would not be taxable, the transaction would not change the OZ benefits, and there would still be $16k/year in cashflow from this building

The cashout proceeds go back to QOF and you'd have two options
1. Distribute to yourself
2. Find another OZ deal

OZ structure allows prop acq until 12/31/28. Buying new property does not restart the 10 year clock. Clock is based on when your initial capital gain funded your QOF

I envision a good operator or even LP investor taking $300k to $800k-$1mm equity invested in 3-4 deals by 2028.

Using cost seg and depreciation this could be $300k+ of tax benefit for someone in a 30%+ tax bracket.

In addition to avoiding depreciation recapture, the 10-year step up allows you to entirely avoid paying long term capital gains taxes when selling OZ property

Investing in good deals in good markets on a 10+ year time horizon makes me excited

My long-term goal is to create a well educated gang of QOF investors who want to compound tax efficiently

I will continue posting threads with OZ content. If you want to get engaged with the OZ content (or other Apartment Related tweets)

Follow along
@DallasAptGP

If you want to get even more engagement with OZ operators, I have also put together a list of #RETwit Opportunity Zone GP’s and vendors.

If you think you should be on this list then just let me know.

twitter.com/i/lists/148358…