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All About Opportunity Zones: The 1031 on Steroids

Looking for a brand new tax-deferred or potentially tax-free investing opportunity? My guest today, Bruce Stachenfeld calls it the 1031 on steroids. Find out why in my latest Richer Life podcast interview, and read the full transcript of the interview below.

Need additional resources on opportunity zones?

Download the two whitepapers Bruce references during the interview, and check out an informational article from the Wall St. Journal:

[show_more more=”Read the Transcript” less=”Hide Transcript”]Robert: Today, I’m very excited to have on as a guest Bruce Stachenfeld. Bruce is one of the nation’s preeminent real estate attorneys. He is a partner in a firm in New York City: Duval & Stachenfeld. One of the reasons I’m very excited to have him on is his interest and expertise in something called qualified opportunity zones. It sounds interesting, and in fact, it’s not only interesting, but it’s also very new and so there’s a lot of interest and opportunity to learn about these opportunity zones for investors. So Bruce, thank you so much for joining Richer Life. Thanks for coming on.

Bruce: Thanks for having me, Robert. I’ll try to make this informative about opportunities zones, for sure.

Robert: Fantastic. So, for people who don’t know you yet, can you tell us just a little bit about yourself and your firm, your practice and what you specialize in?

Bruce: I’m the founding member of Duval & Stachenfeld. We’re a real estate law firm in New York City, and even though we’re about 50 lawyers, the thing that’s unusual about us is that all we do is real estate; we’re called “The Pure Play In Real Estate Law” to make that statement clear to ourselves and everybody else. The thing that’s probably most interesting at this point is that we are the only pure play real estate law firm left in New York City. Every other one has either died off over the years or been swallowed up by major law firms. And mathematically, that means for sure that we’re either the smartest or the dumbest of law firms – I certainly hope that it’s the former, but obviously hindsight will make that clear. In terms of myself, I founded the firm almost exactly 21 years ago. So we are 21 years old; I guess that means we can vote and that sort of thing. And of late, one of the things that we’ve been really working on a lot of is the opportunity zones.

Robert: Yeah, that’s a great introduction, and you’ve clearly been doing this for some time. It’s funny that you call yourself a boutique firm, yet you have 50 attorneys – that’s quite large, at least where I’m from. It’s a nice practice.

So for our listeners, I won’t fault anyone for not knowing about opportunity zones, because these are new. These have not been around long, and in fact, there are a lot of professionals and advisors out there who are not familiar with opportunity zones because of how new they are. They were something that came out of the Trump tax plan.

An opportunity zone is basically a low income area that’s designated by each state and what they allow you to do as investors. If you have some built-in gains from real estate or a business sale or even investments, you can take some of those realized gains and put them into these opportunity zones. By doing that, there are some incredible tax advantages for you, where you can defer tax and (in some cases) you can avoid taxes.

Bruce: Let me interrupt and take you back to how this thing all started. A lot of times people make fun of the government, you know, causing more trouble than success to the world. But this one (for me at least) seems like a dramatic win, in terms of what’s intended. The idea is that instead of the government basically building things or forcing things to happen, the government is basically saying, “Look, if you’re a state and you have an area that’s not doing so well (it’s blighted or has low income), and the goal is to make it better, instead of the government doing something, have people invest in this area and they’ll get some wonderful tax breaks.”

So, it’s kind of like goading capitalism to do its thing and create upsides for everyone in the opportunity zone. This is sort of how it works, and I’ll try not to get technical – due to the fact that I’m not a tax lawyer, I won’t be able to get technical, even if I try.

Every state picks where they want to have an opportunity zone (or zones). I think it’s done by the governor of each state, but I’m not sure how it’s done politically. So, every state has multiple opportunities zones. Some have more than others. For example, Puerto Rico (which as we all know has been devastated by all sorts of things over the last few years), I believe that 95% of Puerto Rico is now an opportunity zone. In New York state, for example, the Bronx, which is now really experiencing a lot of rebirth. The Bronx is mostly (or at least a large percentage of it is) an opportunity zone. So, in any case, the state decides where they wish to spur development. Then they say to the investors of the world, “Well, here’s how you do it.”

Let’s make it really simple. I’m going to use an example that everybody can probably understand. So let’s pretend that you bought stock in Google at $100, and it’s now worth $1,000. So it’s gone up $900. Let’s pretend you’re very wealthy, and you bought a lot of the stock, and that gain is worth $10,000,000 today. Okay? So now, if you sold the Google stock under the current tax code, you would have to pay 20% to the government in taxes. In other words, of your $10 million gain, $2 million would go to the government – plus, of course there’s state tax as well. So you might lose up to $2.5ish million of the $10 million.

Here’s what you could do instead. You could take that $10 million gain, and you could invest it in one of these opportunity zones, which I explained are in every single state throughout the country. So in order for it to be a qualified investment, there’s a whole bunch of things, but the basic idea is this: the government wants development to happen, so they don’t want you to just to take the money and buy a building that just sit there with it. They want something like if there’s a hole in the ground, then somebody constructs a building on it, or something good is going to happen that’s going to create jobs and excitement and upsides for everybody there.

So now you take your $10 million dollars and you invest it into something that will be developed in the opportunity zone. Three things happen here. Okay? There’s three things. The first one is good, the second one is great and the third one is off the charts exciting for everybody, whether you’re in the real estate world or the non-real estate world.

So first, the good part is that you take this $10 million (remember, you would be paying about $2.5 million to the government if you just sold the stock), but now that you’ve put it into an opportunity zone, you do not have to pay that tax until 2026; you get eight years to pay the tax that you otherwise would have to pay today. That’s the good thing.

Now, let’s talk about the great thing. Now the great thing is that, let’s say that $10 million goes into a transaction in the opportunity zone – hopefully you picked a good transaction, and obviously, if it’s a good transaction it will go up in value. So if you put the $10 million into the opportunity zone and you wait 10 years (that’s the timeline), then you pay no tax at all on the gain. So if that $10 million became $20 million over the 10 years, there would be no tax at all on the extra $10 million. This is not good; this is great!

Here’s the third piece, which I think is fantastic. You can take any kind of asset and exchange it into the opportunity zone. It could be stock in Google (like I mentioned), it could be a coin collection, it can be pretty much anything that you have that’s gone up in value. So what this means, for the real estate world at least, is that for the first time, parties that really have had nothing to do with real estate in their past can suddenly be able to diversify their investments into real estate in a tax-advantaged way.

There’s about $6 trillion worth of gains in the last 10 years. We’ve all watched the stock market rocket up, and all sorts of other things have gone up in value. There’s $6 trillion worth of gains, and if you say bought stock in Google, you might have an enormous upside that you have sort of embedded that you haven’t done anything with. You may be thinking, “Well, I’d like to diversify my holdings, because one of my stocks went up so much, but I know if I sell, I’m going to have to pay all this tax.” Well, the opportunity zone allows you to diversify from whatever you have invested in, and in a way you don’t have to pay the tax – at least for eight years. Anyway, that’s my summary. I hope that gives you background.

Robert: It does. Bruce, I think that’s a terrific summary of what this is all about and some ways investors can utilize it, because for the longest time, the listeners may be familiar with 1031 exchanges – which are, of course, you’ve got some real estate, it’s got a gain, you sell it, but you can take that gain and enroll it over into a new project. So that’s been around for years. There’s nothing exciting or knew about that, although the 1031 is extremely powerful. Investors in businesses or (like you mentioned) in Google for example, they’ve never had that same ability to take a gain that’s been realized and to defer that, to roll that over into a new investment. So I’m looking at these opportunity zones as sort of the 1031 equivalent for investors outside of real estate.

Bruce: I’ve come up with a phrase 1031 on steroids, because you’re 100% correct. It is like a 1031. It’s exactly like it, but it’s got a bunch of the features that the 1031 doesn’t have. Apologies for interrupting you

Robert: Bruce, I think you need to trademark that, and unfortunately your firm is full of real estate attorney, so you probably don’t even have an IP guy on staff. But that’s okay. That’s a good phrase because that’s truly what it is. I mean, I’ve worked with clients who have had 80+ percent of their overall net worth in a single stock. And their fear was, if the stock goes down, if it goes out of business, our entire net worth is going to be wiped away. Yet at the same time, they don’t want to pay an exorbitant amount in tax. So this is an opportunity. Like you said, there’s $6 trillion of unrealized capital gains, and I think for a big percentage of these folks, they’re just waiting for lower tax rates maybe. They’re waiting for something, and the opportunity zone could be that way for them to diversify. And so Bruce, you also mentioned that they need to invest in these zones for development purposes. So, let me ask you this: If you’ve identified an opportunity zone, and let’s imagine that there’s an apartment complex there, could I not invest in that apartment complex that’s already built, or do I have to build the apartment complex?

Bruce: The answer is most likely you cannot invest in an existing apartment complex. As I was saying earlier, the government wants something to happen. Okay? They don’t want to just give people a free ability to not pay taxes. They want the people to take their gains or dollars and invest it in some sort of thing that will create something in the opportunity zone. So, if there’s already an apartment building sitting there, what good are you really doing by buying it? You’re not really serving society or the opportunity zone or helping the low income or anything else by just buying it. The general rule is, whatever you pay for it, you have to spend at least that amount. I can’t remember if it’s 36 or 18 months, but you have to invest an amount equal to what you bought.

So for example, let’s say you bought an apartment building and it was really, really dilapidated and needed a major upgrade. Or perhaps, you were developing the land that was right next to the apartment building – maybe retail or something like that. Or maybe you’re buying a building that you can add on additional floors above it. It’s certainly possible that you could be buying a building and creating or making the investment equal to what you spent when you started and qualify, but if it’s just a building and you’re just buying it, that’s not what the government wants to happen and it would not qualify.

Robert: And not only can you invest in properties, but also you can invest in businesses from what I understand. Are you familiar with that process?

Bruce: We’re really just scratching the surface, and as I mentioned the beginning, we are a pure play in real estate law. So we travel the capital stack basically throughout the world in real estate. We don’t spend as much time on the business side. However, you’re very wise, Robert, to point that out. That could even be bigger than the real estate angle: people starting businesses in opportunity zones. There are certain exclusions. I can’t remember them all off the top of my head, but for example, sin businesses are not allowed and massage parlors and that sort of thing – those would not qualify, perhaps for obvious reasons. But if somebody wanted to start a business, create jobs and invest in an opportunity zone, the odds are if it was done properly, it would indeed qualify. And if you start thinking about the upside and the benefits that a successful business can have, it can be dramatically more than a real estate investment.

So, right now we’re scratching the surface of all of this, but there’s one big thing looming that I should mention. Now, this was put into the tax reform act in December of last year, and I really think almost nobody noticed it; there was no press on it. I didn’t hear a word about it until probably January or February, when my tax partner was hunting around and found this thing in the tax reform act, and was thinking, “Does this really say what it seems to say?” So it was something that sort of came out of the blue. It’s very short. I think it’s only about two pages of text. It hasn’t had very much in it. So what is needed? There are an enormous number of questions about how this thing will work: how you do the investment properly, the timing of when the money comes in, etc. There’s all these things that investors need to know in order to be able to be sure that the transaction that they’re doing will really qualify. And we are hoping that all of this will be put forth in the regulations that the IRS will be issuing. However, (and this is sort of the big, big question mark right now) the government has been telling us really for probably three or four or five months that the regulations will be coming out any day now – next week, next month, whenever. And we’re still waiting. And there’s a ton of people sitting there trying to figure out what they are going to do. Are they going to raise their fund? Are they going to do their deal? But they’re waiting to be sure that they don’t accidentally set up their fund or do their deal in a way that doesn’t qualify, which obviously would be tragic from the point of view of the taxpayer. They sell their Google stock, they trigger the gain, they think they’re going to get all these tax advantages and somehow they blow it, because the regulations make it so that it doesn’t work. Obviously, they would want to know about that head of time.

One last thing I’ll say on this though, is there are a fair number of our clients that are actually doing deals now even without the regulations in place. And the way they’re doing this, what we’re doing with our clients is we’re just assuming that when these regulations come out, they will be as negative as possible and make sure the deal still works. I think the phrase is down the fairway. I guess it’s for all the golfers out there, but basically the idea is to do the transaction in a manner that will work almost no matter what the regulations say, and obviously if the regulations are better, which we do anticipate, that will just be gravy and make things better.

Robert: So there are currently funds that are starting these, it sounds like?

Bruce: Yes,  there’s no question about it. There’s been a fair number that have announced publicly that they’re raising these funds. Some of them are clients, some are friends of the firm and other people we’d just read about in the newspaper, but there’s certainly been a fair number of parties announcing they are raising funds to do this. And this leads me to something that I would kind of throw out as a cautionary note. When something new happens that’s tax-advantaged, there’s excitement about it because this is a chance to legitimately a defer taxes. This is not some tax shelter scam. It’s written right into the code. So you can see a lot of excitement among parties. One thing that we very strongly advocates for our clients (and by the way, our clients don’t even need us to tell them this) is one should not be doing deals because they are in opportunity zones; that, I think, is the height of foolishness. Instead, people should be doing deals that are good deals that they good faith think will be successful. And then, if they end up in an opportunity zone that’s just gravy; it makes it a lot better, a lot easier to raise the money and a lot easier to make the deal successful, and of course, with more of an economic upside to the investors.

Robert: I think that’s excellent advice, because as I was reading through opportunity zones I started to get excited, and then it hit me. Well sure, you’re taking some gains because you invested in something that worked out, and you’re shifting that over into a new investment. At the end of the day, it’s a new investment, and that investment still has to perform, because if it doesn’t all those gains are going to go away. And one of my concerns is that there’s going to be an influx of capital into these areas, and I’m just curious what you think some of the unintended consequences might be as a result of having all of this capital flow into these slightly impoverished areas.

Bruce: So there’s three things that percolate into my mind as you’re talking about it. First is just some good advice about how to do this. If I were an investor that’s not in the real estate world, and I had a gain, and I was thinking that this does sound like something worth pursuing, I would try to piggyback alongside a super high-quality real estate player – either a developer with a fantastic track record and reputation or real excellent institutional investor. And I would try to make sure that those parties are aligned with me economically. They’re putting their own money in on close to the same terms. Obviously they’ll get some benefits for putting the deal together, but they’re very aligned with me. And I can piggyback on the fact that these people know what they’re doing and putting their own money at risk, and the odds are very good that that I will be protected.

Second is the unintended consequence – or maybe it’s an obvious consequence. There will be a lot of parties that (I don’t know if I would use the word unscrupulous) may be overeager, foolish or whatever that I think will rush in to do these deals (as I was saying a minute ago) just because they can raise the money easily. And I do think it’s a bit of a sucker play. And if I were an investor, I’d be very, very careful about making sure that I was not putting my money into someone that is saying, “Hey, give me money. I’ll find you a deal.” That instead it’s somebody who’s like the first part and  says, “I have a great deal. I would do it whether or not it was an opportunity zone. It happens to be in an opportunity zone and I’m open to raising capital.”

The third thing (I’m not sure if this is an unintended consequences or what), is that there’s always political issues when a low income area gentrifies or becomes more valuable. I’m not going to get political on this call. There’s a benefit to the people that is caused the upside, and then there’s also risks of downside to people who can be displaced. But I don’t know if that’s unintended or intended, but that will probably percolate out of this as well.

Robert: And I know we don’t have all the details yet, and you may not be able to answer this, but in looking at investing in businesses (or maybe you already have a business), do you think there is a position where one could move their business into an opportunity zone, and then potentially sell it and avoid or minimize gain on that transaction?

Bruce: I think that there’s a chance of that if it was done properly. I really would need my tax partner, because she’s been living with the opportunity zones pretty much round the clock for the last seven months. She would be able to answer that question either by giving an answer or saying, “We won’t know until we see the regulations.” On this call at least, I don’t know the answer.

Robert: No pun intended, but I just think there’s going to be so many opportunities with this. I’m excited about it. I’m sure folks who are listening who have some built-in gains – either through real estate or through their own business or through investing – are excited. If they are just wanting more information, how would they get started? What would be their first step? Just wait until we get those final regulations? Or can they do something now?

Bruce: I don’t mean this to sound self-serving, but a tax partner I just mentioned has put together two white papers on the opportunity zone. So, the first one is designed to be very simple. It just gives you the basics of exactly how the whole opportunity zone works. We’ve talked about it on this call, but obviously it’s difficult for somebody just to listen and digest a bit. It takes you through, step-by-step exactly how the tax advantages work. You can see some numerical examples. So that would be the first thing. The second one is a step-by-step guide on exactly how to do a deal in the opportunity zone before the regulations are issued. In addition, there’s also a list of the key questions that clients keep asking, which we don’t know the answers to until the regulations come out. Those are probably the two easiest ways to get the quick and dirty a background on the opportunity zones; it’s enough for someone to say, “This is very interesting to me.”

The last thing I guess is this. If you’re in the real estate business, you’re probably already climbing all over this because everybody that I know in the real estate world is either thinking about it, or investing, or trying to invest in, or trying to figure out a strategy pertaining to it. But if you’re not in the real estate world, this may sound really obvious, but talk to your friends in the real estate world. If it’s really significant, feel free to give me a call as well.

Robert: Well, that’s great, Bruce. I appreciate that. I think we need to learn a lot more, but I think we’re going to see a lot more investments and opportunity for folks with these gains that have just been built-in; they avoided paying the tax on it so far, and this could be their chance to diversify. And again, at the end of the day, the whole idea with the opportunity zones was to take areas that needed some help economically, to get a flow of capital to those, and to really turn those around. I was talking about opportunity zones with someone else just yesterday, and they said, “Well, it’s almost like socially conscious investing, where you’re doing good, and you’re making some money at the same time.” And I think that was really the goal with this particular strategy.

Bruce: In terms of the social aspect of investing, one of the things that that could be a major attribute is this. Let’s say you’re a nonprofit, and you’re either in an opportunity zone or you want something good to happen in an opportunity. So let’s say you want to build a school or something like that. You want to create jobs or you want to help the community. The worst thing about a nonprofit is you have to raise money. You have to get people to give you money to achieve your mission. It’s probably the worst thing that anybody has to do: try to get people to give them money.

However, if you think about it, here’s a way for a nonprofit to achieve its mission without raising any money. If they wanted to build a school, normally they’d have to raise $5,000,000 – which is probably one of those awful processes you can imagine. However, if instead they got investors who are selling their Google stock (or whatever it is), suddenly they don’t have to raise any money at all. Really it’s enticing these investors into realizing that they might be able to benefit from building whatever it happens to be in the opportunity zone. This is very vague what I’m saying, and we obviously need to see what the regulations are and a whole bunch of other things, but O think that this is an intended consequence: that nonprofits may be able to achieve a lot of social goals in these opportunities zones in this matter.

Robert: No, I love that. I think that is exactly what this was intended for. I mean, we all want to do good. I don’t think there’s anyone who wouldn’t agree with that. And at the same time we’re all a little bit greedy; we all want to make a few extra bucks, and if we can combine those two, I think this could be a win-win. So I appreciate that. Thank you for your time. And just to leave it on a bit of a personal note, I always like to ask guests, what’s one big goal or project that you’re most excited about?

Bruce: Wow, that’s an open-ended question. The biggest thing that’s happened in my life is that I founded this firm 21 years ago. I’ve been the managing partner, so in other words, I’ve run this business for 21 years. Only last week though, I turned the business over to my longtime friend and partner, Terry Adler, who founded the firm with me. She’s now the managing partner and I’ve become the chairman of the firm – what the chairman actually is, is still a bit of a question. So in terms of projects, I guess my goal is to redefine myself and be of use to clients and other people in the real estate world. It’s a big change for me, and it’s only four business days old.

Robert: Well, congratulations Bruce! I can tell you’ve been a big use to listeners and to me, learning more about opportunity zones. So, congratulations again, and thanks so much for taking some time to help educate us on this.

Bruce: Thanks for having me. I really appreciate it.

Robert: Take care.

Bruce: Bye now.[/show_more]