LossOpportunity Zone Investing (Passive Angle)

The QOF never broke ground and the 90% test failures came out of my distribution

Sold two parcels I'd assembled, gain about $210k. Went into a QOF whose whole plan was 60 acres inside a designated tract, bought for around $2.1M, entitled for build-to-rent, phase one to start within twelve months. I liked it because I know land and I thought I was underwriting something I understood.

What I did not underwrite was whether anything would actually get built, and that's the part that mattered, because raw land held without improvement is not going to carry this program's requirements on its own. The qualifying-property side of it generally turns on original use or substantial improvement of the acquired property, and how that applies to a specific asset is a question for a tax attorney, which I now know from having paid one.

What happened: phase one didn't start in year one. Or year two. The sponsor kept saying the GC number was moving and they were re-bidding. Meanwhile the fund was sitting on land and cash. It missed the semiannual asset testing threshold at two dates that I know about, and there's a penalty for a shortfall, which the fund paid and which came out of fund assets, which is to say out of me. I never got a clean number for it. My best reconstruction from the annual statements is somewhere between $18k and $24k of fund-level penalties across those periods on a fund my share was about 9% of.

Early 2024 the manager sold the 60 acres for about $2.35M. After carry, property taxes on raw ground for three years, the penalties, the sponsor's fees, and the disposition fee, I got back about $189k on $210k.

And the deferred gain came due at that point, since the fund sold and distributed. Roughly $46k for me federal and state. So: $21k of principal gone, $46k due, three years, no appreciation to exclude because there wasn't any to speak of and I wouldn't have qualified for the long-hold treatment anyway at three years.

What I'd do differently: no wire until there's a signed GC contract and a permit in hand, with dates. "Entitled, phase one to start within twelve months" is a sentence, not a schedule. And I'd ask what the fund's plan is for holding qualifying property between acquisition and construction start, because that gap is where the penalties live.

Answer

-1priya_n21PO1C

You underwrote the tax wrapper and the dirt. Nobody underwrote the construction, and construction was the only thing that made the tax wrapper function.

That's the whole loss in one line, and it's not a land expertise problem. You knew more about the 60 acres than the sponsor did, probably. What you needed was the thing you couldn't check from your side: whether these people could get a shovel moving in a market where bids were climbing every quarter. A signed GMP contract and a pulled permit before wiring is exactly right, and I'd add one more, ask for the two prior projects where they went from land close to construction start and how many months each took. If the answer is "this is our first," the twelve month schedule is a hope.

The penalty piece you couldn't get a clean number on bothers me more than the $21k. A fund that can't tell an investor what a compliance shortfall cost, in dollars, at which testing date, has an accounting problem separate from the construction problem. I'd ask for that in writing before wiring anywhere now, phrased as "has this fund or any prior fund of yours failed an asset test, and what did it cost."

3 replies

1devon_pierce Get yoursPRO5

The land piece is the part I've been building a note file on. As I understand it, land acquired inside a zone generally doesn't count as qualifying property on its own, because it can't satisfy original use and the improvement test is measured against the building basis, so a fund holding dirt has to be actively improving it to work. Which means "land banking in an opportunity zone" is close to a contradiction and I've still seen it pitched three times this year. Anyone who's read the regulations more carefully than me should correct that, and the specific application is an attorney question. @parcel did the sponsor ever explain how they thought the holding period worked?

2ehernandez74PO2BPRO5

@marlow's question about prior land-close-to-construction-start timelines is going in my file permanently.

@parcel the thing I'd want to know is whether the operating agreement gave the manager any obligation to start construction at all, or just permission. Mine, when I finally read it closely on a much smaller position, was all permission. The manager "may" do everything and "shall" do almost nothing. If yours was the same then three years of re-bidding was fully within the deal you signed, which is a harder thing to sit with than a sponsor who broke a promise.