With Jonathan McGuire
On Episode 116 of The Unique CPA, Randy is joined by Jonathan McGuire of Aldrich Advisors to discuss Opportunity Zones, a unique element of the tax code introduced by the Tax Cuts and Jobs Act in 2018. Opportunity Zones allow investors to defer capital gains taxes and later taxation by investing in designated low-income communities. Jonathan covers the tax benefits, requirements for Opportunity Zone Funds and Businesses, and types of eligible investments.
Today, our guest is Jonathan McGuire. Jonathan is a partner, newly appointed partner, at Aldrich CPAs and advisors out of Oregon, but all up and down the West Coast right, Jonathan?
Okay, so Jonathan’s new, one of the two newest partners at Aldrich. He heads up the real estate niche, he’s had a deep focus in that working with real estate, working with partnerships. He also specializes in repair regs and Opportunity Zones. Opportunity Zones is what we’re going to talk about today. I’ve heard of Opportunity Zones for quite a while. I can’t tell you much about Opportunity Zones. I got a feeling I’m not the only one. So Jonathan’s gonna educate us today. And he can do that because by Opportunity Zone Magazine, he was named one of the top 25 Opportunity Zone tax specialists. So Jonathan, welcome to The Unique CPA.
Well, thank you for having me, Randy. Pleasure to be here.
So you and I got introduced by Alex Bray. And Alex used to work with us and then you guys stole him from—I mean, then he went to work with you guys. He was your co, I guess, class, of partnerships. So it was you and he that got officially named partners, I’m assuming, January 1 this year?
Yep. As of 1/1, he and I are the official new guys, so.
Yeah. And Alex introduced me to you and thought you’d be a good guest. And I reached out and I agreed with him. So don’t let me down now, I’m counting on that. You’re not gonna let me down. I know. So you’ll be able to live up to it.
Alright, so I teased the fact that Opportunity Zones—again, I can’t even tell you when Opportunity Zones were defined. In my mind, the Tax Cuts and Jobs Act did something to them. But I don’t know if I’m right or wrong on that. So why don’t you just give us a little, your definition of, and that’s probably a huge question, but of Opportunity Zones, and when that came about?
Yeah, so I’ll kind of give you a little legislative history here on it. It was passed as part of the Tax Cuts and Jobs Act. So prior to that it did not exist—it was something that was brand new at that at the end of 2017.
However, the legislation for this was originally kind of conceived and started to go through its drafting and figuring out how this may or may not work, in around, I think it was 2014, 2015, by an economic think tank that was headed up by Sean Parker, the guy that was with Facebook and Napster.
And so from that, so it originated in the Obama administration. And so even though it’s part of the Trump tax cut, this was one thing in that tax cut and Jobs Act that had total bipartisan support. But eventually it was passed. And so there’s three main tax benefits in this. And so the first is a temporary deferral of capital gains. And that that deferral goes until 2026.
Okay, so let me stop you there for a second, because I was trying to read up a little bit. So the temporary deferral on capital gains, this portion of it, is this the capital gains from investments in Opportunity Zones? Or can you defer other gains into investments into Opportunity Zones, or both?
It will be deferring gains outside of an Opportunity Zone into an Opportunity Zone investment.
And any gains? I just sold some IBM stock and had a big gain, can I take that and put it in?
Yeah. Stocks, bonds, real estate, you know, the sale of intangible property, anything that has capital gains tax treatment, exception qualified dividends, it’s, they’re taxed as such, but anything short term or long term, you know, pieces of artwork, all of that qualifies for this.
Okay, so I can take that gain. And I can defer it by putting it into an Opportunity Zone investment. Okay. I cut you off. You were saying there’s three aspects then.
Yeah. So that’s the first one. It’s a deferral until 2026. The second benefit which, as of now no longer has any benefit for anybody new getting into an Opportunity Zone—originally there was a ten percent basis step up in your capital gain that you’re deferring if you hold that investment for five years prior to the end of 2026.
Okay, which you can’t do any longer.
Yeah, you can’t do it any longer. Part two to that one is, if you held it for seven years, you’d get an additional 5% basis step up.
Step up. Okay.
So for people that got into this early in 2018, and 2019, come into 2026, they’re paying 85 cents on the dollar on their capital gains tax, when that temporary deferral period ends.
Got it. So that’s part two?
That’s part two. So no longer a benefit for a lot of people trying to get into this. But the third benefit, and this is why Opportunity Zones exists, is after a 10 year holding period and your opportunity fund investment, 100% of your capital gains realized in that fund, or by sale of the fund itself—100% of it is tax free.
And that’s the gain that you deferred into it and any additional gain that came out of it?
No, it’s just the appreciation. So that that temporary deferral period that you have, until 2026, that capital gain comes due. And so you pay the tax on your original capital gain for the privilege of having the appreciation on this investment that you have now, to be tax free after you hold it for 10 years.
Now, is there a sunset on this at all or that 10 year deferral is there, this is permanent part of the tax code?
So there is a sunset on it. And so you have to have a capital gain, to invest into a fund by the end of 2026. So that’s the, that’s the latest you can get into the program is by having a gain, that’s realized in 2026.
And then, to get the big benefit of tax free capital gains on the back end, you need to exit the fund or the investment by the end of 2047. So there’s a big runway,
Really. Okay. So it’s not once the 10 year investment’s done, you need to get out, you can keep it in there. It’s another potential 20 plus years after that initial investment.
Okay. Alright. So the whole benefit of this from an investor standpoint, is the tax whatever, step up, which no longer exists, but the original step up and basis, and then the deferral of gain, which I get through ’26. And in addition, that no gain, there’s no tax and any gain that came out of the fun. Am I, do I sound educated now?
Yep. Yep, those are the three main benefits that everybody’s looking at, and taking advantage of, to make these happen.
So now, besides them this tax incentive for people to put money in, there’s obviously another economic or just, you know, incentive, the reason that these funds were set up in the first place, I’m assuming “Opportunity Zone” has certain definitions that you meet certain requirements to be able to put the money in. And that’s I’m assuming in areas that need investments that are maybe underserved. What is the, how does an Opportunity Zone get defined, I guess?
Yeah. So when the Tax Cuts and Jobs Act was passed, the first section of the code associated with this said, “Hey, governors of all 50 states and Puerto Rico, you know, nominate about 25%, give or take, of your low income housing zones, your census tracts that are designated low income, about 25% of those are going to be designated as Opportunity Zones. But you, Governor, you get to select these and designate them as such.” And so it wasn’t anything that was done by any House or Senate in whatever state or commonwealth, it was really up to the executive branch of all the states. And so whoever’s in power got to pick and choose what they wanted to do.
Oregon somehow, the entire downtown core of Portland, pre-2020 ended up getting pulled into this and it’s still low income, but the quality of the properties and such that are in there, it’s a it’s a little head scratching, but it’s it still makes sense because it was based off of the 2010 census data.
That was where things were ended up being designated from and how those zones were identified.
So each state’s governor executive branch got to decide. Sounds like there could be some—has there been any issues with people challenging what zones were put into this?
At the end of the day, not really, because I don’t think a lot of people really knew what this was until the zones were actually designated by the governors. because prior to that, and this was at the back of the Tax Cuts and Jobs Act when it was passed. I remember. I mean, there was a lot of changes going on. And because of what this was, and what the code section number was, it was like, oh, this is some one off thing that some special interest group is going to qualify for, until everybody started designating zones. And then everybody comes out of the woodwork and like, what is this? And it was like, oh, crap, this is the biggest tax giveaway ever created.
Alright. So good to hear that there’s no, maybe, fraud and how these zones were identified. Unfortunately, there seems to be fraud going on with some tax things right now, which I won’t get into. But the interesting thing that when you and I talked a month ago, or a few weeks ago, is that I didn’t realize, I thought it was just me taking my gain, and going and investing in some property. But this is a fun thing. People are putting the funds together for me to invest in I don’t have to go identify this property myself. Is that how all of it’s done? Or can I still identify my own property as well?
Yeah, so in order to take advantage of the Opportunity Zone program, you have to make an investment into what’s called a Qualified Opportunity Fund. And this fund is either a corporation or a partnership for tax purposes, that is set up and makes an election, files a form that says, hey, I wish to be a fund, I want to, you know, be subject to all these testing requirements to make sure I adhere to the Opportunity Zone program, so that my ownership group can take advantage of the tax break long term.
And so this fund can be Mom and Pop getting together to start their own little investment thing that they want to do. So, which for me, that’s the bulk of the funds that I work with is something that’s closely held individuals, or business partners getting together to develop something, or a property, or start a business for themselves. Or, you could have institutional syndicated funds, with hundreds of investors in these LLC partnerships. And both structures work. You can also do it through a corporation, but being in the real estate space, I, you know, you don’t put real estate in the corp, so you end up seeing a lot more partnership stuff.
Alright, so that you said it could be the whatever, the Mom and Pop, you putting together your own fund, is that something you help with? Then you set up these funds? And obviously prepare the taxes? And figure out all that?
Yeah, I’ll work with the attorney, they’ll set up the actual entity. But because of some of the IRS instructions and other aspects, I always like to be in on the ground floor, on that initial setup to make sure that the operating agreement has certain language in there that everybody’s agreeing to, hey, this is going to be a fund, on the front end. That way, not to poison pill anything, but to make sure everybody is aware that we’re in this for 10 years or beyond, because you want to avoid having people coming in now, because that can blow up some of the deals for for individuals.
So when you have this fund, then, whether it’s set up yourself or syndicate it is the fun investing just in, like the land. I mean, what if there’s a building on there that’s operating as a rental property? Is that a separate entity then?
So in the fund, the fund can invest in one of three things. It can invest directly into property, so the fund can be the holder of property, so long as it’s in a Zone. The other way is to invest directly into what’s called a Qualified Opportunity Zone Business that is set up as a corporation or a Qualified Opportunity Zone Business that is set up as a partnership. Those are the three investment vehicles that you can take advantage of.
In most cases, you don’t see a fund having a direct hold in property. Early on you did because the regs weren’t out, they weren’t finalized, there was a lot of gray area. But really what you see now is a tiered entity structure where you have the fund, the Fund invests into the Qualified Opportunity Zone Business, and then that business entity either owns the property or owns the new business that is going to be used to be qualified for the Opportunity Zone tax program.
Okay, so you’re not really passing through. And I was gonna ask what would happen to passing through any, you know, operating profit or loss from a rental property or anything like that. That is separate from the Opportunity Zone then.
Yeah, I think so based on how I was understanding that. Because that fund, you’re going to make that investment like into, let’s say, it’s a partnership that’s investing into another partnership. So if it is a tiered entity structure, K-1 goes from QOZB, Opportunity Zone Business, up to the QOF, the Opportunity Fund. And then the fund would spit out K-1s to the investors. So there are operations there that would on an annual basis that would flow out to the individual owners.
And that part’s taxable then?
Yeah. The normal operations are taxable. So it’s going to work just like any traditional, you know, me being in real estate, any traditional real estate investment, where you put money in, you get income or expense allocations over X years that you’re in this, you eventually sell out the property, or 1031 into something else. But eventually you’re exiting, realizing the gain. Really, the Opportunity Zone is just an overlay on all the pre existing tax law.
Got it. Alright, so great. So now we’ve invested in this QOZB, Qualified Opportunity Zone Business.
Alright, I think that’s right. And so now, what are the requirements? And what can the QOZB do?
Yeah, so for the QOZB, and I’ll start on it from a real estate perspective, because that’s the easiest way to explain it, is that you have to either buy what’s called “original use,” or do a “substantial improvement” to property inside of a zone. And so for original use, this is going to be, again, from a real estate perspective, you buy raw land. Land by itself is going to always qualify as original use. So that’s no problem. Or you’re buying a brand spankin’ new building that’s been constructed and never been put into service anywhere.
So if you’re buying the raw land, you build something, that asset is going to qualify, you’re good to go. If you buy a brand spankin’ new building that somebody else constructed, that asset is going to qualify, you’re in good shape.
So that’s original use, substantial improvement is where a lot of opportunities, own projects are moving. And that’s, you know, taking a pre-existing structure and doing a massive renovation to it. And so what the substantial improvement requires is for the portion of the property that you acquire, that is applicable to the building. So if I buy a property for a million bucks, let’s say it’s split 70/30, between land and building. 70% of that asset would be the building basis. I am then required to make an investment into that property to double its basis via improvements. So if it’s $700,000, I need to make an additional $700,000 of improvements.
Oh, wow. Alright. And so this has the incentive to increase what’s going on in those properties. Alright.
Yeah, it really, the intent is to redevelop these so-called dilapidated areas inside of zones that need investment to attract new business, new growth, you know, revitalize the community and create economic progress there.
Yeah, maybe not everybody agrees, but the tax code has more behind it than just generating revenue for the government. There’s incentives that are supposed to help elsewhere and there was a proposal apparently to get rid of the IRS and income tax, and I just don’t see how that’s the best option for us out there.
Yeah, I’ll make a little commentary there too. And that’s you know, the reason why the tax code is so big—let’s define “income.” Or if we want to eliminate the IRS and abolish the income tax and replace it with the use tax that are whatever they are saying is, well define “use.” So, and all of a sudden you’ve got a, you know, massive bible of documents.
Yeah. So I don’t think it’s going to change, it’s just going to change the way we I have to report the taxes now. I don’t think it’s gonna happen anyways, I think it’s more of a publicity stunt. Maybe I shouldn’t be doing my views on here. But I mean, that’s I just don’t see how the IRS could get abolished, it’s just not gonna happen. them.
Alright, a couple more questions that pop into my head when we’re talking about the Opportunity Zones. This is just because I figured most people are in the same boat as me if they’re a lot more educated on this been me great. But how about timing of the investment is there? I mean, hey, I just had a capital gain two years ago, can I now say, hey, I want to go back and take this gain and put it into an Opportunity Zone? Or when do I have to do this by?
Yeah, so there is a timing restriction. And that is, you have 180 days from your capital gain event to make an investment into a fund. And so if that 180 days sounds familiar, it kind of echoes towards the like kind 1031 Exchange, you know, tax code is borrowed from all other tax code, because it’s easier that way. It’s relatable, it’s easier to remember. But yeah, you’ve got 180 days, and there’s some variations upon when that 180 days can start. But for our purposes, I won’t go into that today, but generally speaking, you sell stock on day 1, you’ve got 180 days from there to make a qualified investment.
But no requirement to identify it before you sell it.
Right, yeah, there’s no 45 day requirement, you can touch this cash, and you only need to reinvest the gain, whereas with a 1031 Exchange, you’re investing the fair market value. So it does give you a chance to realize some cash today by holding on to that basis, or that original investment that you made on what you sold. So it’s a nice alternative.
Yeah. Oh, for sure. I feel a lot more educated on Opportunity Zones. Now. Anything that we missed on Opportunity Zones that you want to highlight before we wrap up?
Yeah, the only one other thing, or I’ve got two things that I would want to quickly talk about. And the first is for a fund—the fund has a 90% investment standard that says 90% of the assets inside of the fund need to be invested in a qualified Opportunity Zone Business or in Opportunity Zone Property. So that’s one thing there that is very important. If you fall below that there is a penalty that’s associated with this to maintain your Opportunity Zone Fund tax status, which can get quite expensive. So it’s important that you’re working to achieve that 90% investment test from day one.
The second part to that investment standard test is the Opportunity Zone Business itself has a slightly different test, but it says that 70% of the property that is owned inside of it needs to be eligible property. So having that original use, or substantial improvement requirement.
Alright. Well, it sounds very much like what we do with specialty tax, you know, it’s very specialized. You’re the expert in that. I think we’re probably what we need to do is hire you to come work with us, because I think that’s fits in well with what we’re doing. Don’t tell anybody at all. Tell them not to listen to this podcast. I’m kidding. I’m kidding. John, if you’re listen to this podcast, I’m only kidding.
Yeah, I’m not going anywhere right now. Work hard enough to get get to this point, being a partner.
Yeah, well, John, your Managing Partner, I feel I’m good friends with him. And so he’ll know I’m kidding. He’s a great guy. I always like talking to him.
Alright. So then, I’ve got two other things to ask you, not related to Opportunity Zones. So just want to make sure you were able to say everything you wanted to on Opportunity Zones here, or you want to put a bow on top of the Opportunity Zones?
The only thing I can say is if you’re doing one of these, and it’s going to be real property investment, get that cost segregation study now, because on the back end, when you get that tax free capital gains, it’s the mechanism is a step up in basis to the fair market value at the date of sale. So you get to realize all of that depreciation today and tomorrow, and not have to recapture any of it.
Alright, so that’s the additional benefits. Alright. And then so that my final two questions, the last one will be contact information but before that, like to ask everybody gets to know him better besides doing Opportunity Zones, and being a CPA and a partner in a large firm, what’s your passions outside of work? What do you enjoy doing?
Number onew being with my family. I’ve got three kids—six, three and onew at home. So a little busy.
Main hobby is golf, played it in college, played it in high school. It’s been a long, long, lifelong passion for me.
Nice. I’m gonna have to come out there, so you can teach me some things. I’m golfing in two days, and I know I’m not going to be good. So, but I know that that’s the positive, I know going in. I did golf, maybe twice this year, which is like a record in the last five years, I think. So this’ll be interesting.
Alright. Anybody that has kids that are high school or younger, that is always their answer. So you fall in with the kids, which is understandable, you’re pretty busy. Especially with, what did you say? Six, three, and one?
Yeah, two rambunctious boys, and an older girl.
Older girl. So not rambunctious. It’s the boys that are.
They’re at each other’s throats already at one and three.
Alright, you’ll see how that goes. And then the final question, then, if people want to find out more about you and Opportunity Zones, and if they want to reach out to you with any additional information, how would they get ahold of you?
Yeah, so to get a hold of me, you can email me—my email is JMcGuire@AldrichAdvisors.com. You can also reach out through our website, that’s AldrichAdvisors.com, and find my profile on there, and click the button, send me a message. And I think the phone number’s on there, too. I don’t have that memorized for some reason.
Alright. Well, great. And actually, I just called that phone number recently on my phone, I think it is on your website. And, Jonathan, I really appreciate you educating me and others on Opportunity Zones, because I think it is a great opportunity tool to use and I honestly don’t think it’s as well known or as well understood as it should be. Maybe that’s just me, but I appreciate you doing this today.
About the Guest
Jonathan McGuire is a partner at Aldrich Advisors with nearly a decade of experience providing strategic tax planning and compliance expertise to private middle-market clients. He has a deep focus as a real estate accountant, working with investors, developers, realtors, property managers, and other professional service providers in real estate. He works with a wide range of property types ranging from single and multi-family residential to commercial properties. Jonathan specializes in repair regulations and the effects they have on those who own real estate. He also helps clients defer capital gains taxes using qualified opportunity zones and qualified opportunity funds.
Jonathan was recently named 2021’s Top 25 Tax Specialists and has been previously featured in Forbes. Prior to joining Aldrich, he spent time in public accounting in Seattle, Washington. Jonathan earned his master’s in taxation from the University of Denver, and his bachelor’s in accounting and business management from Corban University in Salem, Oregon. Jonathan is also an adjunct professor at Corban University’s business school.
Meet the Host
Randy Crabtree, CPA
Randy Crabtree, co-founder and partner of Tri-Merit Specialty Tax Professionals, is a widely followed author, lecturer and podcast host for the accounting profession.
Since 2019, he has hosted the bi-weekly “The Unique CPA,” podcast, which ranks among the world’s 5% most popular programs (Source: Listen Score). You can find articles from Randy in Accounting Today’s Voices column, the AICPA Tax Adviser (Tax-saving opportunities for the housing and construction industries) and he is a regular presenter at conferences and virtual training events hosted by CPAmerica, Prime Global, Leading Edge Alliance (LEA), Allinial Global and several state CPA societies. Crabtree also provides continuing professional education to top 100 CPA firms across the country.
Schaumberg, Illinois-based Tri-Merit is a niche professional services firm that specializes in helping CPAs and their clients benefit from R&D tax credits, cost segregation, the energy efficient commercial buildings deduction (179D), the energy efficient home credit (45L) and the employee retention credit (ERC).
Prior to joining Tri-Merit, Crabtree was managing partner of a CPA firm in the greater Chicago area. He has more than 30 years of public accounting and tax consulting experience in a wide variety of industries, and has worked closely with top executives to help them optimize their tax planning strategies.