Here are a few basic facts about the Opportunity Zone program, which came into being as part of the Tax Cuts and Jobs Act of 2017.
- Qualified Opportunity Zones (QOZs) are lower-income, federally designated regions in which people can invest.
- Investors may benefit from tax deferrals if they funnel their capital gains from the sale of assets into QOZs.
- Entities don’t invest directly in QOZs. Rather, they invest in Qualified Opportunity Funds which, in turn, put resources into the designated Opportunity Zones.
Specifically, the QOF is set up as either a partnership or corporation, and must have at least 90% of its investments in eligible property located in a QOZ. The question here is whether limited liability companies – LLCs – can qualify as QOFs.
To answer this, let’s first discuss the purpose of LLCs, then define if—and how—these set-ups could be certified as QOFs.
Multiple Faces of Limited Liability Companies
A limited liability company—LLC—is a business structure that is becoming more common in the United States. As this formation occurs under state statute, regulations governing these entities vary from state to state. Many regard the LLC as a hybrid structure that combines the features of a corporation and partnership in the following ways:
- Like a corporation, LLC owners enjoy limited liability in the event of business failure.
- Like a partnership, LLCs “pass through” profits, so they are taxed as part of owners’ personal income.
But the main point to consider is that the LLC is a business entity and not a tax classification. This means that the IRS treats the LLC as a corporation, partnership or individual (depending on the elections made by the LLC and its members).
Another important point to consider is that an LLC with one member is considered a “disregarded entity” by the IRS. In other words, the LLC’s activities are reflected on the owner’s federal tax return through the 1040 or 1040-SR forms. More to the point, under the parameters of a single-member LLC, the LLC isn’t taxed. The single member is.
From LLC to QOF
Back to the question of an LLC as an Opportunity Zone, the final answer is: “It depends.” Again, the LLC is a state-formed business structure, rather than a federally taxed entity, meaning that:
- To be certified as a Qualified Opportunity Fund, the LLC must be set up as either a partnership or corporation.
- Single-member/owner LLCs (disregarded entities) are not QOF-eligible, as they are not partnerships or corporations and are not taxed as such.
- Regardless of whether the LLC is a partnership or corporation, other requirements must be met (such as the 90% asset test rule).
The main takeaway from the above is that the limited liability company is a business structure rather than an entity set up for tax purposes. As such, the LLC, itself, can’t be a Qualified Opportunity Fund. Partnerships or corporations set up as LLCs can.
There are material risks associated with investing in QOZ properties and real estate securities including liquidity, tenant vacancies, general market conditions and competition, lack of operating history, interest rate risks, the risk of new supply coming to market and softening rental rates, general risks of owning/operating commercial and multifamily properties, short term leases associated with multi-family properties, financing risks, potential adverse tax consequences, general economic risks, development risks, long hold periods, and potential loss of the entire investment principal. Costs associated with transactions may impact investors’ returns, and may outweigh the tax benefits.
Realized does not provide tax or legal advice. This material is not a substitute for seeking the advice of a qualified professional for your individual situation. This material is for general information and educational purposes only. Information is based on data gathered from what we believe are reliable sources. It is not guaranteed as to accuracy, does not purport to be complete and is not intended to be used as a primary basis for investment decisions. It should also not be construed as advice, meeting the particular investment needs of any investor.