The Great Return on Equity Debate in Real Estate Investing with Chris Lopez
Maximizing Return on Equity for Real Estate Investors
July 5, 2024

July 5, 2024
Last Updated : July 5, 2024

Harnessing Opportunity Zones for Real Estate Investments

In a recent Tax Smart REI episode, Barrett Linburg shared his comprehensive journey and insights into the burgeoning field of Opportunity Zones (OZs). Barrett, a seasoned investor based in Dallas, Texas, has notably capitalized on the OZ legislation to foster significant development in low-income communities while offering attractive tax benefits to investors.

Starting his career post-college in 2005, Barrett initially focused on acquiring and renovating dilapidated apartment buildings in Dallas. His early experiences as a mortgage broker and property manager evolved into a full-fledged investment venture, leading to the formation of Savoy Equity Partners. This company specifically aims to develop apartment projects within Texas’s Opportunity Zones.

What are Opportunity Zones?

Opportunity Zones, established by the 2018 legislation, are designed to stimulate investment in economically distressed areas through enticing tax incentives. These zones have attracted over $200 billion in equity, making them the most successful tax incentive program of their kind in U.S. history.

Understanding the Tax Benefits of Opportunity Zone Investments

Opportunity Zones (OZs) not only encourage the revitalization of economically distressed areas. They also offer substantial tax benefits to investors, which Barrett Linburg eloquently unpacks in his discussion. Here’s a closer look at these tax incentives:

  • Deferral of Capital Gains Taxes:
    The initial lure for many investors is the ability to defer capital gains taxes on prior investments until April 2027. This means if an investor realizes a gain from the sale of an asset, such as real estate or stocks, they can reinvest that gain into an OZ and not pay taxes on it until the 2027 tax filing deadline.
  • Reduction of Capital Gains Taxes:
    If the OZ investment is held for at least five years, investors receive a 10% exclusion of the deferred gains from their taxable income. Holding for seven years increases this exclusion to 15%, further reducing the tax burden.
  • Elimination of Capital Gains on Future Investments:
    Perhaps the most significant benefit, and a point Barrett emphasized, is the elimination of capital gains tax on any profits from the OZ investment itself, provided the investment is held for at least 10 years. This exemption not only includes the appreciation in value of the original OZ investment but also negates the usual tax implications of depreciation recapture, offering a powerful incentive to maintain long-term investments in these zones.

These benefits represent a formidable incentive structure designed to channel resources into areas that need them most, while also providing a financially appealing opportunity for investors. The structure of OZ investments showcases a thoughtful blend of community support and investor reward, aligning profit motives with societal benefits.

The Practical Impacts of OZ Investments

During the discussion, Barrett highlighted the real-world impact of OZ investments. For instance, he described the process of transforming a $1 million property investment into a significantly higher value over a decade, all while utilizing the tax benefits to shield profits from taxes. This approach not only aligns with legislative goals but also demonstrates the potent combination of patience and strategic foresight in real estate investment.

Facing Challenges and Misconceptions

Despite the clear benefits, some investors hesitate due to the perceived complexity and initial illiquidity of OZ investments. Barrett stressed the importance of educating investors on the nuances of OZ funds and the manageable nature of these investments. Addressing misconceptions, he noted that while OZ investments require a long-term commitment, they are far from “locked up” funds, with potential interim returns and refinancing options.

The Future of Opportunity Zones

Looking ahead, Barrett is optimistic about the extension and expansion of the OZ legislation, citing bipartisan support and the tangible improvements these investments have brought to targeted communities. He believes that continuous advocacy and legislative tweaks will further enhance the attractiveness and effectiveness of OZs as a tool for community development and investor returns.

Conclusion

Opportunity Zones offer a compelling avenue for real estate investors to contribute positively to societal needs while benefiting from significant tax advantages.

With the right knowledge and strategies, OZ investments can yield substantial economic and social returns, proving that conscientious investment can go hand-in-hand with substantial financial gain.

Learn how to put tax strategy into action by contacting us today. Continue reading for this episode’s transcript.

Transcript

Introduction

Ryan: You’re now listening to the Taxmart REI Podcast, the number one tax podcast for Real Estate Investors. Well, thank you, Barrett, for joining us. Would you be able to give our audience a little bit of an overview of who you are and your background?

Barrett Linburg Introduction

Barrett: Sure, well, thanks for having me, Ryan, Justin. I appreciate it. I’m based in Dallas, Texas. I’m in the apartment business. I’ve been doing that for my entire career since right after I got out of college in 2005. I started by buying old, beat-up buildings—the really ugly buildings that you pass by on your way home or to church or the office and you say, “Man, I wish somebody would buy that building and fix it up.” I would buy that building, fix it up, make it look better, lease it up, and usually we would sell it, although sometimes hold it. Really, that’s how I started my apartment journey.

His Start

I bought my first building in 2012 after being a mortgage broker for a long time, fixed it up, sold it, then bought a 13-unit building, then 65, then 116, and just kind of grew from there. So, continue doing that. Eventually, I partnered with a guy who was my property manager—I was his mortgage broker—and we partnered up and have been doing projects together for the last seven years. As the market got hotter and hotter in Dallas specifically, we would look for ways to find an edge.

Interest in Opportunity Zones

So, we learned historic tax credits, we learned fractured condo deconversions, we learned a lot of different things to kind of make sure that our project still worked, and really doing weird stuff but still doing apartment renovations—that was the core competency that we had. Eventually, that led us to what we’re going to talk about today—opportunity zone tax structure. That has been the main thing that we’ve focused on for the past four years. So, we formed a company around it. For a long time, we never had a company.

We would just go find a project that we liked, we would raise some money around it, we would start an LLC, give it a name, and go do the deal. But a few years ago, we actually started a company called Savoy Equity Partners. We formed this company just to do opportunity zone projects throughout Texas, but mostly in Dallas, and they’re all apartment projects and all in that tax structure. So, thanks for having me to talk about it. I appreciate it.

Basics of Opportunity Zones

Ryan: Yeah, we’re excited to have you on. The first question—maybe I’ll just start with some of the basics. So, just walk us through big picture: What is an opportunity zone? Opportunity zone investment that you’re making, and maybe just a little bit of kind of the history there, just to get us started.

Barrett: Yeah, so six questions in one, but I’ll start really broadly. So, the Opportunity Zone legislation was passed in 2018, and it’s a pretty simple high-level deal where legislators want investment in low-income communities, and people like tax breaks. So, they said, “Well, let’s make it as frictionless as possible to get people who want tax breaks to invest in low-income communities.” Essentially, that is the legislation that passed. Amazingly, Congress passed something that generally makes sense.

Because they did that, over the past six years since the legislation passed, $200 billion of equity has gone into these areas. It’s been the most successful place-based tax structure that’s ever existed in American history.

New Market Tax Credit Structure

The number two structure is the New Market Tax Credit structure, which has a lot of friction and has had a whole lot less equity put into these low-income communities. It’s important to understand that when we say low-income communities, that was based on the 2010 census data and was designated by each state’s governor in 2018.

Now, it’s 2024, and a lot has happened in the past 14 years. So, some of these areas in certain states, some governors picked the very lowest income areas in their states. In some states, they were in the path of progress. So, every state’s going to be different, and in some states, a lot has happened in 14 years, and in some states, not very much has happened in 14 years. So, when I put my developer hat on, I’m looking and saying, “Well, where do my investors want to be, and is this specific census tract one of 9,000 somewhere that’s investable?” So, that’s very high level, and tell me if you’re ready to go a little bit further.

Legislative Intent and Investor Incentives

Justin: Yeah, you know, I wanted to pause there just for a second because, you know, Barrett, you very, like, almost subtly mentioned there that the point here was that legislators were trying to find a way to incentivize a particular activity for real estate investors. They wanted to give investors a reason to go and invest capital into these areas. I think it’s important to always know that that’s the main basis for all tax policy right there. So, when things like this pop up, you know, it’s not necessarily that, “Okay, we’re, you know, tapping into something that’s aggressive or foreign or anything like that.” This is exactly what the government was wanting, you know, us as real estate investors to do, and they’re providing these tax breaks. So, that’s fantastic.

Benefits of Opportunity Zones

Justin: So, with that in mind, what’s the point? Why should investors really care about these particular census tracts or these qualified opportunity zones? Like, what’s the benefit then there if we know that that’s the goal with legislation there is to provide these tax benefits? Can you elaborate for us a little bit on what those benefits look like?

Barrett: Sure. So, the benefit to investors is if you have had a capital gain from anything—so, selling real estate, certainly, but selling a business, selling a stock, selling a collectible, selling crypto—any type of short- or long-term capital gain, then you can get tax benefits from investing in the Opportunity Zone tax structure. So, what does that tax benefit look like?

Immediate Gratification

Well, the first benefit—people love immediate gratification, and you can get immediate gratification from investing in the Opportunity Zone tax structure. That is, you don’t owe your taxes next year; you owe them in April of 2027. So, you get a deferral, and that’s a calendar date, not a number of years, but you get a deferral, and that’s an interest-free loan from Uncle Sam. Everybody likes that short-term, immediate hit of dopamine. That’s the smallest benefit from investing in the OZ tax structure.

Step-Up in Basis

The much larger benefit is this second one, and really, that sticks with the legislators’ goal of the legislation, which is long-term, patient investment in these low-income census tracts. If you hold the investment for 10 years, then once you sell it, you don’t owe any taxes, and you don’t have to recapture depreciation. The reason for that is because you get a step-up in your basis as long as you hold for more than 10 years. So, the only other time the IRS offers that to you is if you die. So, it’s really a super powerful benefit.

The only other time you get it is if you die, and here, the IRS is giving it to you because of this OZ legislation. So, it’s that powerful, and you get it after a 10-year hold in the OZ. Legislators want to incentivize this behavior so much that they’re offering this benefit. So, the two things are no capital gains tax on the appreciation and no depreciation recapture. I know you guys on this podcast talk a lot about depreciation, depreciation recapture, and capital gains tax, and we basically make all those things go away using this tax structure.

Practical Example

Justin: Absolutely. I just pressed everybody’s pain point right there: depreciation recapture. If we’re talking about real estate, that’s huge. So, to maybe put a little bit of just—I’ll kind of oversimplify it because we don’t need to get too technical, but just to kind of put some realistic numbers to this, say you were to invest into a property that’s in a qualified Opportunity Zone, you’re using a qualified Opportunity Fund to do so, and you acquire property for a million dollars.

We maybe can talk about how you’ve got to put—like, we’ll say post-renovation maybe on a property is up to a million dollars. So, your cost basis in that property is $1 million, and you hold that for 10 years and a day, essentially. Now, 10 years later, that property is worth, say, $2.5 million. All the while, during that 10-year hold period, you’ve taken roughly—I’ll say $300,000 worth of—we’ll just ignore a cost seg, we’ll just say, like, straight-line depreciation over the course of that year.

Deadline Requirement

So, now we’re at 10 years and a day, we’re selling the property for $2.5 million, and we’re looking at what we would have had depreciation recapture for, say, $300,000. What you’re saying there essentially is by meeting that holding period requirement, being in the zone, and being through a fund, is that $1.5 million of capital gain and the $300,000 of depreciation recapture are eliminated, essentially, right? That’s massive. If there was nothing else to take away from today, it would be that you could have a very, very large exit. Speaking of that, though, I mean, I kind of threw out there it’s just 10 years and, say, one day to barely meet that requirement.

Barrett: Yes

Justin: Is there a deadline? I mean, if I wanted to hold it for 20 years, 30 years, can I? If I can reap this huge amount of capital gain tax-free and I like the idea of real estate hopefully always going up in the long term, how long can I hold it?

Barrett: Well, there are some things in the Opportunity Zone world that haven’t been defined yet. This is kind of one of them. So, December 31, 2047, is the sunset on Opportunity Zone, and the legislation says that’s the last day that you’re allowed to step up your basis.

Step-Up in Basis

Justin: Oh, okay.

Barrett: So, there’s a question there which says, “Okay, well, do I need to sell by then?” Well, no, they probably can’t make you sell. “Okay, well, so then do I just step up my basis like as if I died?” So, do I just go get an appraisal and kind of go through that process? I think that’s probably where the IRS guidance will land, but they haven’t given any guidance yet, and they probably won’t until 2046.

Justin: Or December 2047.

Barrett: Yeah, exactly. But we’ll get there. The legislation, though, says by December 31, 2047, you must step up your basis.

Legislative Uncertainty

Justin: So, a little bit of that’s still up in the air, but at least it sounds like we’ve got quite a bit of runway on this before we really have to worry about them making some last-minute decisions, it sounds like.

Barrett: That’s it. I mean, you could just step up your basis at that point, and then your depreciation schedule totally resets, then you start depreciating it all again.

Justin: I like that comparison there to the step-up in basis at death. I don’t think I’ve ever heard anybody draw that comparison or that parallel. That’s pretty interesting.

Ryan: Right.

Depreciation and Step-Up in Basis

Justin: For those of our listeners that may not be familiar with that, if you pass away with appreciated property that you have been also depreciating and you leave that to your heirs, there’s a quote-unquote step-up in basis, and that your heirs get to inherit the property at whatever the fair market value is at the time of your death, as well as eliminate all the depreciation that’s been accumulated during your lifetime. So, for property that you’ve held for especially extended periods of time or just property that’s been the result of multiple 1031 exchange replacements that have deferred and deferred and deferred tons of capital gains, that can be a very massive benefit.

But that’s kind of, you know, Barrett’s drawing the intent to do here is in order to really tap into that, it’s great for your heirs, but you have to die. But with the qualified Opportunity Fund, you don’t necessarily have to perish in order to take advantage of this tax benefit in your lifetime.

Barrett: Big win.

Potential Legislative Changes

Ryan: Yeah. As we think about the laws, we haven’t seen a whole lot of change in the legislation. Is there any sort of legislation out there right now, or do you foresee any sort of legislation change coming out that might change some of these dates or anything like that?

Barrett: There is, yeah. So, there’s legislation pending to extend and kind of tweak the Opportunity Zone legislation as it sits right now. It’s actually advanced out of the House Ways and Means Committee already, and it is on the floor of the House. It’s not going to pass in an election year. It may pass next year, maybe on its own, more likely as part of some comprehensive tax legislation, and we’ll see how that goes. I was in DC last year, last October, with Democrats and Republicans. It was surprising to me how it didn’t matter whose office I was in, whether Democrat or Republican, overwhelmingly, the Opportunity Zone legislation had support from both sides of the aisle. It really is that rare thing that has bipartisan support.

So, I do believe that this will be extended. I think that the first step will be a two-year extension, and it will be retroactive, I believe, so people who currently owe their taxes April of 27 will now owe their taxes April of 29, which will be really nice for people who’ve already invested or may invest. Hopefully, the next step will be that the program gets essentially reauthorized, and we have a new OZ bill that goes for another 10 years. Because of its success—$200 billion already—I believe that that is inevitable, but we will see.

Housing Crisis and Opportunity Zones

Justin: Absolutely, yeah. That will be very antsy to see how that develops because you’re right. I mean, it sounds like it’s been a pretty wide benefit across the board for these markets getting improved and then having the investment incentive for the investors.

Investor Benefits Post-2026

Justin: So, Barrett, along those lines, we’re talking about these deadlines or timelines potentially getting extended. If nothing does change legislatively in the next couple of years, is there any benefit to investors still being interested in qualified opportunity zones after 2026, or would the program essentially—I won’t say die—but become useless after 2026?

Barrett: So, the last open date for investment as of now is December 31, 2026. As of today, it’s not only there’s no point to investing after 2026, there’s no option to invest after 2026.

Justin: I see. So, that would definitely make a big impact if the deadline gets extended, but I guess as of the time of this recording at least, it’s May of 2024, we still have about two and a half years to take advantage of this. So, luckily, you’re hearing it now and not in December of 2026, right?

New Apartment Developments

Barrett: That’s right. The other big point I think to make is as of right now, 20% of the new apartments in the United States are being built in opportunity zones. In 2016, it was only 8% of the new apartments in the US were being built in opportunity zones. As we see more and more focus on the housing crisis in the US—I mean, just this past week, a bipartisan committee on the housing crisis was created—I think that there’s going to be more focus on, “Hey, this OZ thing actually is making a dent.” So, I think that that may change as well.

Ryan: I think it’s going to take some time too. This is a fairly new program. We’re going to have to wait and see how much of an impact—it’s not just going to be this boom first year. I’m sure it does right away make an immediate impact. It’s going to take some time, though. Hopefully, once we get closer to that 2026 sunset, we’ve seen some change legislatively, which I think will be good too.

Raising Capital for Opportunity Zones

Ryan: Yep. Just to pose you a different question here, obviously, you are on the side where you’re kind of raising capital and then deploying that. Do you think that a lot of people are out there kind of doing this on their own, or do you think that most of these dollars are coming through kind of a fund, kind of like your company, where you’re raising the capital and then deploying that into an Opportunity Zone fund? So, kind of people doing it on their own, kind of DIY sort of thing, or do you think most of the dollars are coming into like a syndication?

Barrett: So, the lion’s share of Opportunity Zone money is still coming through a dozen very large Opportunity Zone funds. Think about, you know, Goldman Sachs of the world, their wealth management groups, and then they’re funneling that to the very large Opportunity Zone funds that have on their own each raised more than a billion dollars. They’re raising a fund each year, and then they are allocating it to developers, and so that is where most of the Opportunity Zone money is.

Opportunity Zone Maturity

I will say that that is starting to change as the OZ world has matured. You have groups like mine where we’ve now raised over $60 million that has come from high-net-worth folks investing directly with us. Separately, there is a larger and larger ecosystem every day of high-net-worth folks who are starting their own Opportunity Zone funds and then allocating that directly to developers. I know high-net-worth folks who have started Opportunity Zone funds of $5, $10, and $20 million. So, there are people who are doing it on their own, for sure.

Justin: And if they’re doing it on their own, it’s not necessarily that they would have to be running the entire project on their own, right? I mean, they could be starting their fund, and then their fund can then invest into a larger fund, right?

Barrett: It is the latter. So, they’re creating an LLC that is self-certifying as an Opportunity Zone fund, and then they are using that money to invest as an LP in developers’ projects.

DIY Opportunity Zone Funds

Justin: That’s great. I think that’s a really good opportunity or at least a highlight for a lot of investors that are saying, “Well, I don’t know if there’s any one of these zones that’s in my area, or even if there is, I don’t know if it’s one that’s really the best investment for me.” But if I could form my own fund, put my capital gains into that, say, with just myself and my wife, but then I could come to somebody like you and say, “Hey, I’ve got my fund set up that has this capital sitting in it. I need to get it placed.”

That opens the door for a lot more opportunity as far as being able to rely on other professionals like your group to say, “Hey, I’ve got some of the funds to deploy. Can you help me place it?” Essentially, because one of the requirements for a qualified Opportunity Fund, of course, is to be investing in what’s referred to as qualified property. They get really creative with the terms, don’t they? But qualified property could be an investment into another qualified Opportunity Fund itself. So, that’s a nice little caveat there that you don’t have to be running the entire project yourself.

Structure and Entity Requirements

Ryan: And just to add on to that, Barrett, you have to have—let’s say it’s me, right, just by myself. Do I have to go have an LLC? Do I have to make some sort of a partnership or any sort of entity structure? Let’s just kind of talk about that for a second.

Barrett: Yes, you do have to create a partnership that files a tax return to self-certify as an Opportunity Zone fund. So, you would have to have someone else in the entity with you in order to do so. So, Justin, you’re in luck. You get to join Ryan’s OZ fund. or someone else with a capital gain, right?

Ryan: Okay. And from what you’ve seen, are you primarily seeing new construction sort of projects, or are they mostly kind of rehab projects?

Types of Projects

Barrett: Both. We’re seeing a lot more new construction than anything else, but also adaptive reuse, also large renovation projects. We’ll see both.

Refinancing in Opportunity Zones

Justin: So, another question I have for you, Barrett, is it sounds like there’s a good mixture of new construction but also maybe the rehabilitation-type projects as well. I think a lot of people would kind of liken that in their minds to the BRRRR method-type style of properties. So, I’m curious, is there opportunity for the refinance side of things with qualified Opportunity Funds, or is it more restrictive in that regard?

Barrett: Yeah, it’s certainly like any other project. So, the only restriction on a refinance is that you cannot make a substantial distribution within the first 24 months. But after that, you certainly can. At any time, including within the first 24 months, you could make a refinance from the qualified Opportunity Zone business to the qualified Opportunity Zone fund. You just couldn’t make a distribution from the fund back to the investor.

Justin: Okay, so it’s almost kind of, yeah, making sure that there’s not just basically a debt-financed kind of distribution sort of situation.

Opportunity Zone Names

Barrett: Exactly. So, if the fund invested in a business and then the business knocked it out of the park and refinanced a huge amount of money back to the fund, well, great. Now the fund can just go invest into another business. When I say business, I don’t mean like a lemonade stand. What I mean is a real estate project. So, you mentioned there’s a name for everything in OZ. Well, the three names are Qualified Opportunity Zone Fund, Qualified Opportunity Zone Business, and Qualified Opportunity Zone Property. The way that those three work is the fund is where the money goes, the business is where the real estate is owned, and the property is the real estate.

Justin: That makes sense. I appreciate breaking all that down because I’m sure it’s easy for everybody to get a lot of those terms co-mingled or confused with one another. Can’t just put a bunch of money in the banana stand, it sounds like.

Barrett: That’s it.

Refinancing and Depreciation

Justin: Okay, excellent. So, that definitely poses some significant advantages there. So, as long as that refinance is occurring, and it could be before the 24-month period, as long as those funds are then being used to say reinvest into additional Qualified Opportunity Zone businesses or property, that’s still in QOZ.

Barrett: Exactly. If you do use refinance proceeds to then go develop another project or renovate another building, that’s wonderful because not only have you created more assets for your OZ fund, but also you get to depreciate those, and you’re never going to have to recapture the depreciation. You’re never going to pay capital gains tax on the appreciation. But also—and this is the thing most people don’t realize—you’re not restarting the 10-year clock because the clock is tied to the investment into the OZ fund.

Justin: Ah, interesting.

Ten-Year Hold and Reinvestment

Barrett: So, the 10 years started when you first put money into the OZ fund. So, now, if that OZ fund goes and wheels and deals and wheels and deals and does refinances and is out there developing projects and all this stuff, well, that’s wonderful. But the 10-year clock started the day that the money went into the fund, and that’s the only time that the clock starts ticking.

Justin: Okay, that’s great. So, let me recap that real quick. So, money goes into the fund, the clock starts ticking for the 10 years, and the fund finishes—say, its main projects—but just absolutely crushes it. Maybe, God willing, rates have gone down maybe a couple hundred basis points, something like that. They do a refinance, and now say we’re at year three, we’ve got seven years left to go on that 10-year clock, and it reinvests into another project that generates some additional depreciation. That’s a really great point that I had never thought of—the fact that you’re also increasing the amount of depreciation you could be taking.

My mind was kind of latched onto the fact that that’s another property now that ideally is going to appreciate over the next, say, seven or eight years before that 10-year clock goes ding. That’s additional capital gains, but additional appreciation that you could tap into when selling it, say, at year 10. That almost doubles the opportunity, not to be too much of a thrill, a pun in there, but that’s pretty fantastic.

Interest Rate Risk

Barrett: Yeah, it’s a great way to do it. I will say, you mentioned interest rates, which are always a conversation that comes up with investors, especially after the last two years. One thing that we’re doing is hedging that interest rate risk using a financial instrument called swaptions, which basically allows us to buy an option on where interest rates will be around the time that we think the project will stabilize.

It doesn’t guarantee a cash-out refinance, but it certainly hedges our refinance risk and allows us to have a lot more certainty around doing a cash-out refinance, which is a big deal when that’s a huge part of our 10-year hold strategy. So, we’re trying to have a lot more certainty around doing what you’re talking about, right?
Saying, “Hey, we think that we’re going to have excess cash to deploy into another project in two or three years so that we can create more depreciation, so that we can create more assets,” doing all those things. So, it’s definitely a little bit different when you really are wearing this 10-year hold hat versus, “Hey, I’m going to build this and flip it in three years. Check out my IRR.”

Investor Hesitancy and Ideal Candidates

Justin: That’s a good point.

Ryan: So, as we’re talking about all these benefits, it’s kind of making me ask myself the question, why wouldn’t people be getting into this? Why isn’t this more popular? So, just two questions from that kind of thinking: Number one, what do you think holds back people from getting into a QOZ fund? But number two, who would be an ideal person to get into this? Is there a threshold for the amount of gain that you think people should have a minimum of to get into this?

Steep Learning Curve

Barrett: I think whatever I say, you’re probably going to have three follow-up questions. You know, it’s taken me a long time to make this sound fairly simple. So, I’ve been doing it for four years, and there’s a very steep learning curve. In fact, even a year in, I probably didn’t know very much. And I’d been at it a year, and then two years in, I could explain it pretty darn well. And now, on and on and on. So, I think that’s a part of it. It’s just a steep learning curve, and it’s very daunting.

Illiquidity and Capital Gain

Number two, I think because of the illiquidity and because you have to have a capital gain to invest into it, both of those are pretty high hurdles to want people to invest. So, I think that’s another part of it. And then the last one, I think, and hopefully we’ll talk about this more, is there’s a lot of misinformation or misunderstanding. Hopefully, we can maybe clear the air on it a little bit. But people look at it and say, “Man, I still have to pay my taxes in 2027. Is this really a good deal?” I think we’ve really cleared the air on a lot of that, but there’s still a lot of just not great thinking on it. So, we like to really educate people surrounding that.

Time Value of Money

Justin: That actually makes me think of something you had said earlier. To that point, we kind of likened it to taking depreciation. I think you touched on it earlier. This is like taking a no-interest loan from the government. Even if you are going to have to recognize that in the 2026 tax year or whatnot, we know just based off the time value of money, if you’re able to even just hang on to that and, say, throw it into—even if it’s a traditional investment that’s only going to—maybe it’s something like throwing funds into the S&P 500 or something, like an index fund or whatnot, right?

So, that’s kind of what you’re—like, part of what you’re driving at, I’m guessing, is the fact that, yeah, even if you are having to pay it down the road, you’re able to take advantage of that time value of money or the investment pathway.

Barrett: Yeah, I think even larger, though. You guys are CPAs and an EA, right? All you do all day is talk taxes. If I tell you today that you’re going to have a tax liability in 2026, what questions do you ask me right now? If I tell you I’m going to have a tax bill in 2026, what questions do you ask me right now?

Tax Planning

Justin: How can I eliminate that before then?

Barrett: That’s the first question, right? And what kind—what did the tax bill come from, right? Was it active, passive, portfolio? Like, what kind of losses can I create to offset it? And those are the same conversations I’m having or trying to get my investors to have with their EA and their CPA. Because if it was a business sale or a real estate sale, well, great. The depreciation losses that I create for them are going to help them reduce or possibly eliminate that impending tax liability.

Or if it was a portfolio sale, you know, they sold stock. Well, hey, could you tax loss harvest over the next two years to make that go away? So, those are the things that I try and get them to think through. Because if somebody invests a million bucks with us and they think, “Well, man, I’ve got this $250,000 sledgehammer hanging over my head that’s due April of 2027.” It’s like, “Well, I don’t think you do if you play your cards right.” You just need to make the professionals around you aware that this liability is there so that you can work your way through it.

Time is on Your Side

Justin: That’s a good point. It’s almost like saying, “Hey, you know, in most traditional senses, if you had that capital gain, you know, say, tomorrow, you’d be looking at, ‘Oh my gosh, okay, what can I do before December 31st of this year to work around that?'” And, you know, like six and a half months, it’s not a whole lot of time, but what if you could extend that runway an extra couple of years? That gives you really, I mean, that’s a world of a difference as far as being able to plan around that.

And not just plan for it, but as we know, like real estate, a lot of the strategies can take some time too. It’s not something you just snap your fingers and—or tell your CPA, “Hey, throw this thing on my tax return,” or whatnot. Sometimes it’s going to take some kind of action on your part. So, extending that runway, I think, is a huge benefit there too, just giving yourself more time.

Knowing the Gain

Ryan: I just want to comment on two things too. So, number one, what’s nice about the 2026—you know exactly how much your gain is, right? You’ve got a nice, pretty form that says, like, “Hey, here’s your gain.” And it’s not like, “Oh my gosh, what is this going to be?” And blah, blah, blah. Sure, you might not know exactly, “Okay, what tax bracket?” And blah, blah, blah. But it’s like, you know exactly how much the gain is. So, it’s like you’re saying, Barrett, we’ve got time to think about it, and you’ve got this space to consider.

Real Life Example

Okay, so like for our clients—I’ll actually give you an example. One of my clients, I can think of, he did a really big gain. I think he sold a business, had this, I think, million-dollar, couple-million-dollar gain that he was expecting. He’s like, “Hey, I’m going to put a bunch of that into a qualified Opportunity Zone fund.” So, over the last several years that we’ve been working with him, it’s been kind of walking through, “Okay, what can I do in 2026?”

And you know what he’s going to do from when we started working with him to 2026? Buy a bunch of real estate, and then he’s going to be a real estate professional in 2026, do cost segs on all of them in 2026 to basically completely eliminate that. And in the time being, he’s completely deferred that until that time, but then completely eliminated that. And then if he continues to hold, like we’re saying, the whole 10-year hold benefit, now he’s got even that additional appreciation, that additional depreciation recapture benefit. So, I actually like that line of thinking, Barrett. I hadn’t thought about it like that. It will be then essentially up to the taxpayer with that gain. Are you serious enough to eliminate that? Because you have options to consider from there.I think that’s a great point.

Passive vs. Non-passive

Barrett: My question for you would be if they had a passive gain coming in and they invested with me and they were not a real estate professional, the depreciation losses I give them are passive. Wouldn’t the passive losses be able to offset the entirety of the passive gain?

Ryan: Right. Because it should retain its character as being passive, is my understanding.

Barrett: Yeah. So, they don’t—I mean, like your guy, would he need to be a real estate professional?

Ryan: He would because he sold a business. So that was like capital gains that he’s got. Yep. Exactly. His was nonpassive. Yep.

Barrett: Okay, like his personal business.

Justin: Non-passive, yeah. His gain is non-passive.

Barrett: Gotcha. Pairing that active and passive can be more art than science, I think.

Justin: Yes, it certainly can be a tripwire for sure. And selfless plug, that’s why you need a qualified expert in this area to help you navigate those subtleties.

Barrett: I said it earlier, right? It’s like what I tell these folks is there are ways—as of today, you have 30 months, right? To figure out how to get rid of this big sledgehammer coming. But you need you guys to do that, and I think it’s very doable.

Misconceptions and Investor Suitability

Justin: Absolutely. Well, we kind of touched there a little bit on—that sounded kind of like a misconception. Are there any other common misconceptions that you hear, maybe like the naysayers out there, of why not to do a qualified Opportunity Zone or something like that?

Barrett: I think the other one I mentioned is the liquidity, and we already kind of touched on that, right? But all of these are really big, either developments or renovations. Well, it doesn’t make any sense to do a development or a renovation if the project isn’t going to be worth more than you spent once you’re done. Well, if it’s worth more than you spent once it’s done, and you add moderate leverage to do it, which we usually do 50% to 60% loan-to-cost, well, then you should be able to do a cash-out refinance regardless of interest rates and hedging and whatever else. You should be able to do a refinance once you’re done and pull some cash out.

Cash Flow

Well, that gets rid of some of the illiquidity. And then after that, you should have some decent cash flow. And so now, somebody invests with us tomorrow, in two or three years, they’re going to get a decent check, and then they’re going to have some cash flow. So, if someone invests with us or in any Opportunity Zone deal—deal-dependent, but in most of the projects that I look at, it’s not they write a check and then they see their money again in 10 or 11 years. It’s they write a check, the project gets developed, then they start seeing cash flow in two or three years. So, there is some illiquidity, but a short period of time. So, I think that that is likely the biggest misconception.

Justin: Gotcha, yeah. Sort of typical short-term or temporary liquidity, but that is important to know. We do want these investments, obviously, to make some money, generate some return just outside of the actual disposition. So, I mean, highlighting that cash flow is something that shouldn’t ever be overlooked, especially—I know we’re a little biased because we love real estate, right? We’re the real estate CPAs. But the fact that this investment is also spinning off depreciation deductions as well, a lot of that cash flow could be very heavily shielded from taxation.

Capital Gain from Stock Sale Example

Where if we just kind of draw that quick comparison to, you recognize that $200,000 capital gain from the sale of stock, well, if you just took that and reinvested it into additional stocks, unless it’s, say, like a dividend-producing stock, you’re just going to be recognizing additional gains every time you’re selling to actually increase that level of income. Or even if it is just holding something that’s dividend-producing, sure, you’re going to be receiving a little bit of cash flow from that dividend, but it’s not being shielded by anything like depreciation for comparison.

Location Concerns

Ryan: Do you also see people be hesitant thinking about these census tracts, about this being kind of in a low-income community? Do people get a little concerned about that at all?

Barrett: Yeah, I think so, and I think it’s just a bias that’s easily overcome, right? So, a meeting I had earlier today, it’s a longtime real estate broker in Dallas. He actually sold us one of the buildings four years ago, and he said, “Okay, well, now I’m interested in investing with you.” And I said, “Well, our open investments are in that neighborhood where you sold us the building.” He said, “Well, that’s an awful neighborhood.” And I said, “Okay, well, let’s go for a walk.” And we just spent half an hour walking in the area, and he said, “Well, this area is very pleasant.”

No one accosted us. Every person I saw looked very nice. We saw a woman walking her dog. This is a very nice area. It’s very investable. It’s great. So, the bottom line is, number one, it’s based on the way that governors choose the specific areas. Number two, a lot has changed in 14 years. Number three, developers and their efforts can change areas. So, all those things put together, and the fact that there’s 9,000 of these census tracts throughout the country, it’s like, don’t have bias until you look at the specific project.

Project Viability

Justin: That’s a great point. I’ve been pleasantly surprised at several of the zones that clients of ours have brought up and said, “Hey, this is an area that I’m looking at.” Like you said, because a lot of times they were just maybe an upcoming area, not necessarily a majorly blighted area or something like that. It could even be a relatively young township or whatnot that hasn’t really had the opportunity to go sideways before or something like that, that just isn’t that large or that well-developed, and the governor said, “Hey, we’d really like more funds to go into that area.” So, yeah, I think that’s important to not just draw that immediate conclusion, “Oh, this must be in a super rough neighborhood. I wouldn’t want to invest there.”

Energy Efficient Credits

Justin: So, one more question we had for you, Barrett, is with some of these projects being major redevelopments or a lot of times new construction, are you seeing a lot of these projects trying to tap into any of the energy-efficient credits like the 45L or 25D types of credits while they’re doing these renovations or new construction to be able to kind of get the best of both worlds, both tax credits and also the qualified Opportunity Zones?

Barrett: Yeah, so we love trying to pair anything to kind of stack the stuff together. 45L is really interesting. With the Inflation Reduction Act, 45L was expanded, changed a little bit. So, you can use it at a $500-per-unit level, $2,500-per-unit, or $5,000-per-unit. $5,000-per-unit hasn’t made sense. $500-per-unit hasn’t made sense for us, but $2,500 is in the middle for some projects. So, the trick there is you have to do it for Energy Star rated buildings, and you have to use prevailing wages typically.

Although we pay prevailing wages, you also have to use a general contractor that certifies the project used prevailing wages, which that’s a hurdle that’s tough to jump over sometimes. But we’re doing a 250-unit project that is HUD-financed, which required prevailing wages, and so it was fairly easy for us to get it Energy Star rated, working with our energy engineer. It cost us about $50,000 on a $50 million deal for that change order, and we were able to get $600,000 in dollar-for-dollar tax credits. So, a 12-to-1 payoff was a great deal for us, and we would make that trade again any day. We’re certainly looking for more opportunities to do so.

Combining Tax Credits and Depreciation

Justin: Oh, yeah, that’s huge. Just take the few extra steps there. And just to add in there too, when we’re talking about these here, we’re talking about—with depreciation, we’re talking about deductions. But with these tax credits or dollar-for-dollar credits, so that’s literally if you have a dollar of tax liability, the credit’s going to offset that dollar-for-dollar. So, that’s nothing to bat an eyelash at, $600,000 of tax credits. That’s fantastic. That’s awesome.

Final Thoughts

Ryan: Well, Barrett, thank you so much for joining us. Do you have any final comments for maybe our audience listeners who are wondering about qualified Opportunity Zones? Any kind of final comments?

Barrett: You know, every time I learn more about OZ and think of a new structure and strategy, I just enjoy it more. I appreciate you guys sharing your platform and letting me share more about it. So, thanks so much.