Much of what is written about the Opportunity Zone program involves investors with capital gains from the sale of capital assets. Those gains can be invested in Qualified Opportunity Funds (QOFs) which, in turn, place those resources into one of 8,000 Qualified Opportunity Zones (QOZs). The investors can then benefit from deferred taxes on those capital gains.
But what if the investor isn’t a single person or entity, but rather, decides to form a partnership limited liability company? Can partners of this LLC benefit from Qualified Opportunity Zone tax deferrals. The answer here is yes. LLC partners can certainly defer capital gains taxes, under the parameters of the Opportunity Zone program. In fact, the IRS explains, in great detail, how corporations, partnerships, and LLCs can be organized as Qualified Opportunity Funds (QOFs), with the purpose of investing in QOZs.
Before doing so, it’s important to understand the correct terminology when it comes to setting up, and managing, these types of entities.
First and foremost, an LLC consists of an entity that is formed by a state-specific statute. Many business owners form LLCs to protect their personal assets; the main focus here is personal liability protection.
While these business structures are okayed by the state, the IRS treats an LLC as a corporation, a partnership, or a disregarded entity (the latter is part of the owner’s tax return).
Here are some of the IRS requirements and rules.
- A domestic LLC with at least two members is considered a partnership, at least for federal income tax purposes. The exception is if this entity files Form 8832 for treatment as a corporation.
- An LLC with one member is considered an entity that is separate from its owner, unless said owner files Form 8832 and decides to be treated as a corporation.
Additionally, the IRS has a whole host of classifications when it comes to defining business entities as corporations. These include business entities formed under federal or state statute; certain foreign entities, insurance companies, associations, or state-chartered businesses conducting banking activities (as long as deposits are insured by the FDIC).
So, to summarize, LLCs formed to either invest in, or form, a Qualified Opportunity Fund, can take the form of corporations, partnerships, or disregarded entities.
Explaining Partnerships and Corporations
But what is a partnership? In its most basic sense, a general partnership is made up of two or more people/entities who share ownership of a business. Under this arrangement, all partners are responsible for expenses and liabilities; they also share in the business profits as well. Each partner is also responsible for his/her own tax liability.
Meanwhile, corporations are separate from the owners. The corporate entity is responsible for taxes (though depending on the setup, shareholders must pay personal taxes on profits as well). But there is no personal liability in a corporate structure.
LLCs, Partnerships, & QOZs
When it comes to working within the parameters of a QOF, an LLC is taxed as either a partnership or a corporation. On the other hand, LLCs that certify as QOFs can benefit from the tax-deferral options provided by the Opportunity Zone program.
But those interested in forming LLCs for the purpose of QOZ investments should consult with their tax experts to ensure a correct, and helpful, setup.
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 the transaction 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.