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Investing in an opportunity fund is more complicated than many financial advisors might realize even after the Treasury Department announced its second set of proposed regulations, which were just published in the Federal Register on Friday.

“When the law first came out I was really excited,” says Chris Cordaro, chief investment officer of RegentAtlantic, an RIA based in Morristown, New Jersey. “Everywhere we have clients with liquidity events or just capital gains in their portfolio.”

(Related: IRS Releases New Round of Regs for Opportunity Zone Funds)

Investors can defer that gain when they invest in an opportunity zone fund within 180 days, and the gain is reduced by 10% if the investment is held for five years and by 15% if held for seven years. 

The gains from the investment in an opportunity zone get even more favorable treatment. If the investment is held for 10 years, the gains are tax-free (They’re cut by 10% if held for five years and by 15% if held for seven years).

Those tax benefits “translate into real savings because if you hold the investment for 10 years and it’s a reasonable investment you’re saving somewhere between 2% and 3% a year,” Cordaro continues.

Opportunity Zone Requirements

“But when you dig deeper into the regulations you realize to qualify for the opportunity zone investment …,” Cordaro said, “you’ve got to … have a substantial increase in the basis, which everyone takes to be double the basis … So if you buy a building for $1 million — $250,000 was  for the land and $750,000 is for the building — you have to improve the building by $750,000. That’s the kicker.

“Now you’re asking a real estate developer to hold onto a property for 10 years. That’s not what they do. Developers develop a property and then sell it to a core portfolio. … It’s complicated, and you need a real estate investor that has both parts of that — does development and holds onto core portfolios. … That’s why it’s become difficult to find an investment that’s worthwhile.”

Cordaro did find one opportunity zone fund to invest in for a client but says he “kissed a lot of frogs” beforehand.

There are a growing number of opportunity zone funds being formed for investments throughout the U.S. — there are roughly 8,700 tracts designated as opportunity zones. Novogradac, a national accounting firm that emphasizes services for the real estate sector, lists 123 opportunity zone funds on its website representing more than $27 billion in community development investing capacity.

Most funds currently focus on real estate, but the latest proposed rules from the U.S. Treasury pave the way for investments in other businesses operating in the zones. They allow businesses to qualify for the 50% gross income requirement if half of the company’s employee hours or  wages are sourced in the zone or if its tangible property and management or operational functions performed in the zone are each necessary to generate 50% of its gross income.

“The second set of rules provides flexibility for the operating companies and will help bring jobs to the areas,” says Martin Muoto, founder and CEO of SoLa Impact Fund, which invests in the distressed neighborhoods in South Los Angeles and is raising funds for a $100 million opportunity zone fund that invests similarly.

The second set of proposed rules also clarified that a fund that invests at least 90% of its assets in qualified opportunity zone properties — which is a requirement — will not lose its tax-advantaged status if it sells qualified property, stock or partnership interests in the fund so long as it reinvests the proceeds in another qualified property within 12 months.

“This provides a lot of clarity and ample room to do things,” said Neil Faden, a partner with the Manatt, Phelps & Phillips, a law firm that works with individuals and funds on opportunity zone investments.

Dual Purposes of Opportunity Zone Funds

Opportunity zone funds have two basis purposes: to provide investors a long-term tax-advantaged investment and to encourage economic growth in distressed communities.

But while the Treasury has issued almost 250 pages of proposed regulations on investments and tax treatment for opportunity funds, in two installments, there are currently few requirements for tracking these investments and none to measure their social and economic impact.

To that end, the IRS, a bureau of the U.S. Treasury, also recently published a request for information soliciting input on data collection and tracking for qualified opportunity zones. The IRS is asking for ideas about how to revise Form 8996, which funds must file annually, to include, among other things, a fund’s impact on economic development and job creation in distressed communities and data useful for measuring a fund’s attractiveness for investors.

Fran Seegull, executive director of U.S. Impact Investing Alliance, which helped create a reporting framework for opportunity zone funds, is pleased that the IRS is addressing the reporting issue but believes its approach to require only aggregate information, released with a lag, is too limiting. She testified before the IRS in February about the importance of data collection on opportunity zones because investors need to deploy capital into funds within 180 days of realizing capital gains.

(Related: A Reporting Framework for Opportunity Zone Funds)

Quinn Palomino, principal of Virtua Partners, a global private equity firm specializing in real estate that has already broken ground on its first opportunity zone fund investment — a SpringHill Suites by Marriott in the western suburbs of Phoenix — suggests that fund reporting be simple.

It should include a breakdown of the number jobs created with salaries and training for opportunities for upward mobility and, in the case of housing developments, the number of units created at market rate, workforce rate (priced for those earning 80%-120% of area median income) and affordable rate (for those earning below 80% of area median income), says Palomino. “We aim for 10-25% of workforce and affordable housing as a rule,” said Palomino.

That may not be enough for investors who are especially interested in the social impact purpose of opportunity zone funds, but it will likely satisfy investors focused on the funds’ tax advantages.

“I haven’t gotten anybody who’s interested on the impact side,” says Cordaro. “ It’s been on the tax side.”

— Check out Conservative-Leaning Tax Think Tank Questions Opportunity Zones on ThinkAdvisor.