The Grand Slams in OZ will be Operating Businesses, Not Real Estate

Blake Christian

The Opportunity Zone Expo Podcast
The Grand Slams in OZ will be Operating Businesses, Not Real Estate


Jack: Welcome back everyone to the OZExpo Podcast. I am your host, Jack Heald and I am joined today by Blake Christian. Blake is a partner with Holthouse, Carlin, Van Trigt, is that right?

Blake: Right, yeah. We go just go by HCVT now. Great to be here. Thank you for the opportunity.

Jack: What is it you do there at HCVT specifically? And what services does HCVT provide in general?

Blake: Right. I'll start with HCVT. We're a full-service firm with 12 offices, about 650 total headcount and headquartered in Los Angeles. I work out of the Long Beach, California and the Park City offices. My concentration is business tax consulting and compliance. And then high net worth individuals. I have a lot of serial entrepreneurs and I also specialize in various tax incentives including the new Opportunity Zone program.

Jack: You're a tax specialist and it's the Opportunity Zone. That's why we're here today. Before I dive into some of the specific questions that I want to ask you about the Opportunity Zone, I want you to just think back to 2017 or I guess early 2018 when we first found out about the Opportunity Zone. When you heard it, what were your initial impressions and how have those played out in the previous 18 months?

Blake: That's a great question. And since I specialized in the prior 20 years on various national, federal and state incentive programs, like tax credit programs, I got all the questions from other partners and clients. And when I first looked at it, I was underwhelmed, frankly. I thought, gosh a 10-year investment horizon. It's complicated. I just don't see a whole lot of people doing this. And then I ran numbers and the excel analysis opened my eyes about the power of tax-exempt income in 10 years and the haircuts. And then as I dove into it, the every day flexibility of the program is pretty baffling. Just how many ways you can use it. It's not just for real estate; it’s for active businesses, it’s for blown 1031s. It's just incredible.

Jack: We were talking before we started recording and you mentioned several types of questions that you get and one in particular caught my ear. Talk about using Opportunity Zone investing as a safety net for a blown 1031 exchange.

Blake: Well, most people know you've got a similar 180-day period. But you must make the commitment before you sell. You must place the funds in escrow with an accommodator and you must identify properties up front, and then you have to close and sometimes it's multiple deals. I'm working on a $50 million 1031 right now. They're going to replace it with about eight different properties. Invariably they either can't find an appropriate replacement, or they do, and the price isn't right. Or there's other complications.

180 days isn't very long. If you had that blow up -- let's say it blows up in September -- under the OZ program your gain, the 180 days doesn’t generally start clicking until December 31 on those gains and you could salvage it. Most states have adopted the program, so it's going to apply for both federal and state. And unfortunately, a lot of my clients are in California and they're not going to fully conform. We'll still have the California… We do push clients to 1031s if they're in states that haven’t adopted.

Jack: You mentioned that this four-year replacement did this replacement window can go up to 48 months. And I've been rolling that around in my head and I can't figure out how you turn that into 48 months.

Blake: If you had a gain on January 1 that's going to land on a K1, you have a full 12 months there. You have 180 days to reinvest it, you're at 18 months. And then you drop down month 31.

Jack: It's 49.

Blake: Yeah, it's actually 49.

But it's pretty amazing and I get a lot of panicked calls about, “I don't know if we can deploy the funds quick enough.” I go, “just put it in the Opportunity Fund and we'll work out the deployment of that cash.”

Jack: That leads us kind of naturally into a question that I wanted to ask you because of your expertise in the tax side. I just interviewed an attorney this morning who was very clear that she was not a tax expert. I wanted to ask, at what point do you make that decision to either set up your own fund or to invest those funds through an outside fund? Is there a clear delineator between roll your own and trust somebody else? And if so, how do you make that decision?

Blake: Right. A question I get every day. My threshold if you put it in dollar terms, if you're deferring a $1 million gain, at most you're going to be saving -- on the federal side -- roughly $240,000 at 23.8% and then your state is. It's not an insignificant amount, but you do have to be sensitive to costs.

And that's what I tell people. It should be $1 million or cumulatively you're going to put $1 million of gains into it -- you don't have to put it all at once -- to justify having your own. Because you're going to have to file probably at least one likely two tax returns for the OZs entities. You'll have accounting fees, you'll have legal fees and those are going to add up. On the flip side…

Jack: Yeah, what's on the flip side?

Blake: I get this question all the time. I looked at one of about 50 prospectuses that I've reviewed so far this morning from somebody that was all excited about it and I had to tell him what I tell everybody. I said, “this is a 2% annual management fee. This one had a 20%, no, it had 30% carried interest in it, which is huge.”

But if you do the 15% carried interest and then a 20% cumulative management fee over the life of a minimum of a 10-year hold, right. You're 30%.

Yeah. I think it's an unsurmountable hurdle. I mean as amazing as the program is, you can't have it all eaten up with fees. You must be careful to look at some of these programs. And a lot of times if you really dig into it, they're buying properties that they already own and they've inflated those and so you're in a big hole. So be careful.

Jack: One of the things that I've wanted to ask and somehow have completely failed to manage to ask any of the other tax experts I've spoken with is the following question. 

This is hypothetical, this is not really me. I'm excited about the 10-year hold with a 100% tax deferment after 10 years, but I don't have a cap gain that I can invest right now. Can I take some other investment that's not a cap gain, move it over into an Opportunity Zone investment and leave it there for 10 years and still qualify for that 100% deferral once it's held ten years? Or must it strictly be a cap gain investment up front to get the cap gain deferral on the back?

Blake: Right. Yeah. I'll get right to the meat of your question. You must roll a capital gain to get the great benefits, the five-year step up, seven-year step up and 10-year exemption. You can, however, and we are seeing this, take what I refer to is after-tax money out of your account and invest alongside of an OZ investor. And some people may want to do that just because there is a higher probability of these having higher than average returns because they're investing in depressed areas and should have more juice out of them. But unfortunately, and I have told this to everybody, you're not going to get those step ups along with the other people.

Now if you do have some leverage. If somebody's looking for money for a project and it's not one of these public funds and maybe they're a developer builder, they may give you some special allocations in a partnership agreement because you're putting up the funds that maybe they have a problem getting from other sources. I wouldn't tell somebody not to invest alongside of a qualified OZ investor, but again, you've got to go in knowing that you're not going to get all those great benefits.

Jack: Okay. So that answered that question. Seems to be answered definitively. Another question that I've had. You addressed the “roll your own” versus “invest in a public fund” question: the dividing line is essentially a monetary decision at -- let's call it -- $1 million. There's another part of that question that I'm interested in. Let's assume that I make the decision to set up my own fund. Now what? What is involved in setting up the fund and how is setting up a qualified Opportunity Zone fund different from setting up a typical fund?

Blake: It's quite simple. The more complex things are things that you touched on. Hey, do you have a qualified gain? What's the timing of 180 days? Does it start December 31st or some other period? Who else is going to be involved in it?

The first three we set up, we set up in two days. Of course with attorneys help. But all you're doing is either forming a corporation, it could be a C Corp or an S Corp, (I don't advise people to do an S Corp), or an LLC taxed as a partnership or a limited partnership.

And then the only thing we advise to include language that the purpose of the entity is to qualify as a Qualified Opportunity Fund and that it will likely be setting up a Qualified Opportunity Zone Business and will follow the rules. That's it. Setting it up is probably the easiest part of this whole process. The testing is going to get really complicated and operating that entity is going to be really complicated. Formation is the simplest thing.

Jack: Do you have to make any kind of presentation to the SEC to file anything with the SEC at that point?

Blake: If you get outside investors, then you will have to jump through more legal hoops and disclosures and things. As long as it's located, as you take outside money…

Jack: As long as it's your own money, that's not required?

Blake: Nope, nope. And then the other two steps are you must self-certify that. But you don't have to do that until next year. And then the second part is you have to, if you were doing it for 2018 gain, you would file an extra form on your personal tax return to disclose that you're making that election to roll it into an Opportunity Zone fund.

Jack: Gotcha. Okay. I'm one of those people who reads a lot more headlines than first paragraphs. Had I read the first paragraph the 30 or 40 times I read this headline, I'd have the answer to the question I'm going to ask. But I've never read that paragraph. Why do folks recommend against an S Corp for this kind of structure? I've seen that headline, but I haven't drilled down. Why anything other than an S Corp?

Blake: Well, you just have a whole lot of compliance requirements. You can step on a landmine really easily. You can't have two classes of stock. So if you want to do any special allocations, so maybe one partner needs extra cash, you give him or her an extra $10,000 and go, oh, we’ll true that up later. Technically you've created two classes of stock. To tell you the truth, there's very few cases -- I've only read one or two -- where the IRS has actually blown up an S Corp and removed its status because of this. But it's a danger.

And the other big reason you wouldn't want to do it is you never want to put an appreciating asset in an S Corp. And the reason for that is, it's very inefficient when you go to sell that. Because the buyer isn't going to want to buy the stock, which would give the seller 100 percent capital gains. Because they're going to step into the old owner's shoes and all the assets on the balance sheet are going to retain their old tax basis.

Somebody might come in and spend $50 million on that company and get a balance sheet that has the tax value of $1 million. If they sold all that the next day, they'd have a $49 million gain. It's just really, really inefficient. And, all of these OZ projects, 80% of them are real estate and 20% of them are active businesses that are going to be formed. And both of those, the only reason somebody is doing that is they think it's going to appreciate. So, you'd never want to put it under S Corp.

Jack: Okay. Very good. I appreciate that.

Blake: That's the first paragraph.

Jack: That's the first paragraph. Yeah. Well now I know why I didn't read it because there are already words in there that just made me go bleh…

Blake: It's boring.

Jack: I have a short attention span. I know that there are some significant benefits to opening or moving an operating business into an Opportunity Zone. Obviously, most of the press, most of the attention, most of the money seems to be going to real estate. I'd love to talk a little bit more about some of the significant benefits of using the Opportunity Zone program for an operating business. And I think you've got some insight on that if I'm reading some of your materials correctly.

Blake: Yeah. About half of our projects involve operating business or at least planned operating businesses within the funds that we've set up. I had -- I'm trying to remember his name -- the head of the Opportunity Zone program out of Washington DC…

Jack: Scott Turner

Blake: Scott Turner. I got a chance to meet him at your OZ Expo in Vegas and talk to him for a little while. And he and the administration is focused on -- and I heard Steve Mnuchin say this last weekend -- that they're very focused on using these for operating businesses because you're going to get sustained employment out of that. You're not going to just have construction jobs that'll go away after the project's done and you're more likely to hire people from within the census tracts that the operating business operates in.

Plus, you don't have all the entitlement delays that you're going to have on the real estate probably. Unfortunately, I think half of the real estate projects or more are going to be well-intended, but they won't get done because they're not going to get through all the entitlement process. And then you think of, “What is a home run on a real estate project?” It might get 10% appreciation per year.

Jack: Yeah.

Blake: I won't compound it in my head, so let's say you double the value in 10 years. Everybody's pretty fat and happy. They got a nice big exemption.

But now you say, “Hey, you might be able to start a business.” You don't need $20 million to start a business. You might start it for $20,000, $200,000 and then you sell i for a 10 multiple. You could be talking about an exemption in the 10-, 20-, 30-times what you put into the project.

Jack: Yeah.

Blake: I'm much more excited, equally excited for real estate's good and we're doing plenty of those. But the operating businesses I think are going to be the grand slams in these.

Jack: I certainly hope so. I'm keeping my ears open and keeping my eyes open, looking for the folks who are coming up with the really great ideas and I know they're going to eventually surface. But I agree with you. That's where the grand slams are going to be. It's not going to be real estate. Those are going to be the singles. Some doubles now and then.

Blake: Exactly.

Jack: What are some of the biggest myths or misbeliefs that you deal with on a daily basis? I know that you just clarified one for me, which was being able to invest non-capital gains and still get the 10-year exemption. What else do you run into regularly?

Blake: Well, a lot of people think that you must be selling an asset out of an Opportunity Zone. That asset could be in Beverly Hills and you're just forced to reinvest it in a lower income community that's already designated by statute.
You can sell collector cars; you could sell bitcoin or some other cyber currency. I've seen seeing people looking at it for artwork dispositions and intangibles. Somebody could have a patent on something and certain patents will create ordinary income, but most of them will create capital gains. That's what I was talking about earlier. The flexibility of this program.

A lot of people don't realize, but that was one of the other things in the 2017 Tax Act, they watered down 1031s. And those can only be done now for real estate. They don't apply. Used to be able to do them for cars and artwork and movable equipment fleets of trucks. And now you can't do that. This opens the door back up for that.

Jack: Can I ask you a question as a non-tax professional to a tax professional? I look at things like the old 1031 rules where you could literally exchange one classic car for another classic car. And I just laugh. Do tax professionals ever look at this stuff and laugh or are you just so close to the trees that the forest, isn't obvious to you?

Blake: I used to do those and it's really fun to do those very high-end cars. People didn't realize it, they're sitting on a $2-, $3 million car. The people that collect cars? It's a disease. They are not going to go away from that and I know they're going to get another vehicle. So why liquidate, pay tax and then go buy a car with $0.60 cents on the dollar when you can use 100%. And they love it. And sometimes they let me drive those cars.

Jack: Okay. I think you may have just answered my question, but to me, it's funny that it was written into the tax law. I'm imagining the conversation that took place in the coat closet and the halls of Congress of, “I'll give you this provision if you'll allow me to put the classic cars in the 1031 exchange.”

Blake: Okay, well to clarify though, it wasn't written to include those. They just didn't think ahead to exclude those.

Jack: Gotcha. Right.

Blake: But if they had thought about it, they probably would have excluded it.

Jack: It's guys like you who sat around and went, “wait a minute. This isn't explicitly excluded.” 

Blake: Yeah, exactly.

Jack: Yeah. And that's where I understand why doing your kind of job actually could be fun because you get to find those interesting loopholes. I didn't have an appreciation for the work you guys did until I started talking to a bunch of tax experts about this because it is deadly boring. 

Blake: I tell students we got a reputation for being boring, but we see some really interesting things.

Jack: I want to ask you just a couple of things. I saw as I was doing some research on you that before coming to HCVT, you were a partner with, I can't remember… 

Blake: KPMG

Jack: KPMG.

Blake: Right?

Jack: How in the world did you make the decision to leave a partnership at KPMG and come to a firm as, I mean, I realize 600 people is not small, but that sure ain't KPMG.

Blake: I wouldn't be where I am today if I hadn't started my career at KPMG. The big four have a lot to offer -- a great, great breeding ground for people fresh out of school. But as you move up, you kind of realize, and I had always kind of heard rumblings, that even as a partner, which I was for several years, I always heard, oh, you're really just a glorified employee.

And it was more what I saw happen to other partners than things that happened to me where all of a sudden a very senior partner would say, “Hey, you're going to get transferred to the Des Moines, Iowa office. And yeah, we know you have three kids, but tough luck.” Or they'll do a downsizing and 300 partners go away. And so anyway, you just don't have a whole lot of control over your destiny. And here, I get to specialize in Opportunity Zones if I choose, you know?

Jack: I suspected as much.

Blake: The partners say, go ahead. If you could make some money doing it, great. But if you don't, it's not our problem.

Jack: Tell us a little bit about your background. Did you at six-years-old dream about being a tax specialist and pursued that career for your life?

Blake: No, no. I was going to be a marine biologist. I grew up in Southern California as a surfer. I was going to go to Scripps Institute and be Jacques Cousteau. And then I researched it and -- I realized in high school that I was a pretty hardcore capitalist -- and that didn't pay all that well.

My parents talked me into because I was always good at math and I had a great uncle that was a CPA and he lived on 17 Mile Drive and was a very successful guy. They said, “You should do that.” I said, “Look, I'll give it a try, and if I don't like it, I'm changing majors.”

And ironically my brother, who's two years older and smarter than I am, took it also and quit it about halfway through. And I said, “Okay, this is one thing I can do better than my brother, so maybe I'll stick with it. Yeah.”
He's always been supportive.

Jack: You know, I'm the older brother and I went to college to get a music degree. I was three years ahead of my brother. I was a senior when he was a freshman. He came to the same university and started as a music major. And I remember at Christmas his freshman year, my senior year, I took him aside. I said, “Look, the money’s in the computer industry. Don't go with a music degree.” 

I'm the type of person that had, had the roles been reversed, I would have completely ignored him. But the one useful piece of information I've given him my life, he took. And he's been in that industry his entire life. 
And I like to think that he owes it at all to me.

Blake: Yeah.

Jack: Well, this is good. Before I let you get away from us, I'd like to give you an opportunity for last words. Any last good words that you want to leave our listeners with?

Blake: You know, this is hands-down the most powerful diversification tool I've seen in basically 40 years of practice. For the CPAs and the attorneys that are listening that don't have an expertise in this and don't necessarily want to spend 1,000 hours figuring it all out is just partner up with somebody that knows the area. Because you are going to get a flood of phone calls for the remainder of the year from people that have a transaction or a pending transaction. And at least if you can be conversant and then bring another person onto your team, that way you'll retain the client. Otherwise, and I've seen it where people will just go somewhere else. And you do have to get a little bit of a working knowledge just to be conversant on how the program works.

Jack: You know, I said last words, but that rings a bell for me about a question that is appropriate at this particular time. We're recording this show on Wednesday, June 19. We're closing in on end of June. Are you seeing, and if not, do you expect to see pretty soon a rush to the door because we're within 180 days of the end of the year? Are you seeing that?

Blake: Yes. We're getting flooded with calls right now about rolling their 2018. And then we can all kind of take a deep breath and then get ready for yearend. Now yearend, most of these gains, if they're coming in on a K1 or if they’re a 1231 gain asset used in trade or business, most of those, the tolling of the 180 days won't start until December 31. You'll have until late June of 2020.

But if you sold a bunch of Amazon stock or Apple or, or something right now that 180 days is ticking. We'll have calls throughout the year, but we'll get a little rush at yearend and then a big rush again 12 months from now.

Jack: Right. That was my expectation. All right, good stuff. Well, Blake, if folks want to get a hold of you or HCVT, what's the best way to do that?

Blake: Our website is, My phone number direct dial, (435) 200-9262.

Jack: Very good. I will remind our listeners that information in printed form will be available on the podcast website so you can go to it there. On behalf of Blake Christian, I am Jack Heald for the OZExpo Podcast. Thank you for listening. Be sure and press that subscribe button so you're always updated when we get new episodes out. And we will talk to you next time.

Announcer: This podcast is for informational purposes only and does not constitute legal tax or investment advice or specific recommendations. Please consult with your financial, legal, or tax professional.

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