Business Law

Qualified Opportunity Zones and Funds - What’s the Big Deal?

The Tax Cuts and Jobs Act added the concept of “Qualified Opportunity Zones” to the tax code on December 22, 2017.  In short, a “Qualified Opportunity Zone” is a low-income community that has been nominated by the state and certified by the US Treasury.  The State of California’s Department of Finance has published a list of over 800 tracts of land across 57 counties within California that have been designated as Qualified Opportunity Zones. 

So, what’s the big deal?

Investment in a Qualified Opportunity Zone has significant tax benefits.  To be eligible for these benefits the investment must come from capital gains[1] stemming from the sale to, or exchange with, an unrelated person (20% rule) of any property held by the taxpayer (e.g., stock, real estate, etc.).  The investment must also be made within 180 days of the date of the prior sale or exchange. 

Okay, so assuming I hit those requirements, what are the benefits?

First, the tax that would otherwise be due on the invested capital gains is deferred until the earlier to occur of (1) the date the investment is sold or exchanged or (2) December 31, 2026 (as applicable, the “Tax Date”).

Second, at the Tax Date, the taxable gain recognized will be equal to the lesser of (1) the gain previously excluded or (2) the fair market value of the investment as of the Tax Date. 

Is that all?

No.  If the taxpayer holds the investment for five years, the taxpayer’s basis in the investment is automatically increased so that only 90% of the previously excluded gain is taxable.  If the investment is held for seven years, the taxpayer’s basis in the investment is automatically increased so that only 85% of the previously excluded gain is taxable. 

For example, say taxpayer Tim invests $1,000,000 into a Qualified Opportunity Zone, all of which represents gain from the prior sale of other investment property.  Tim makes the investment on July 1, 2019 and holds the investment through December 31, 2026.  In 2019, he recognizes no gain from the prior sale and his basis in the new investment is treated as $0.  On July 1, 2024, Tim’s basis in the investment is automatically increased to $100,000 (equal to 10% of the deferred gain - meaning that, at most, only $900,000 remains taxable).  On July 1, 2026, Tim’s basis in the investment is automatically increased by another $50,000 to a total of $150,000 (meaning that, at most, only $850,000 remains taxable). 

 Using the above, consider the following scenarios:

 Scenario 1: On December 31, 2026, the fair market value of the investment is only $900,000.  Therefore, on December 31, 2026, Tim must recognize gain of only $750,000 ($900,000 fair market value (which is less than the original $1,000,000 of deferred gain) less $150,000 of increased basis).

 Scenario 2: On December 31, 2026, the fair market value of the investment is $2,000,000.  Therefore, on December 31, 2026, Tim must recognize gain of only $850,000 (original $1,000,000 of deferred gain (which is less than the fair market value) less $150,000 of increased basis

Okay, is that all?

No.  Following recognition of the applicable gain as of the Tax Date, if the taxpayer holds the investment for at least 10 years from the date of investment, the investment effectively grows tax free

Using Scenario 1 from our prior example, Tim recognizes $750,000 of gain on December 31, 2026 at the time that the investment’s fair market value is worth $900,000.  Tim’s basis in the investment is increased at such time to $900,000.  On December 31, 2029, Tim sells the investment for $5,000,000.  At the time of such sale, Tim may elect to have his basis in the investment increased to the sale price of $5,000,000.  The result is that Tim pays no tax on the increase. 

One important caveat is that the proposed regulations provide that the investment must be sold no later than December 31, 2047 in order to benefit from the foregoing. 

Okay! I’m in!

Not so fast.  There are entry barriers and obligations.  First, the only way to participate in a Qualified Opportunity Zone is through a “Qualified Opportunity Fund” meaning a corporation or partnership organized for the purpose of investing in “Qualified Opportunity Zone Property.”  “Qualified Opportunity Zone Property” essentially means (1) property within a Qualified Opportunity Zone (for purposes of this article, “Option 1”) or (2) interests in a business of which substantially all of its tangible property is located within a Qualified Opportunity Zone (for purposes of this article, “Option 2”).[2]

Option 1: If the fund proceeds under Option 1, 90% of the assets held by the fund must be “Qualified Opportunity Zone Business Property” (i.e., tangible property within a Qualified Opportunity Zone used in a trade or business, acquired after December 31, 2017, and to which the original use commenced with the Qualified Opportunity Fund or to which the fund makes substantial improvements).  

The primary scenario at this point is one in which the fund acquires already developed property and proceeds to improve the structures thereon.  Pursuant to Revenue Ruling 2018-29, the fund is not required to improve the land and, by implication, it appears that the land itself counts towards the 90% asset rule so long as the structures are improved.  That said, the fund must make substantial improvements to the structures on the property within any 30 month period beginning at the date of acquisition.  In short, the fund must double the amount invested into the structures on the property to satisfy the substantial improvement requirement.    

Using and expanding upon our prior example, Tim invests $1,000,000 into Qualified Opportunity Fund A (“Fund A”).  Fund A, after obtaining other investors, spends $10,000,000 on a factory within a Qualified Opportunity Zone.  $3,000,000 of the purchase price is allocated to the underlying land.  $7,000,000 of the purchase price is allocated to the actual factory building and improvements.  Accordingly, in order for Fund A to be eligible for the tax benefits described above, Fund A must, within any 30 month period, spend another $7,000,000 improving the property.     

It is important to note that the rules are not yet well-defined regarding how unimproved land is treated and what would therefore constitute “substantial improvement.”  One reasonable interpretation would be that at least 90% of the assets of the fund be utilized to build improvements upon the unimproved land, thereby satisfying the 90/10 requirement.          

 Option 2: If the fund proceeds under Option 2, the rules vary.[3]  Although 90% of the fund’s assets must still be in Qualified Opportunity Fund Property, the fund can satisfy this requirement more easily by ownership of stock or partnership interests in a business that holds Qualified Opportunity Zone Business Property.  The underlying business is then obligated to satisfy the requirements discussed above, including but not limited to substantially improving the structures on the property.  This model does, however, currently provide more flexibility in satisfying the requirements.  Curiously, and as an example of such flexibility and one of the substantial differences between Option 1 and Option 2, the underlying business is only required to have 70% of its assets as Qualified Opportunity Zone Business Property.        


The foregoing article provides a basic overview of the ups and downs related to investments in Qualified Opportunity Funds.  The fact remains though that this is an entirely new area of the law and one that is still pending final regulations.  Accordingly, the rules are subject to change and related IRS interpretations. 

In closing, there is still much regarding Qualified Opportunity Funds that we do not yet know.  However, as of the date of this article, the evidence surrounding them indicates that the IRS wants them to work and as such, they may be a very lucrative investment vehicle for individuals who also desire to make a positive impact on less fortunate areas. 

[1] Other funds may be invested but they do not qualify for the benefits described herein.

[2] There is no requirement that a fund choose one option over the other, or to the exclusion of the other option.

[3] A full analysis of the variations between Option 1 and Option 2 is beyond the scope of this article.

Written by: Doug Mitchell


Forming a Business - Deadlocks, Disputes, and Transfer Restrictions

Forming a business with your business partner is an exciting time and one during which most people avoid thinking about what may go wrong.  As exciting as it is, the parties should still take some time to think through the issues that might arise.  Here are a few things the parties should consider:

1)         Approval Requirements and Deadlocks

For partnerships, corporations, and limited liability companies, a number of issues can arise depending on the number of owners.  If there are two equal owners, or multiple owners with ownership interests that can easily add up to a 50/50 dispute, deadlocks can occur.  If there are owners with minority interests, the majority interest holder(s) can likewise overrule the minority if the voting requires simple majority.  Accordingly, the parties should consider (1) certain actions which require approval of a specified percentage of owners (or percentage interests) and (2) deadlock provisions. 

Approval Requirements

Approval requirements are centered on the business deal of the parties.  If one party holds all the cards, they are most likely going to make all of the decisions.  However, assuming that there is room for negotiation, the parties should consider acts that require approval of all of the owners or at least a super-majority (usually defined as 66.67% or 75%).  A few areas in which the parties should consider unanimous or super-majority approval include:

  1. Any amendment to the operating documents;

  2. Any requirement that any owner make additional financial contributions;

  3. Incurring of any contractual obligation or the making of any capital expenditure with a total cost in excess of a specified amount;

  4. Incurring of any debt, or debt refinance in excess of a specified amount;

  5. The purchase, exchange, or sale of major assets;

  6. Dissolution of the business;

  7. Approval of cash distributions;

  8. Settlement of any lawsuits or claims; and

  9. Filing for bankruptcy.


Deadlocks naturally arise in settings where the parties have equal rights. These deadlocks can be resolved through various means. It may sound silly, but for small disputes (think very minor), I recommend a coin flip. For others, you can give the authority to cast the deciding vote to a third-party tiebreaker. Similarly, you can engage in regular arbitration or “baseball arbitration,” meaning that the parties each submit their proposal and the arbitrator selects one without adjustment. Further, you can mandate the dispute be resolved through the formal dispute resolution method described below. The list goes on and on and the parties are even free to come up with their own method (I’d love to draft a rock-paper-scissors provision!). Regardless, the point is that the parties can sort through these issues now.

 2)         Dispute Resolution

Even the best business partners find themselves in business disputes.  Although it is impossible to predict when or if such a dispute will ever arise, the parties can agree how they will handle one should the situation arise. 

If left unspecified, the default is litigation unless the parties agree otherwise.  What that means in practice is the filing of a complaint, service of process, an answer by the defendant (and any cross-complaints), discovery, experts, motions, settlement conferences, mediation efforts, and, if all else fails, trial.  Beyond the dispute, what that also means is $$$$$$$, psychological damage, and wasted time. 

As an anecdotal tale, early in my career I was involved in a dispute between business partners/husband and wife.  Skipping the juicy details, I was shocked during a meeting when the senior attorney on the case told our client that he could expect to spend at least $500,000 (!!) to get the matter to trial.  Even the smallest matters I worked on in my prior life as a litigator, meaning the ones that were just letter campaigns pre-filing of a lawsuit, usually came with $10,000 attorney fee price tags.  The fact is that disputes are costly.

So, how should you handle it?  There is no perfect method because we are talking about something that may arise in the future and you never know what side you may be on.  That said, my main recommendation is to include a “Dispute Resolution” clause which requires that the parties meet and confer first, mediate second, and litigate or arbitrate third.[1]  The hope is that by forcing the parties to meet and confer first and then mediate, the business parties may be able to reach an amicable solution early on when costs are low and disruption to the business is still minimal.  As an added bonus, mediating the matter early on gives the parties the benefit of a third-party opinion regarding the merits of their position.  Without such a provision, mediation does not normally occur until the parties are gearing up for trial.  At that point most of the expenses have already been incurred by the parties (note the placement of “mediation efforts” above). 

If mediation fails, litigation or arbitration comes next.  With that comes significant fees.  To counter this I recommend a broad attorneys’ fees provision for the prevailing party (which means the loser pays the winner’s attorneys’ fees and costs).  This alone can provide a disincentive for frivolous litigation. 

That said, there is no perfect method but at least with a contractual agreement among the parties you have certainty about how the dispute will progress - control the things you can. 

 3)         Restrictions on Transfer; Buy-Sell Provisions 

The next big area that owners can agree upon is what we call the Restrictions on Transfer and Buy-Sell provisions.  These provisions govern the rights of the business and the other owners to essentially control the parties with whom they are in business and also force other owners to sell on the occurrence of specific events.  Think of it this way.  You start a business with an individual named Clark Griswold.  Years later Clark decides he needs a vacation and wants to sell his interests to his cousin who we will call Eddie.  The Restrictions on Transfer and Buy-Sell provisions protect you from having to run your business with Eddie.

Restrictions on Transfer clauses state that an owner may not sell his or her interest without the other owners’ consent unless to a pre-approved category of buyer.  For instance, your goals may be to transfer the business to your kids one day or, for estate planning purposes, it may become beneficial to have your interests held in trust. 

Buy-Sell provisions state that on the occurrence of certain specified events the business and/or the other owners have the right to buy the ownership interests of another owner, at a specified price or pursuant to a pre-determined formula, and on specified payment terms.  Typical events that trigger the Buy-Sell provisions include:

  1. Transfers and sales of ownership interests (e.g., Clark’s attempted sale to Cousin Eddie);

  2. Retirement/Withdrawal;

  3. Death;

  4. Disability;

  5. Dissolution of Marriage (think about doing business with your partner’s angry ex-spouse); and

  6. Bankruptcy.     

As mentioned above, these provisions should include how the purchase price is determined should a Buy-Sell event occur and what payment terms will be utilized.  Should there be a discount for an owner that skips town and leaves the other owners struggling to maintain the business?  Should there be a discount for minority interests?  Should the price be paid in cash, under a promissory note, or through some combination? 

Like most matters in an agreement, the specifics are subject to discussion and the parties may ultimately decide that they do not want any Restrictions on Transfer or Buy-Sell provisions.   

Closing Thoughts

Forming a business is an exciting time and one that is almost always hectic.  Let’s be honest though – the contractual side of it may not be your first priority.  As such, in my opinion, the goal of any attorney should be to provide their clients with a complete understanding of the issues that may arise, possible solutions, and ultimately, an agreement that embodies the business deal of the parties.

[1] California law mandates that mediation efforts are confidential absent an agreement to the contrary. 

Written by: Doug Mitchell