What Can Opportunity Zones Offer NNN Investors?

Even if the final regulations do not include net leased assets, the expected increase in retail stores in these districts is promising.
Jonathan W. Hipp

For answers to that question, we’ll just have to wait a while. If the current partial shutdown of the US government doesn’t hang things up too much, the Treasury Department is expected to come out next month with regulations that are said to answer that question and many more. In the meantime, net lease investors will just have to bide their time.

Unless of course, you’re a 1031 investor. We’ll have more on that shortly. But first, some basics:

Opportunity Zones were a creation of the 2017 Tax Cuts and Jobs Act, geared to infusing investment in economically challenged areas. According to Craig Bernstein, partner at OPZ Bernstein in Washington, D.C., the opportunity zone legislation is the most powerful piece of real estate legislation since 1031 exchanges were created in 1979.  These investments have the ability to touch the lives of more than 31 million residents in designated opportunity zones in all 50 states. Identified by the governors in each state, there are over 8,700 opportunity zones in urban, suburban and rural areas throughout the US.

By the way, Bernstein ought to know: He created one of the nation’s first real estate private equity funds focused exclusively on opportunity zone investments. OPZ Bernstein is currently raising a $500 million Opportunity Zone fund.

Do Passive Investments Qualify?

Investments in Opportunity Zones need to be IRS-qualified, says Bernstein, and one of those qualifications is that, at least 50 percent of the total gross income of the business come from the active trade or conduct of a business. And therein lies a potential rub for net lease investors. Since NNN leases have historically been classified as passive—rather than active—investments, “a passive triple-net investor may not qualify. We just have to wait for the second set of regulations to come out in February for the IRS to opine.”

If good news comes out of Treasury, there are some impressive benefits in the opportunity zone structure that could accrue to future net lease investors: “First is a deferral of your initial tax liability until Dec. 31, 2026,” says Bernstein. “Second is what amounts to up to a 15 percent step-up in basis equal to your initial gain (which is effectively a 15 percent discount off of your initial tax liability).”

The third potential benefit is perhaps the most appealing, he says, “If you reinvest your initial capital gain into an opportunity zone fund investment, and you hold that investment for at least 10 years, any appreciation that accrues over that period of time would be tax-free once you sell the asset.”

More Retail Means More Net Leases

Even if the news doesn’t work in favor of net lease investors, there are still the normal gains of investment. Activity breeds more activity, and an initial investment, be it in a restaurant, pharmacy or convenience store, always attracts interest, which can result in economic expansion, additional absorption and more potential clients.

Now for the 1031 exchanges. Traditionally, 1031 investors are just seeking to kick the can down the road. If, let’s say, three partners decide to sell an asset, if they decide to roll the proceeds into another deal utilizing a 1031, they have to reinvest those gains together.

Opportunity Zones allow the partners to decide individually whether to reinvest their sales proceeds into the next investment or not. Therefore, 1031s are great if you intend to keep the assets for the long term. If those assets have appreciated and you’d like to dispose of them now or in the next few years, you might want to consider an Opportunity Zone investment instead.

Clearly, there are opportunities for net lease investors in Opportunity Zones. But for clarity on exactly how much of an opportunity they present, we’ll just have to wait and see.

Jonathan W. Hipp is founder, president & CEO of Calkain Cos.