This publication recently interviewed the wealth management group about the US program's tax incentives, investment opportunities - and challenges.

Since the present US administration enacted its tax changes at the end of 2017, one element has gained more public traction – the Qualified Opportunity Zone program, with tax incentives to encourage investment of unlocked capital gains, targeted at poor neighborhoods. These zones were designed to strengthen distressed neighborhoods across the US through economic development. In some ways they are congruent with the trend known as impact investing, in which money is put to work to yield non-financial as well as monetary returns. If investments are held for minimum periods there are tax breaks, such as from capital gains taxes. This publication is speaking to wealth managers about the attractions, and potential risks, of these zones. (See an example of an article here.)

During a recent visit to the offices of Abbot Downing in New York, Family Wealth Report discussed some of the challenges around these zones with Lisa R Featherngill, who is head of legacy and wealth planning and subsequently with Nina Streeter, a director of asset management. With its roster of ultra-high net clients, Abbot Downing wants to explore to what extent investment in such zones should feature in portfolios. 

First, the positives: can you describe what you see as the main positive features of these zones as far as clients are concerned.
The tax benefits (deferral of tax on original gain, possible reduction of taxes on that gain, and elimination of Federal tax on any appreciation of the Qualified Opportunity Zone investment) are key positive features. Second, there are potential social benefits from job creation and neighborhood improvements. Third, there is the expectation for positive investment returns in the QOF itself.

 What sort of clients should consider these opportunities?
 Clients with large capital gains who are comfortable with illiquid investments and can ideally bolster their existing portfolio of alternatives with the QOF investment are the best candidates for these funds. They also should have a slightly elevated risk tolerance since most of these funds are targeting ground up development, which is the riskiest type of real estate. Additionally real estate developers with gains and capacity for additional longer term illiquidity should consider this since they are familiar with the project development aspect of the investments and could develop a project within a zone themselves. 

What has been the general level of enquiry at Abbot Downing about these zones since the legislation got signed?
Clients have been curious to learn more about Opportunity Zones and interested in any program that can reduce their taxes. There is also a level of cautiousness because clients understand there are unresolved issues. Some of our clients are considering creating their own funds.

Are your phones hot with calls about this?
No, as I mentioned, they are curious and interested, so opportunity zones come up in our conversations, but clients are not feverishly calling about this.

There are lots of potential complexities that clients/advisors must consider. Do you think at this stage there is much awareness of how complicated they are? Clients are not aware of all of the complications, but we are. They hear us talk about the complications, which probably leads to their cautiousness.

Risks/challenges:

How aware do you think people are about the hurdles that participants must jump over to obtain a qualifying investment? 
There are two levels of hurdles: the client needs to find a good QOF and the QOF needs to find good real estate or business investments. The QOF operators are clearly aware of their hurdles and working hard to build their pipelines. The clients are starting to hear about QOFs but don’t necessarily know how to conduct due diligence on them, which is what our clients rely on us for.

How heavy are the due diligence requirements and to what extent could the costs blunt returns?
The due diligence requirements are the same as for any other illiquid fund, but those requirements are augmented by the need to understand the regulations, various fund structures, and the managers eventual plan for the sale of the assets. Inside the fund, there are additional legal, risk, accounting, and compliance costs due to IRS requirements that may create a drag on returns.  

These zones are to some degree creatures of politics and that raises risks of its own. Is that your take?
The legislation supporting the creation of these zones was bipartisan, and the zones themselves were identified by each state’s Governor and approved by Treasury in 2018. Although the zones are based on 2010 census information, the demographics in some of the zones have changed significantly since that time, which in some cases has raised eyebrows regarding their inclusion.

What sort of resources is Abbot Downing putting into advising people about the benefits/risks of such zones? 
We are approaching this topic from both an investment and planning perspective because we believe both need to be addressed, and have invested a significant amount of time and effort in this cross-functional assessment. We are educating team members and clients through presentations both internal and external. 

Do you think the wealth industry needs to take a more coordinated approach in educating people about these zones?
There is a host of information available regarding Opportunity Zones which has been generated by various types of firms. The CPA and law firms were early to market with tax/legal information, while the investment firms have been coming to market more recently since they had to first digest that prior tax/legal work. The tax, regulatory, and investment issues need to be addressed together and there isn’t much information available that takes this holistic perspective. This is why Abbot Downing has created a cross-functional team to provide the integrated approach.

In the broadest terms, in what ways can the zones be seen as a facet of impact investing? 
The QOFs are clearly impact investments. The zones are by definition “low income” and have been identified by government as needing an influx of private capital where that capital can make a transformative difference to a neighborhood.

Are there other points you want to make? Investments in these QOFs are far more complex than a typical closed-end real estate fund, for example, and investors need to be particularly careful about selecting the right QOF manager for their investments.