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March 22, 2019

Stroock Special Bulletin

By: Evan Hudson, Jeffrey D. Uffner, Eric Requenez, Brian Diamond

Asset managers tend to continually evaluate their capital sources and often seek to expand their investor base. Many managers have concluded that the future lies with retail investors, a large and growing segment of the capital markets. Real estate managers and sponsors are no exception, and many are exploring ways to tap into the retail market.

There are many options for raising retail capital. Non-listed alternative products intended to diversify the portfolios of retail investors have included NAV REITs, lifecycle REITs, interval funds, BDCs and private offerings. Since 2018, those options have grown to include Opportunity Zone Funds, which can be structured in several different ways. Should Opportunity Zone REITs, specifically, be included in that list of possibilities?

The answer is a resounding “yes” — and, in fact, certain managers already have been utilizing REIT structures for the offering of their Opportunity Zone Funds.

With Opportunity Zone REITs already starting to be formed, savvy investors and asset managers have been taking a closer look at the potential benefits of structuring an Opportunity Zone Fund as a REIT. Here are some of the reasons that a sponsor might consider structuring an Opportunity Zone product — whether a public or private offering — as a REIT, as opposed to a partnership, limited liability company or other pass-through entity. Of course, this is based on the current tax regulatory guidance, and it is possible that updates from Treasury may put a new spin on all this thinking.

What is an Opportunity Zone Fund? An Opportunity Zone Fund is a vehicle through which investors can reinvest their capital gains into a business located in a Qualified Opportunity Zone, one of many specially designated low-income areas across the country. The business can engage in almost any trade or business activity, including the simple rental of real property to tenants, provided that it meets certain requirements relating to the nature of its assets and income. The incentive for investors is that in exchange for their investment of “rollover” capital gains into an Opportunity Zone Fund, the investors receive certain tax benefits on those capital gains.

What are the potential tax benefits? The tax benefits include deferral of the tax on initially reinvested capital gain until 2026, and potentially a reduction in the amount of tax ultimately owed on such capital gain by 10% or 15% if the investment is held for 5 or 7 years (respectively). In addition, there is another major benefit if the investment is held for at least 10 years: the elimination of tax on any future appreciation of the investment prior to its sale. For example, if a $400 initial reinvestment grows to a $1,000 value over those 10 years, that could represent savings of tax on the entire $600 of appreciation.

What is a REIT? A real estate investment trust, or REIT, is a type of entity that primarily owns real property (and must accordingly meet certain asset and income tests to qualify to elect REIT status) and receives special tax benefits pursuant to its tax classification as a REIT. Most notably, the REIT benefits include the ability for the REIT to reduce its taxable income by distributing the income to its shareholders, effectively eliminating the “second layer” of tax ordinarily arising at the corporate level.

Let’s talk about some reasons to put these two together — to form an Opportunity Zone Fund that also qualifies as a REIT.

First, a REIT structure provides a great deal of flexibility on exit. One key limitation of the Opportunity Zone rules is that investors must exit by selling their interest in the Opportunity Zone Fund. A REIT, however, can meet this requirement by selling its assets and immediately liquidating, as a sale of assets and liquidating distribution are generally treated for tax purposes as a disposition by the shareholders of their interests in the REIT. There is no analogue for this treatment in other common real estate vehicles such as a partnership or LLC, and accordingly the ability to engage in an asset sale may be limited for such entities in the absence of further Opportunity Zone guidance. REIT shares also can be listed on a national securities exchange, which can provide additional exit opportunities in case the preferred exit is not a sale of the assets and liquidation of the REIT. Listing REIT shares on an exchange provides shareholders the flexibility to exit the investment on their own, with control over the amounts and timing of their sales. On the other hand, the sponsor would continue to effectively control a permanent capital vehicle.

Using a REIT for an Opportunity Zone investment provides other advantages as well. These advantages include:

  • The 20% dividend deduction. This deduction essentially enables investors to pay a reduced tax rate on their distributions from the REIT. Although it is available to any effectively “pass-through” entity, including a partnership or LLC, regulatory limitations may apply in the partnership or LLC context to preclude investors’ ability to take the full 20% deduction.


  • No dual-state income tax exposure. A partnership or LLC generally passes through the entity’s tax attributes to its members, which could result in the members being subject to taxation in the jurisdiction(s) in which the entity does business (i.e., where its properties are located). A REIT (though eligible for certain tax benefits in the nature of a “pass-through” entity) is a type of C corporation, and therefore its shareholders generally are subject to taxation only where the shareholders reside, rather than in the jurisdictions of property owned by the REIT. The REIT alone would be responsible for any state and local tax filings.


  • No K-1. Similarly, a REIT provides its shareholders with a Form 1099, a much simpler form of reporting than the K-1s associated with a partnership or LLC (and some fund structures could result in multiple K-1s). For investors sensitive to the type of tax document received, this could be a meaningful advantage.

So — are Opportunity Zone REITs a path to the retail market?

The short answer, again, is yes — Opportunity Zone REITs should be considered as a possible path to raising retail capital. The simplified reporting requirements and the expanded set of potential exit structures make REITs an attractive investment vehicle both for investors generally and for investors in Opportunity Zone Funds. There may, of course, be reasons not to use a REIT in a given deal, and other structures may provide other advantages — and it is possible that future tax regulations may provide additional benefits to Opportunity Zone Funds formed as partnerships or LLCs (for example, regarding ability to make distributions). Nevertheless, the benefits of a REIT structure are significant, and may especially be so for certain investors.

We note that nothing in this bulletin should be construed as legal advice. Readers should consult their own advisors for actual legal advice — and, as noted, the above discussion is based on statutory and regulatory guidance to date and may be subject to change. But for now, when a client asks whether an Opportunity Zone REIT is a path to the retail market, the answer is “let’s definitely consider it.”

For More Information:

Evan Hudson
Jeffrey Uffner
Eric Requenez
Brian Diamond

This article is for general information purposes only. It is not intended as legal advice, and you should not consider it as such.

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