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Newsletter – May 2020

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Subchapter V of the Bankruptcy Code and How This Can Help Small Businesses

The unprecedented crisis brought on by the coronavirus has hit every facet of the economy. Companies that were operating profitably and with robust growth expectations have been decimated by the impact on the health of employees and customers, of stay at home orders and disruptions to supply chains. Federal and state plans to mitigate the impact continue to roll out, but it is clear that the economy will experience devastation not seen since the Great Depression.

In this time of uncertainty, companies must plan for every conceivable outcome. Small companies in particular are especially vulnerable and must assess all tools at their disposal in order to survive.

The purpose of this newsletter is to highlight a new provision of the Bankruptcy Code which can be a lifeline to small businesses. We intend to provide you with an overview of the features of the newly enacted Subchapter V of the Bankruptcy Code so you can understand this alternative as a means to survive the current crisis. The information presented below is for informational purposes only and should not be considered legal advice or opinion, which should only be sought from an attorney.

Subchapter V is part of the federal Bankruptcy Code that came about from a new law called the Small Business Reorganization Act of 2019 on February 19, 2020. Subchapter V is aimed at small business corporate and individual debtors, and it is intended at reducing the complexities of Chapter 11 by increasing efficiency, lowering costs and easing the plan confirmation process.

Initially, Subchapter V was limited to a person or entity with total debt of less than $2,725,625. The CARES Act raised this amount to $7.5 million; this higher amount will only remain in effect until one year after the effective date of the CARES Act, i.e. March 27, 2021. The one exclusion to Subchapter V is single asset real estate entities.

The advantage of a Subchapter V filing over a Chapter 11 filing includes the following:

There are no fees, apart from an initial filing fee. Also, administrative expenses may be paid over the life of the plan (as opposed to the date of the plan confirmation as with Chapter 11 filings).
Filing requirements are the business’ most recent balance sheet, statement of operations, statement of cash flow and tax returns, or a sworn statement that such documents do not exist.
Subchapter V has no creditor committee, unless the court orders otherwise.
The petitioner will submit the plan to the court and, if it meets certain requirements, it will be accepted by the Court.

Under a typical Subchapter V filing, the chronology of events is as follows:
A status conference will be held in bankruptcy court within 60 days of filing;
The debtor must file a report detailing efforts to reach a consensual plan of reorganization no later than 14 days prior to this conference, and;
The plan must be submitted for approval within 90 days. Extensions may be granted where there are circumstances for which the debtor cannot be held accountable.

The plan will generally be confirmed as long as all disposable income for the ensuing 3-5 years will be used to repay creditors.

If creditors can’t agree on the petitioner’s proposed plan, the Bankruptcy Court Judge may be asked to order the plan approved (a “cram down”). The success of the proposed plan would need to be demonstrated to be more attractive to unsecured creditors than a conversion to a Chapter 7 liquidation plan, which is usually very easy to be made.

A small business owner may continue to operate post filing as a debtor-in-possession and must continue to file the schedules and statements required of all debtors under the applicable section of the Bankruptcy Code. However, the court can strip a small business debtor of its debtor-in-possession powers for cause such as fraud, dishonesty, incompetence or gross mismanagement, either before or after the bankruptcy case or for failure to perform the obligations specified under a confirmed plan. In such an event, a Small Business Trustee would take over the operation of the business.

In summary, the advantages of Subchapter V over a Chapter 11 filing are costs, ease of filing requirements, ability of the owner to prepare the reorganization plan without having the involvement of a creditor committee and relative ease of confirmation by the Court as long as certain hurdles are met.

For business owners who are undergoing challenges, we hope that your firm will be able to successfully withstand the current crisis and be able to return to normalcy in the near future, and that you will not need to consider Subchapter V. However, we encourage you to consider this alternative if it can result in your firm’s survival. CFO Consulting Partners can assist you in seeking legal advice and assistance from our broad network of contacts in the legal field.

Finally, we wish the best to you and your loved ones for safety and continued good health.

The content of this newsletter is meant for general information purposes and is not to be considered legal advice or opinion. As with any bankruptcy or restructuring filing, you need to consult with an attorney to cover your own unique situation and circumstances.

By Mark Sloan, Director, CFO Consulting Partners, msloan@cfoconsultingpartners.com
David DeMuth, Sr. Managing Director, CFO Consulting Partners, ddemuth@cfoconsultingpartners.com

Newsletter – April 2020

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Thinking Ahead – Accounting for Loan Losses During and After Covid-19

One of the many challenges posed by the current health crisis is the need for lenders to reassess their borrowers’ ability to repay their loans. While it may seem unfair, or even unseemly, to have to address this issue at this time, financial institutions will need to do exactly that in closing their books and reporting on the First Quarter of 2020 in their regulatory reports and (for SEC registrants) Forms 10-Q.

The accounting approach most community institutions are following, and on which we will focus here, is the traditional, probable incurred loss model. This model requires institutions to provide for losses that are probable to have been incurred under the GAAP literature in Accounting Standards Codification (ASC) 450, Contingencies, and 310, Receivables. In practice, this usually involves a modeled component, based on historical write-offs over a look-back period, and a qualitative component, based on the current state and trend of economic and other factors affecting the portfolio. A good summary of the factors to be considered in this qualitative analysis are the nine points summarized in an Interagency Policy Statement issued in 2006 by federal banking agencies, which can be found at this link: https://www.occ.gov/news-issuances/bulletins/2006/bulletin-2006-47a.pdf

Generally, increased loss provisions are expected but likely too few facts are available to make specific loss assumptions. Measuring specific incurred losses at the end of Q1 will be difficult and most likely will be addressed through additional qualitative factors. Reserve assumptions for those credits already under analysis should be reevaluated and likely dealt with across product and delinquency categories.

Following are the nine points from the Policy Statement, in italics, followed in each case by our comments:

1. Changes in lending policies and procedures, including changes in underwriting standards and collection, charge-off, and recovery practices not considered elsewhere in estimating credit losses. This would include loan forbearance and other regulatory relief measures enacted to assist with resolution of the crisis: https://www.fdic.gov/news/news/press/2020/pr20038a.pdf

2. Changes in international, national, regional, and local economic and business conditions and developments that affect the collectability of the portfolio, including the condition of various market segments. The effects of the current health crisis will be pervasive, as covered in the other points.

3. Changes in the nature and volume of the portfolio and in the terms of loans. Institutions will need to address any shifts in new lending – in some portfolio segments, new production will have stopped, and thus not be available to offset increased non-performing loans and normal amortization within those segments. Thus, looking forward and doing the math, loss rates will increase within these portfolio segments.

4. Changes in the experience, ability, and depth of lending management and other relevant staff. Will there be sufficient staff available to effectively manage the portfolio? Will remote collection efforts be as effective as prior techniques?

5. Changes in the volume and severity of past due loans, the volume of non-accrual loans, and the volume and severity of adversely classified or graded loans. A sharp increase in delinquencies can be expected, albeit delayed by the TDR forbearance mentioned above. The ultimate losses may be mitigated by any government guarantees that are available, as well as borrowers’ ability to access business interruption insurance.

6. Changes in the quality of the institution’s loan review system.
Improvements that strengthen the process of reviewing loans could be a mitigating factor. If however, the loan review process weakens, either because of staff illness or other limitations, this factor may be another reason to strengthen reserves.

7. Changes in the value of underlying collateral for collateral-dependent loans. Real estate loans will be a challenging area, as the impact of current developments on the commercial and residential real estate markets will take some time to shake out, however declines in market values seem likely.

8. The existence and effect of any concentrations of credit, and changes in the level of such concentrations. The effect of concentrations can become more severe as conditions in certain industry sectors worsen, and the relative size of concentrations can become larger as healthier loans run off in a low origination environment.

9. The effect of other external factors such as competition and legal and regulatory requirements on the level of estimated credit losses in the institution’s existing portfolio. These factors include forbearance that is enabled by legislation e.g., restrictions on foreclosure that lead to increased losses from deterioration in the physical condition of properties and/or in the property market.

Your portfolio consists of two types of borrowers: healthy and current borrowers who may be negatively affected by the duration and severity of the current crisis; and those already exhibiting financial stress (past due and delinquent accounts, businesses already under severe attack from a variety of sources including the lack of a viable internet strategy, lower cost of foreign competition, and many others) for which the current crisis may finalize their situation. Both may benefit from the governmental assistance and forbearance programs, however the exclusion from TDR accounting applies only to the former borrowers. You should track and maintain records of your borrowers’ status throughout the deferment and modification process in order to demonstrate those which are not TDRs.

We have discussed the challenge of first quarter reserving with senior representatives from several large accounting firms, and the following pieces of practical advice emerged:

* Now is not too soon to begin discussing reserving considerations with professional service providers, including auditors and consultants.

* Most institutions are targeting timely filings of their First Quarter reports, notwithstanding the grace periods being offered by regulators, including the FDIC and SEC. See the announcement of the grace periods at:
https://www.fdic.gov/news/news/financial/2020/fil20028.html
https://www.sec.gov/news/press-release/2020-53

* Auditors, regulators, analysts and other interested parties will be looking for a strengthening of the environmental/qualitative reserve, along with supporting evidence that identifies the impact of current events and links to any adjustments.

* Whatever process is followed, it will be necessary to step back and consider whether the result makes sense.

* Whatever answer is arrived at for First Quarter reporting, further adjustments will undoubtedly be required in the Second and Third Quarters as more information becomes available.

We are familiar with these issues and accustomed to working remotely. Please let us know if we can help in any way.

Note on CECL: Institutions that have adopted the new Current Expected Credit Loss Model in the First Quarter will have similar considerations, but with the additional challenge of adopting the new model. They should also consider the possible impact of the CARES Act on timing of adoption, and related regulatory actions, including the Federal Institutions Letter on the interaction between timing of adoption and capital relief:
https://www.fdic.gov/news/news/financial/2020/fil20032.pdf

Larry Davis – ldavis@cfoconsultingpartners.com
Paul Karr – pkarr@cfoconsultingpartners.com
Eric Segal – esegal@cfoconsultingpartners.com

Curated Articles: Insurance Coverage Amidst COVID-19

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Amidst the chaos of the COVID-19 outbreak across the United States, it is imperative to understand the insurance coverage issues that arise from a pandemic such as this.
Below are published articles and videos about insurance coverage issues related to COVID-19:
  • In an article, titled “Insurance Coverage Issues Related To Coronavirus,” by Christopher Loeber, a partner at Pryor Cashman, Loeber lists three essential steps that should be taken by all corporate policyholders.
    • Review and understand your insurance policies.
    • Enlist the assistance of insurance professionals.
    • Tender claims promptly but pursue coverage patiently.
  • In the article titled “Insurance Considerations in Light of COVID-19,” authors, Cecelia Lockner and Carl E. Metzger, partners at Goodwin Procter, discuss insurance-related issues relevant to clients dealing with the outbreak. They highlight the three key issues small businesses need to consider.
    • What type of losses might be covered by insurance.
    • Claims under insurance policies in the wake of the COVID-19 Outbreak.
    • Negotiating and Underwriting Insurance Policies During the COVID-19 Situation.
  • In an interview of Finley T. Harckham on Bloomberg, Harckam discusses the role of insurance in a virus fallout. Harckham offers options that businesses should use to ensure against risks like the COVID-19 and the role of insurance in managing virus business interruptions.
CFO Consulting Partners does not endorse any particular publication, direct or indirect. We do assist companies in evaluating its financial management needs and in recommending a best fit. Please feel free to reach out to Allan Tepper, Senior Managing Director, at (646) 650-2028 x701, or by email at atepper@cfoconsultingpartners.com

 

By Peyton Wille, CFO Consulting Partners

Curated Articles: Blockchain in Finance, Supply Chain and Accounting

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As new technologies are constantly emerging, it is crucial for firms to be able to adapt to the new technologies to not risk trailing behind their competitors. Currently for many accounting,  finance, and supply chain functions, that new technology is blockchain. Blockchain can be described as a data structure that holds transactional records and while ensuring security, transparency, and decentralization. You can also think of it as a chain or records.
Below are published articles related to the use of blockchain:
  • In the Fortune article titled “How Blockchain Will Shake Up the Financial World: 5 Questions for Author Alex Tapscott,” Jeff John Roberts interviews Alex Tapscott about some of the impacts of blockchain technology. Alex Tapscott is a best selling author who is most famous for his book Blockchain Revolution. Alex Tapscott discusses the three main pillars of our modern society who are deeply invested in blockchain; the civil society, governments, and private industry.

 

  • In an article published by Wharton Business school, titled “How Blockchain Will Redefine Supply Chain Management,” Stefan Gstettner is interviewed about the impact of blockchain on supply chain. Stefan Gstetner is a partner and associate director at Boston Consulting Group and he expects blockchain to have the greatest impact on dispersed networks with many participants.

 

CFO Consulting Partners does not endorse any particular publication, direct or indirect. We do assist companies in evaluating its financial management needs and in recommending a best fit. Please feel free to reach out to Allan Tepper, Senior Managing Director, at (646) 650-2028 x701, or by email at atepper@cfoconsultingpartners.com

 

By Peyton Wille, CFO Consulting Partners

Curated Articles: Hitting the Wall

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As companies grow, at some point many will “hit a wall.” It is likely, based on prior studies, that the if and when this may occur will not have been predicted by company management.
Below are published articles related to companies hitting the wall:
  • Eric M. Ross published an article, titled “Hitting the Wall,” in which he mapped out the typical timeline for companies as they grow and expand. In order for companies to remain profitable and have continued growth in sales after they’ve hit the wall, Ross explains the key areas of focus, which are:
    • Management approach
    • Organization, processes, and systems
    • Working capital availability
  • The most suitable person to understand how to predict when a company will hit its wall would be someone who has been there before. In an article from Inc. Magazine, also titled “Hitting the Wall,” the founder James Bildner of J. Bildner & Sons explains what indicators to look for before a company hits the wall. He stresses that the main theme for all companies that reach this point of stagnation is the same, poor cash flows.
  • In Mike Rogers article, “How to Avoid Hitting the Growth Wall,” he dives into the management techniques that can be detrimental for companies as they grow. He lists the five management practices that he feels stalls growth:
    • Treadmill Mentality
    • Management by Insanity
    • Rear-View Mirror Management
    • Management by ESP
    • Midas-Touch Management

Newsletter – October 2019

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Insurance Update – Includes our Takeaways from the Annual SIFM Conference

We attended the Annual Conference of the Society of Insurance Financial Management held in Atlantic City, New Jersey, on September 15-18, 2019.  This excellent and well-attended Conference brought together finance professionals from insurance companies and professional service providers to discuss topics of current interest.  This update incorporates a few of the themes introduced by speakers at the Conference.
Overall:
Financial leaders in insurance will continue to be challenged by our rapidly changing industry and the real need to more quickly deliver meaningful financial information.  Many financial executives are wrestling with support of innovative new products, how to best leverage new technology, accounting and tax changes, and the need to maintain a quality high workforce.
Meeting Evolving Customer Needs:
 
The needs of the industry’s customers continue to change, and finance teams need to be able to support their business partners in meeting those needs.  This will require speed, agility and affordable cost.  One potential enabler is automation, but the base finance and accounting processes themselves need to be evaluated to make sure they are optimized for existing technology and to avoid “paving the cow path” when new technology is implemented.
Where there is a lack of comfort with a source of management and financial information, for any reason, multiple sources tend to proliferate, which creates a need for a single source of the truth.  Until that single source is achieved, the multiple sources need to be reconciled each and every reporting cycle. That effort, which can be considerable, should achieve the obvious control objectives as well as underscore the need to eliminate the multiple sources.
Implementing New GAAP for Credit Losses:
This new accounting standard has more applicability to insurers than some may realize.  First, an outline of the effective dates for calendar year-end entities, incorporating the FASB’s tentative decision in October to defer certain dates:
      1. Public business entities that meet the definition of an SEC filer, excluding “smaller reporting companies” (as defined by the SEC) – January 2020
      2. All other entities – January 2023
Most insurers will expect the new GAAP (ASU 2016-13) to apply to held to maturity investments and commercial mortgage loans, BUT it also applies to reinsurance receivables!  The new GAAP model, Current Expected Credit Losses (CECL), requires reserving expected future losses at the time the asset is initially recorded (there is no “probable” trigger anymore).
Reinsurance receivables therefore are required to be viewed as having a probability of default, which requires estimating both that probability and the amount of loss that would occur in the event of a default.  There are several practical considerations to keep in mind in making these estimates:
  • For probability of default, where the insurer has no history of having experienced defaults in its reinsurance arrangements, it may be necessary to use industry statistics;
  • For amount of loss in the event of default, the required reserve may not be very sensitive to this estimate if the probability of loss is low.
For statutory accounting purposes, the rules on credit losses have not changed yet, but we can reasonably expect those rules to follow suit after the GAAP world has developed some experience applying the new standard.
Tips for Insurance Company CFO’s & CEO’s:
 
Merger & Acquisition-
  • As brokers perform due diligence on acquisition opportunities, client agreements should be reviewed to ensure that these agreements allow for transfer of the contract to the acquiring company.  Otherwise the acquiring company could experience more rapid client attrition than anticipated.
  • With the reduction in tax rates, as companies model acquisition opportunities, companies should be sure to incorporate these lower rates in the net operating loss forward calculations
Supplemental Compensation-
  • Brokers need to thoroughly understand the terms of their Carriers’ Supplemental Compensation Agreements. A worthwhile exercise is to read each agreement and recompute the amount that should have been received for each of the last few prior payment periods.  Then compare these calculations to the computations provided by the Carrier.
Product and Business Unit Performance-
  • Some companies are using expedient methodologies to allocate corporate overhead across business units or products – i.e., the allocation of overhead as a percent of revenue.  In other cases, when business drivers are utilized to allocate these costs, expenditures needed to support the rapid future growth of one product are inappropriately distributed across all products.  This occurs because current period business drivers are used to compute the current period cost allocations.  As a result of these two allocation approaches, Product and Business Unit internal reports could be inaccurate.
  • Business intelligence tools and complex spreadsheets are often used to provide additional analysis.  Financial information on these additional profit segments is used to make key decisions for business in a particular geography, industry, sub-product, or marketing channel. Control and review processes must be established in order to prevent the same revenue from being counted twice or partial capturing of certain costs.
The Insurance Industry team at CFO Consulting Partners are senior level professionals with CFO, Controller and Rating Agency experience.  We have helped Carriers and Brokers manage credit ratings, implement strategic planning and business analysis functions, improve financial reporting and accounting processes, and strengthen internal controls.
by Michael Sheahan, Director, CFO Consulting Partners
and Paul Karr, Director, CFO Consulting Partners

Biweekly Newsletter – Technology Transformation

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Streamlining financial control and reporting is crucial for a company’s success and ability to drive change. How robust is your accounting system?

Below are recently published articles related to ERP Software:

  • Does your company need an ERP system? Glenn Tyndall in “The Real Cost of an Enterprise Resource Planning System” defines an ERP system as “a suite of software packages that can perform accounting, product planning and development, manufacturing, inventory management, sales management, human resources, and other business tasks,” and dives into costs of the system including:
    • Implementation
    • Training
    • Development for Customization
    • Process Redesign
    • Maintenance
    • Upgrades
    • Support
  • Eric Kimberling in “What are the Top ERP Systems for 2019” analyzes the best accounting systems for small to mid-sized companies taking into account “market share; ease of implementation; maturity, flexibility, and scalability of solutions; ease of integration to third-party systems; ease of organizational change management and training; strength of vendor ecosystem; and average time to benefits realization” to rank the best ERP Systems.
  • Lori Fairbanks in “Best Accounting Software and Invoice Generators of 2019” evaluates affordable, easy-to-use accounting programs designed for startup and small companies summarizing pros and cons for over 30 different systems.

CFO Consulting Partners does not endorse any particular accounting system nor does our firm have any connection, direct or indirect with any particular software developer or value-added reseller. We do assist companies in evaluating its financial management needs and in recommending a best fit. Please feel free to reach out to Allan Tepper, Senior Managing Director, at (646) 650-2028 x701, or by email at atepper@cfoconsultingpartners.com.

By Zach Gould, CFO Consulting Partners

Biweekly Newsletter – Fintech in 2019

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Following the trend of our latest newsletter, AI and Machine Learning, this newsletter will focus on the growth of FinTech in 2019.

Deloitte defines financial technology (“FinTech”) as “digital innovation in the financial sector. At its inception, the understanding of FinTech was limited to innovative ways of facilitating payments and transactions. Underpinned by revolutionary shifts in internet and mobile technology in recent years, the realm of FinTech has witnessed explosive growth. Nowadays, it refers to a wide variety of technological interventions within the financial services arena, such as crowdfunding, online customer acquisition, mobile wallets, P2P lending, MPOS (mobile point of sale), MSME (micro, small, and medium enterprise) services, personal financial management, private financial planning, Blockchain and cryptocurrencies. FinTech is also used to describe businesses that aim to provide financial services by making use of software and modern technology.”

Below are recently published articles related to FinTech:

 

By Zach Gould, CFO Consulting Partners

Biweekly Newsletter – Machine Learning and Artificial Intelligence

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Machine learning has the potential to disrupt every industry. A computer’s ability to iterate through data and solve complex mathematical calculations is developing rapidly with improved processing speeds and data storage.

SAS Insights defines machine learning as “a method of data analysis that automates analytical model building. It is a branch of artificial intelligence based on the idea that systems can learn from data, identify patterns, and make decisions with minimal human intervention.”

“Humans can typically create one or two good [financial] models a week; machine learning can create thousands of models a week”

-Thomas H. Davenport, an excerpt from The Wall Street Journal

Below are recently published articles surrounding the world of AI:

  • How are top-performing companies in all industries using AI in marketing to improve their brand image and revenue? Louis Columbus’s article, “10 Charts That Will Change Your Perspective of AI in Marketing” include staggering statistics on how AI “enables marketers to understand sales cycles better, correlating their strategies and spending to sales results.”
  • How does one value the most critical asset of modern business, information? In Virginia Collins and Joel Lanz’s article titled “Managing Data as an Asset,” Collins and Lanz explain how “treating data as an asset can enhance its value, facilitate organizational activities, and achieve strategic goals.”
  • In Steve Lohr’s article, “How Do You Govern Machines That Can Learn? Policymakers Are Trying to Figure That Out,” Lohr analyzes brainstormed legislation by The Organization for Economic Cooperation and Development, whose policy focused on AI, attempts to “foster responsible economic development, balancing innovation and social protections.”

By Zach Gould, CFO Consulting Partners

Newsletter – June 2019

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Qualified Opportunity Zones – an Executive Summary

Mark Sloan, Director, CFO Consulting Partners

There has been much discussion regarding Qualified Opportunity Zones (“QOZ”), the tax benefits of investing in a QOZ and how it should fit into a strategy of minimizing taxes on long term capital gains. This newsletter will provide an overview as to the rules governing QOZ and some practical considerations regarding investing in QOZ.

BACKGROUND:

As a result of the Tax Cut and Jobs Act (“TCJA”) passed in late 2017, a taxpayer may elect to recognize certain tax deferrals and exclusions on the gain realized from the sale or exchange of property to an unrelated party if the gain is reinvested in a qualified opportunity zone fund within 180 days from the date of the sale or exchange and the gain remains invested for a defined period of time.

Opportunity zones are eligible low-income census tracts that had either poverty rates of at least 20 percent or median family incomes no greater than 80 percent of their surrounding area’s, according to the U.S. Census Bureau’s 2011-2015 American Community Survey. Such tracts have been nominated by governors and certified by the U.S. Department of Treasury for designation as an Opportunity Zone. There are over 8,700 such tracts located throughout the United States.

A qualified opportunity fund (“QOF”) is the vehicle to which gains must be invested in order to qualify for the tax benefits of the program. In order to achieve the tax benefits, the taxpayer must invest in a QOF and not directly into qualified opportunity zone property. A QOF is a corporation or partnership organized with the specific purpose of investing in opportunity zone assets. The entity must invest at least 90% of its assets in qualified opportunity zone property.

Qualified opportunity zone property can be in the form of direct ownership of business property, or into opportunity zone portfolio companies through either stock ownership or partnership interest. Certain businesses are precluded for consideration as property to be held by opportunity zone portfolio companies and these include golf courses, country clubs, massage parlors, tanning salons, hot tub facilities, racetracks, casinos or any other gambling establishment and liquor stores. These limitations do not apply when a QOF is investing into the Qualified Opportunity Zone directly.

Upon the investment of qualified gains, the basis in the capital gains will be zero. The gain will then be recognized into income on the earliest of the disposition of the opportunity zone property or December 31, 2026. If the QOF is held five years, then the taxpayer’s basis is increased by 10% of the original gain and then it is increased another 5% if held for another two years. If the QOF is held at least ten years, then all gains attributable to the appreciation on the original gain will be excluded from income.

BENEFITS:
There are numerous tax benefits attributable to the timely investment of capital gains into a QOF.

  • Deferral of tax on invested capital gains until December 31, 2026, at the latest;
  • Permanent exclusion of tax on capital gains of up to 15% if held for seven years, and;
  • Permanent exclusion of tax on any subsequent appreciation on the invested capital gains if held for more than ten years.

OTHER CONSIDERATIONS:

There are other advantages to investing in a QOF that make it a more flexible option to Section 1031 as a means to shelter capital gains:

  • As opposed to Section 1031, which requires the investment of the full proceeds in order to qualify for temporary tax deferral on gains, only the gain portion of the proceeds needs to be invested, freeing up cash at the time of the original sale of capital assets.
  • Investment in a QOF can provide permanent exclusion of tax on a portion of capital gains; Section 1031 transactions will only provide for deferral of tax on capital gains.
  • As opposed to Section 1031, which requires the investment of proceeds into like kind assets, the only requirement for a QOF is that the gains are invested into opportunity zone assets. For example, if a work of art is sold at a gain, then the gain can be invested in a different class of asset such as real estate.
  • It should be noted that as a result of the TCJA, the use of Section 1031 is now limited to real estate assets and no longer other types of capital assets.

While there are significant benefits to investing in opportunity zone funds, there are certain caveats that need to be considered:

  • If the investment has not been disposed of sooner, the invested gain will be recognized in income at December 31, 2026. This means that the taxpayer will need to provide liquidity for this event while the gain is still locked up in the investment.
  • To achieve the 15% permanent exclusion on the original gain, there must be a rollover of the gain no later than December 31, 2019 in order to achieve the 7 year holding period for this exclusion.
  • To maximize the tax benefits attributable to this program, the strategy is to lock up the invested gains for a period of ten years. This could result in a lower IRR over the life of the project.
  • Although the census data used to designate tracts as opportunity zones is dated and there may be some areas that have gone through improvement, there can still be a higher risk attributable to investing in areas that are opportunity zones.
  • An investor may not contribute appreciated property directly into the QOF. Such property must be first sold (and begin the clock running for the recognition of a portion of the gain) and the amount attributable to the gain invested into the fund.
  • The regulations impose limitations on the amount of cash and intangible assets that can be held at any time by an opportunity zone fund. This limitation can be mitigated through a structure where the QOF invests into an opportunity zone portfolio company (either through stock ownership or partnership interest). Under this structure, the portfolio company can hold intangible assets that are used in an active trade or business and cash in an amount for reasonable working capital needs.
  • The investment in opportunity zone funds should be evaluated on the overall economics of the fund and its strategy, and there should not be disproportional weight given to the tax deferral/exclusion feature of the program as the basis for investing in the opportunity zone.

This newsletter is meant as a broad overview on Qualified Opportunity Zones. There are many other details concerning the structure of funds, limitations on the type of assets that can be held by a QOF, determination of original use and subsequent improvements, etc. CFO Consulting Partners has been following developments in this area and we stand ready to provide you with guidance in navigating through this new and challenging area. In addition to helping you understand the details and advising you if this program can fit into your investment strategy, we also have relationships with various sponsors and service providers who can offer you opportunities with various funds that they have established. We also have relationships with law firms who can evaluate that the funds are structured in accordance with Treasury regulations.

CFO Consulting Partners is a proud sponsor of the Exit Planning Exchange (XPX). XPX is a multi-disciplinary community of professional advisors who work collaboratively to help owners build a valuable business and assist them in preparing and executing a successful transition.

CFO Consulting Partners XPX Advisors:

Oliver Brooks

Steven Crowley

David DeMuth

John Kovacs

Mark Sloan

Allan Tepper

Joseph VonEhr

We are a proud sponsor of XPX. XPX is a multi-disciplinary community of professional advisors who work collaboratively to help owners build valuable businesses and assist them in preparing and executing a successful transition. Learn more...

We are a proud member of FINACA. FINACA is a nationwide network of independent finance and accounting consulting firms focused on delivering exceptional client service. Learn more...

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