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Opportunity Zones Present Ability to Defer Capital Gains

3/19/2019

by Dale Gillmore

Prior to the 2017 tax reform bill, investors were able to utilize a popular tax-deferral strategy known as a 1031 exchange to defer capital gains on like-kind exchanges -- essentially disposing of one asset and acquiring another replacement asset to avoid generating a current tax liability from the sale of the first asset. Tax reform provided yet another strategy: investment in Qualified Opportunity Zones. Investors seeking preferential tax treatment of capital gains would be wise to consider investment into these economically-distressed communities.

How it works

Subject to the requirements below, a taxpayer can defer immediate recognition of the gain, and, depending on the holding period, get a reduction in the amount of gain realized through a basis adjustment and possibly eliminate tax on the realized appreciation in the value of the interest/assets held in a “Qualified Opportunity Fund.”

A Qualified Opportunity Zone is an economically distressed community that has been designated as a “qualified opportunity zone.” A list of qualified zones can be found here.

The steps and requirements are as follows:

The investment of gain must be made in a “Qualified Opportunity Fund” within 180 days of the date of the sale or exchange that generated the gain. This fund should be structured as either a partnership or a corporation set up for the purpose of investing in qualified opportunity zone property. Note that the taxpayer will need to self-certify that it is a Qualified Opportunity Fund. To date, IRS has not released an official form for doing this, so consulting with a tax expert at this step is critical.
The Qualified Opportunity Zone Fund then makes an investment in a Qualified Opportunity Zone business that holds at least 90% of its assets in a Qualified Opportunity Zone.
The taxpayer must hold an interest in the Qualified Opportunity Zone Fund for at least five years to receive an increase in basis in the investment equal to 10% of the deferred gain invested in the Fund. Holding for seven years increases basis by an additional 5% of the deferred gain invested in the Fund. Note that if the investment is held for seven or more years then only 85% of the initial gain will be subject to capital gains tax. The period of capital gain tax deferral ends on the earlier of the date the investment is sold or December 31, 2026. If the investment is held longer than 10 years, the taxpayer will get a step up in basis in the interest in the Fund equal to the then fair market value.

An example

Conclusion

Investment in Opportunity Zones provide significant planning opportunities for many investors and has the potential to generate additional long-term investment in areas most deserving. It may be a useful tool in capital gains deferral, particularly for individuals, funds, and companies considering investments in low-income communities, and could be ideal for private-equity funds and real estate developers for raising equity. At the very least, this new incentive program provides a capital gains deferral mechanism for short-term investments in a form that is more attractive than current Sec. 1031 like-kind exchanges.

The numerous requirements and technicalities to utilizing the Opportunity Zone tax deferral, as well as the factors involved in deciding where to invest, mean you shouldn’t make this decision alone. An advisory firm steeped in real estate investment strategy and tax savings strategies is your best bet. We're happy to help you get started.

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Get Your Business and Your Family "Deal Ready"

3/15/2019

by Dale Gillmore

The average transaction takes less than a year to complete, but becoming “deal ready” takes years.

Every business owner wants to receive maximum value for their business at the time of their exit. That’s a given. Unfortunately, too many owners discover they have not put enough thought into a growth strategy to achieve that value, and they’re disappointed by the offers they receive when it’s time to sell. It doesn’t have to be this way. You can adopt sound strategies and practical techniques now that will positively position your business for transition. You just need some right information first.

70 to 80 percent of businesses put on the market don’t sell (Exit Planning Institute).

We think this failure rate is largely due to unmet owner expectations -- the surprises and disappointments they face from potential buyers at the time of transition.

No two businesses or owners are exactly alike, but many of the challenges they face as they endeavor to build maximum value – and exit on their terms – are similar. In working with business owners, we continually ask them to answer these 5 questions as we seek to build value and plan for transition.

What’s my business’ actual value right now?

Identifying value is the first step because it gives business owners a baseline measurement from which to track value over time. In other words, as they work to build (and hopefully maximize) value, this baseline number is there to gauge their success. If you cannot see increasing value, how can you know if the strategies you’re implementing are working?

But, the benefits of identifying your business value don’t stop there. Business value impacts the owner’s personal life, too, a fact often missed by business brokers. If you think your business is worth $15 million, but it’s only worth $9 million, that discrepancy will seriously impact your personal estate planning decisions and post-exit lifestyle choices. Wouldn’t it be better to know the reality of your business value far in advance of a transition, while there’s still time to do something about it?

What’s my real number?

Just as important as identifying value, it’s just as critical to understand now the approximate dollar amount needed to live the post-exit lifestyle you desire.

There are many variables that go into determining your number, but basically, we’re going to want to take stock of your future obligations, goals, and dreams. The tasks we must tackle include:

Reviewing estate documents (e.g., will, revocable trust, financial power of attorney, health care power of attorney, living will), insurance policies and retirement account/pension beneficiary designations
Retitling assets to avoid probate and maximize the use of estate exemptions
Developing a detailed budget
Preparing a personal net worth statement that reflects all assets and liabilities
Undertaking a global investment asset allocation review with your financial advisor

Beyond that, and again what a lot of advisors miss, is the question of the kind of life you envision living after transition. Do you see yourself starting a new business, or acquiring an existing one? Will you consult part-time? Do you want to travel, pursue philanthropy, buy a vacation property, join an exclusive golf club, fund your grandchildren’s college years? Your life doesn’t end simply because you stop owning and operating your current company, so it’s important not to choose a transition partner who will leave you after the sale. In many ways, your life will begin again. Don’t neglect the planning of it. You’ll need money to make it happen, so identifying your post-transition goals, your current net worth, and your future expenses and obligations is critical at this time.

How can I eliminate risk to protect my business?

Business owners face a seemingly endless list of risks: lawsuits, regulations, technology, debt, customer concentration, human and intellectual capital, business model disruption, natural disasters, safety/compliance, embezzlement, death/disability, and cybersecurity, just to name a few.
The more risk that your business bears, the less someone will be willing to pay for it. Protecting business value, therefore, entails addressing and mitigating current and potential risk-related issues (business, financial, and personal). Have you begun that process? Do you even know where to begin?

How can I build value – in every way?

Building value is a necessary step for every business owner regardless of circumstances. Why?

If you as a business owner have identified a gap between your company’s actual value and your target value, you’ll need to build value to close or eliminate that gap.
If you’re lucky enough that your business’ actual value is also your target value, you’ll still need to build value so that you and your team can facilitate a transition under the time frame and conditions you desire.
Buyers want to invest in growing companies. While the current value of your business may be of interest to a potential buyer, they might be wary of pursuing a deal if recent growth has been flat or modest.

When we talk about value, we’re really talking about two kinds of value: tangible and intangible. Tangible value is the “easy to see” stuff -- plant and building improvements, systems upgrades, marketing, and so on. Intangible value is everything else that matters: human capital, customer capital, structural capital, and social capital. When it comes to valuing a business, intangible value just as important as tangible value. You’re wise to focus on building both.

Which transition option is best for me?

Again, every business is different. No single transition option fits the needs of every business owner. If someone is trying to sell you an “out of the box” approach to transition, keep moving.
From family/intergenerational transfers to management buyouts, sales to existing partners, third-party sales and even liquidations, there are lots of roads to consider.

Our passion at Quest is to educate clients on the options available to them so that they make the best decision -- a decision which can only be made by weighing each transition option against individual business, financial, and personal goals. It's just what we do. Is your current transition advisor asking guiding you in this way?

If you have questions about maximizing the value of your business and/or need help aligning your personal and business goals, please reach out. While we advocate doing this years in advance of a planned transition, we can successfully navigate you through a transition when emergencies arise. Just give us a call.

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The 10 Questions Prospective Buyers Will Ask

3/11/2019

by Dave Swartzendruber

As a business owner, your business has consumed the majority -- if not all -- of your time. It’s made of your dedication, your employees, your stories, accounts won and lost, systems and process, and so much more. So, when a potential buyer comes along, who will evaluate your business through a far different lens than yours, their emotionless questions can be jarring. And, whether you work with a broker or not, your buyer must decide whether to bid based on the answers you provide to their questions. To do that, you’ll have to be prepared.

Unless you’re being rolled into a larger company or dismantling individual assets, you’re essentially selling the present value of future cash flow, an imperfect estimation based on both objective and subjective factors. A buyer must decide whether to bid after careful examination of both negative and positive aspects. Depending on structure and interests, what’s negative to one buyer may be positive to another (e.g., existing non-owner management, real estate). You won’t be a good fit for everyone, and that’s OK, but you’ll still need to be able to answer the questions. Keep in mind, these questions are not even close to the due diligence questions we’ll discuss in another blog posting.
Decades of experience tell us that, in initial calls, buyers are trying to determine the following:

How you’ve built the business, how you think, and how easy you are to deal with (because no one wants to deal with a difficult person).
What owning and operating your company would look like -- from day-to-day operations to long-term strategic planning.
What a change in ownership would look like and how the business may look in the future (good and bad).

Essentially, the buyer’s goal is to structure a deal in such a way that he/she maximizes the benefits and minimizes the risks, without losing the deal during the negotiation. To do that, they’ll have to ask some very direct questions about your business and how it operates. Will you be prepared to answer them?

Knowing what to expect is half the battle. In addition to the obvious questions surrounding financials, here are 10 questions you’re very likely to hear:

1. Why are you selling your business and why did you get into this business in the first place? What excites you about it?
2. Can you describe your management team’s strengths and weaknesses? What problem does your company solve? Why do your customers choose you over your competitors?
3. Walk me through the entire process of your service/product line. What are your company’s competitive differentiators?
4. What is your day-to-day role in the business?
5. What would your ideal transition look like? What do you want to do post-sale?
6. What are your expectations of a buyer?
7. Other than you, who are the leaders/executives in the company? What are their current and potential roles? When a problem arises, who deals with it, and how?
8. How long have your employees been with you? Why do they stay (or leave)?
9. What capital expenditures are made annually in this business, and on what?
10. What opportunities exist in this market through the next 3, 5, 10 years?

Whatever the question, be honest. The truth will come out in due diligence anyway, and little white lies have an uncanny ability to end negotiations. Plus, your business deserves the right buyer, and you deserve a peaceful exit. Honest responses to buyer questions will produce both.

Selling a business is a huge and meaningful transition, and no one article or list can do it justice. As you prepare for the journey, reach out to us for assistance. Together, we can make your transition a successful one.

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