Edited transcript of the teleseminar, ‘Opportunity Zones: The Next Big Thing in Multifamily’

With special guest Matt Wills

Originally broadcast on Nov. 21, 2019

Listen to the teleseminar

 

Kim Lisa Taylor:

Welcome to Syndication Attorneys, PLLC’s free monthly teleseminar, where we talk about topics of interest to real estate syndicators and startups with opportunity for live questions and answers at the end of the call. I am attorney Kim Lisa Taylor. Also joining me on the call is Charlene Standridge, who is our law clerk and business develop director, and our special guest, who we’ll introduce in a moment.

Before we get started, please note that all of our calls will be recorded and may be used for future promotion, posted on our website or broadcast in a podcast available to the public. If you don’t wish to have your voice recorded, please schedule a one-on-one consultation instead of asking questions during the live call. The information discussed during this free teleconference is of a general educational nature and should not be construed as legal advice. This is an audio-only conference.

Today our topic is “ Opportunity Zones: The Next Big Thing in Multifamily.” Our special guest today is attorney Matt Wills. Matt has recently joined the Syndication Attorneys, PLLC team. So, we’re really pleased to be able to introduce him to all of you and hopefully some of you will get to start working with him in the future.

Matt is originally from the UK and is licensed both there and in New York. He has nearly 20 years’ experience as a tax attorney and also has experience in securities laws. With Matt on our team, we’re able to provide clients with better advice related to structuring opportunities on transactions, blocker companies and tax issues related to foreign investors, 1031 exchanges, and joint ventures.

I want to start the call today with something that just came out in GlobeSt.com. If some of you are getting the subscription to GlobeSt, then you will have seen this article and hopefully read it. If not, you should, and if you aren’t a subscriber already I would recommend it. Not only do they publish great content and trends in multifamily and just real estate, commercial real estate in general, but they also host some great events around the country. If you have an opportunity to go to one of their events, then you’re going to be able to be up to speed on the latest trends in whatever your commercial real estate track is.

Here’s a quick summary of what the article talked about: They were citing some statistics, and they said in Q2 2019 (so second quarter of 2019) there were 300-plus investment funds with targets to raise $50 billion to invest in Opportunity Zones. That’s a lot of development. Multifamily development projects have accounted for 35 percent of all of the development projects in Opportunity Zones, and multifamily development sites in Opportunity Zones have jumped 66 percent in the past 18 months, representing over 50 percent of the total commercial real estate investments in Opportunity Zones.

This is just showing you that there is opportunity in multifamily in Opportunity Zones and these numbers are expected to continue to rise. So you’ve got some opportunities there. We want to tell you how you can avail yourself of those opportunities and how we can help you. So we’re going to just go ahead. Matt, welcome to our program.

 

Matt Wills:

Thank you, Kim. It’s great to be a part of your team and great to have the opportunity to talk with you today.

 

Kim Lisa Taylor:

Matt also wrote a really great article on Opportunity Zones that really just kind of outlines it in very plain English. It’s not legalese. It really outlines the whole Opportunity Zone program. You can read that article at our website. It’s there. It’s linked to the newsletter that you got invited to this program. So you can click on that, if you want, and read that article. I’d encourage you to do that. There was another article that I had written way back when the first set of regs came out and that’s also available on our website but I think Matt’s information is pretty up to date, so I definitely encourage you to read that. So Matt, let’s just talk about big picture on Opportunity Zones. How are Opportunity Zones determined in the first place?

 

Matt Wills:

Sure. The areas that have been nominated as Opportunity Zones are  Census tracts that have been nominated by the governors and heads of territories. This is all based on the census tract information from the 2010 cCensus, so the respective governors and heads of territories put forward the nominations. The nominations are approved by the Secretary of State, and the object of Opportunity Zones is really to give investors tax breaks in return for spurring economic growth and development in lower-income areas. There have actually been some recent developments in relation to Opportunity Zones, including which areas have received the Opportunity Zone designation.

There is growing pressure from Congress as they feel that some areas have been given this designation that shouldn’t qualify as low-income areas. Those areas include some locations in Nevada around the Los Angeles area. There is a bill that is with Congress now, H.R.5042, which proposes some changes to the tracts that have been designated as Opportunity Zones. Even though the U.S. Treasury has issued two sets of guidance documents, this is still an area that’s subject to change.

 

Kim Lisa Taylor:

But for right now, we’ve been told that we can rely on the regs that have been issued to date and the Opportunity Zones that have been so designated for now. So I don’t think that anything that anybody started is going to get taken away, although there could be some adjustments coming in the future, assuming that our government actually can get something accomplished.

 

Matt Wills:

It will be interesting to see that if some states have areas taken away, whether they’re able to nominate different areas.

 

Kim Lisa Taylor:

Sure. All right, there were some terms that were defined in the two sets of guidance that came out trying to give some clarity on what the regulations actually meant. That is where all of the things that we’re talking about today have come from. For example, QOZP, Qualified Opportunity Zone Property. Can you just explain what that is?

 

Matt Wills:

That is property that is owned by a Qualified Opportunity Fund (QOF), and that’s another term that needs to be defined. That can be either Qualified Opportunity Zone stock, partnership interest or Qualified Opportunity Zone business property.

 

Kim Lisa Taylor:

So the QOZP could be just personal property that’s owned by a business operating in an Opportunity Zone, right?

 

Matt Wills:

That’s correct. One of the interesting factors with Opportunity Zones is that they are much broader than just real estate. For our client base, though, a lot of the focus will be on the real estate aspects.

 

Kim Lisa Taylor:

Sure. What is Qualified Opportunity Zone business?

 

Matt Wills:

It’s a business where all of the Qualified Opportunity Zone business’s property is located in the Opportunity Zone. There is a different definition as to what substantially it all is, depending on whether it’s direct or indirect ownership. There are also a number of other conditions. The business must receive 50 percent of its gross receipts from the active conduct of the Opportunity Zone business or must hold a substantial proportion of physical property that is used in the active conduct of the Opportunity Zone business. The business also cannot include certain enterprises that are disqualified or considered “sin businesses” for the purpose of Opportunity Zones.

 

Kim Lisa Taylor:

Sin businesses are things like massage parlors. Can you name a few of them?

 

Matt Wills:

Yeah, massage parlors, racetracks, gambling facilities, golf courses and country clubs.

 

Kim Lisa Taylor:

How did country clubs get added?

 

Matt Wills:

That’s an interesting question. When it comes to golf courses, the Opportunity Zone regulations refer to a piece of the Internal Revenue Code that was passed back in 1986. The golf courses were included within that definition as a business that receives tax exemption for the use of bond proceeds because that code hasn’t been updated since 1986. The fact that the regulations refer back to that piece of code means that golf courses and country clubs are excluded from the types of businesses that can benefit from the Opportunity Zone.

 

Kim Lisa Taylor:

All right. So I mean it’s really just targeting specific kinds of businesses that probably those kinds of areas really need in order to spur, just not development directly within the zone but even the ancillary areas around it. So, the intent is to create businesses or developments that have services that actually provide a product or a service to the local community. I think that’s the intent, right?

 

Matt Wills:

Exactly. It can also include businesses that are located within the Opportunity Zone that conduct business outside the zone. One example in the guidance notes is a landscaping business where the owner-operator may have his management function of the business located within the zone but his client base is outside of the zone.

 

Kim Lisa Taylor:

So they could still qualify as a qualified Opportunity Zone business?

 

Matt Wills:

Right.

 

Kim Lisa Taylor:

But they have to store their equipment there, too, right?

 

Matt Wills:

That’s right.

 

Kim Lisa Taylor:

All right, so you can see that this is designed to be used for more than just real estate. You can invest in businesses within these Opportunity Zones as long as they’re not one of these sin businesses and they meet these criteria that Matt’s been telling us about of having substantially all of their business within that zone.

Let’s talk then about a Qualified Opportunity Fund (QOF). What is that?

 

Matt Wills:

A Qualified Opportunity Fund, essentially, is an entity, which can be a partnership, LLC or a C corp. So S corps cannot be used as an Opportunity Zone Fund. Essentially, it’s an entity where the sponsor has filed an election with the IRS to self-certify that it wants to be treated as an Opportunity Zone Fund. One of the great things about this piece of legislation is at the moment there’s very little government oversight, so there’s no prior approval required from the IRS to file the election. The only requirement really is at least 90 percent of the entity’s assets are held in Qualified Opportunity Zone property.

 

Kim Lisa Taylor:

So the way that this works – and I recently spoke just this … last week actually … at an Opportunity Zone expo in Miami and learned some new things myself there – but the way that this works and the way that it’s mostly being implemented is the Qualified Opportunity Fund is the place where the syndicator will pool investor money in a QOF (Qualified Opportunity Fund), and then that QOF invests in one of these QOZBs (Qualified  Opportunity Zone Businesses) or it can buy the real estate directly. But the rule, as Matt just said, is 90 percent of the proceeds have to be invested within the Opportunity Zone to maintain that qualification as a QOF. However, a Qualified Opportunity Zone business only has to conduct, isn’t it, 70 percent of its business operations within the zone?

 

Matt Wills:

That’s correct.

 

Kim Lisa Taylor:

Right, so if a Qualified Opportunity Fund invests in a Qualified Opportunity Zone Business, then you could actually do a little multiplication and say, 90 percent of the QOF’s funds are invested in the QOZB but the QOZB only has to do 70 percent of its business in the Opportunity Zone so the 90 times the 70 effectively means that you could have 63 percent of the funds invested in the Qualified Opportunity Zone. For purposes of real estate, it’s not that hard to reach that 90 percent level.

If you’re actually operating real estate and multifamily property within the Opportunity Zone, then 90 percent of your funds are going to be invested there anyway, so I don’t think that that’s an issue. So much for real estate as it is for people who are investing in these other funds but even so, there’s still sometimes, use this two-tier structure where the property would be owned and classified as Qualified Opportunity Zone Business by a single-purpose entity that would hold title and then the Qualified Opportunity Fund would own the interest in that single-purpose entity. So you say in your article that the deferred gain crystallizes on December 31, 2026. What do you mean by that?

 

Matt Wills:

What I mean by that is one of the incentives that have been offered in the terms for an Opportunity Zone investment is to enable investors to defer tax on any prior gains that have been invested in a Qualified Opportunity Fund. That deferral runs until the earlier of the date on which the investment in the QOF is sold or exchanged or December 31, 2026. For example, if I sold stock today and realized a $200,000 gain, which I invested in a QOF, and if I held the QOF interest for 10 years, I would defer paying capital gains tax on the 200,000 until 2027, so the gain would be recognized on December 31, 2026, which I would report in my 2026 federal income tax return, which I would file by April 2027.

 

Kim Lisa Taylor:

So what if you hold the property longer? Do you have to start paying the tax?

 

Matt Wills:

If it is held longer, as long as the investment is still held on December 31, 2026, then the original gain would be crystallized. So that point, that gain would be recognized and there would be a need to report that gain in your tax return and to pay any associated taxes.

 

Kim Lisa Taylor:

Except it isn’t the purpose of the Opportunity Zone that if you hold it that long, for the 10 years, then your gain is actually lowered? You get a step-up basis, right?

 

Matt Wills:

That is correct. You get a step-up basis so if you hold your interest in the Qualified Opportunity Fund for 10 years, you can file an election to step up your basis to the full market value of the asset at that time and so what that would do, that would eliminate any gain on your investment in the QOF but it doesn’t eliminate the original gain that has been invested in the QOF.

 

Kim Lisa Taylor:

I guess I’m not following that.

 

Matt Wills:

So if I go back to the example where I realized a $200,000 gain, which I’ve reinvested in the QOF, if I hold that interest in the QOF for 10 years and during that time, that $200,000 has tripled to become $600,000, that $400,000 gain, if I file the election, would be wiped out to zero. So all of the tax relations to the gain associated to my investment in the QOF would be eliminated but I would still have the need on December 31, 2026, to pay capital gains tax in relation to that $200,000 gain that I’ve realized in the first place.

 

Kim Lisa Taylor:

So it’s the gain that you’re bringing to the deal. You’re still going to pay taxes on that original gain but any additional gain that you’ve realized while it’s been invested in the QOF is essentially going to be wiped out as long as you’ve held it for at least 10 years within the Opportunity Zone?

 

Matt Wills:

Right.

 

Kim Lisa Taylor:

So that’s a pretty big deal. Does the December 31, 2026, date apply if somebody didn’t invest until, say, 2022 and they held the property for 10 years? Is that December 31, 2026, date still going to happen for them?

 

Matt Wills:

Yes. That happens regardless.

 

Kim Lisa Taylor:

For everyone?

 

Matt Wills:

Yeah. One of the requirements is that the investment is made in the Opportunity Zone before December 31, 2026, but you can hold your investment up until December 31, 2046.

 

Kim Lisa Taylor:

Up until the end of 2046. All right. So I think we kind of understand that now. These are some really complex subjects. I hope we’re not losing anybody and I hope you guys are getting value from this. I know I’m certainly learning some things from Matt. So you mentioned an added benefit of collecting income on the deferred gain that could be greater than the deferred taxes. Can you expand on that?

 

Matt Wills:

This is super-complicated, so it would probably best to answer it with an example. If an investor sells their stock portfolio that’s worth, say, $3 million and it has a basis of $1 million, that would give rise to a capital gain of $2 million, which would be subject to capital gains tax of $400,000, at today’s rates of 20 percent. If the investor then takes that $2 million and invests that into a QOF, there are a number of big tax breaks that they would get.

The first one would be the deferral of the capital gains tax on the $2 million until 2027, which we’ve talked about previously. They would also get the appreciation on their investment and, if they’ve invested into income-producing property like real estate, they would be able to collect income from that asset. Then, if they’ve also invested in the past through an entity that’s invested in an asset like real estate, they would also get pass-through reductions, which includes depreciation. Given there is a 20 percent deduction for pass-through entities, that means that a substantial part of that income would be received tax-free and so when you add all of this up, this could mean that during the investment period in the QOF, the amount of income appreciation and depreciation that the investor receives would far outweigh the amount of the gain that they’ve invested into the QOF in the first place.

 

Kim Lisa Taylor:

Wow, okay. So that’s pretty substantial. Thank you for explaining that. Okay, so let’s talk about the timing. There were some timing rules that were put into the guidance, being five, seven and 10 years. Can you tell us what happens in each of those time frames?

 

Matt Wills:

Sure. The rationale behind these time frames is to promote long-term investment in these areas. With that in mind, the government has said that if someone holds their investment in a QOF for five years, then the investor will receive a 10 percent reduction in tax. So if we go back to that previous example with the stock portfolio where if the $2 million is reinvested into a QOF and that’s held for five years, the investor in this case, they would receive a $40,000 reduction in their capital gains taxes given on the $2 million gain, they would be liable for $400,000 in capital gains taxes.

The way it operates is that it is done on basically stepping up the basis in the QOF. So the basis of the investment in the QOF would be increased by 10 percent but in reality, it has an effect of reducing the tax liability by 10 percent. That is just the way they’ve got the legislation worded, so that it operates on a step-up basis rather than a tax-reduction basis, but the practical effect is the same.

 

Kim Lisa Taylor:

So that $2 million investment that they made into the QOF would step up to $220 million as far as the basis was concerned, after they’ve held it for five years.

 

Matt Wills:

Yes.

 

Kim Lisa Taylor:

All right, then what happens in seven years?

 

Matt Wills:

So, in seven years they get a further 5 percent step up.

 

Kim Lisa Taylor:

Now we’re at $230 million for our basis, is that right?

 

Matt Wills:

Yeah, $2.3 million for the $2 million investment, yeah.

 

Kim Lisa Taylor:

Then what happens in 10 years?

 

Matt Wills:

Then, in 10 years — this is the icing on the cake — this is when all of the gains on the $2 million that was invested is eliminated.

 

Kim Lisa Taylor:

So at that point, whatever the new appraised value of their interest in that QOF is, becomes their new basis.

 

Matt Wills:

Exactly, yes.

 

Kim Lisa Taylor:

Whether it’s doubled or tripled in value. Okay. Now we’ve heard that there were some benefits that were going away if people didn’t invest before the end of this year. What is the benefit that goes away?

 

Matt Wills:

There is a lot of confusion around this. December 31, 2019 date and really the benefit that goes away is the ability to get the full 15 percent step up for holding the investment for seven years.

 

Kim Lisa Taylor:

Still get the five, right? We still get the five-year benefit and if we hold if for 10 years, we still get the 10-year benefit. It doesn’t matter if it was invested after the end of this year.

 

Matt Wills:

That’s right. So there’s still some fantastic benefits available if you don’t make the investment before the end of this year.

 

Kim Lisa Taylor:

Okay. That was a very big source of confusion early on in this and I think that that’s been sufficiently clarified now. Everybody should feel safe to continue to invest in Opportunity Zones, certainly, and you said that you had to make the investment before December 31, 2026, though, right?

 

Matt Wills:

That’s correct.

 

Kim Lisa Taylor:

That’s right. So you’ve got from now until December 31, 2026, to find these deals in these Opportunity Zones and make these investments. All right. Let’s see. Then you have to sell the property before December 31, 2047, or pay the tax, right?

 

Matt Wills:

Right.

 

Kim Lisa Taylor:

So what kind of gains are eligible for tax benefits under the Opportunity Zone programs?

 

Matt Wills:

So the investment of both short-term and long-term capital gains will receive the tax benefits. This could be gains from the sale of stock, real estate businesses, collectibles, precious metals. It’s real, wide-ranging gains that you can stand to benefit from the incentives here.

 

Kim Lisa Taylor:

So that takes us into our next question. How do Opportunity Zone investments differ from 1031 investments, with respect to real estate?

 

Matt Wills:

So we just touched on one there. It doesn’t have to be a like-kind exchange. With a 1031, you have to exchange like for like – so a real estate asset for another real estate asset of a similar nature – whereas for Opportunity Zones, you can sell any type of asset and then you can invest that into any type of asset as long as it meets the criteria for being a Qualified Opportunity Zone property. With  Opportunity Zones only the gain has to be invested so the principal can remain in the previous investment or cashed out.

Similar to 1031s, there are some time limits. With Opportunity Zones, there’s a 180-day period within which to reinvest the gain, but that can also be extended to the start of the tax year. So with real estate gains, given the way that the rules work, it is the net gains from real estate that can be invested in an Opportunity Zone and so those gains would tend to be netted at the end of the taxed year. So Opportunity Zones, you touched on before, can be used as part of a syndication whereas that’s a little more challenging with 1031 exchanges.

Then I think the final difference is actually there’s a lot less administrative requirements in connection with Opportunity Zones. There’s no need for an intermediary to be used. A taxpayer can act as the sponsor of an Opportunity Zone Fund. They can set up the entity, made the election and then receive the cash from their investors prior to making that investment in the Opportunity Zone property.

 

Kim Lisa Taylor:

Right, and that’s significant because as some of you listeners may know, if you’ve ever had a call with me when we’ve talked about how you can include 1031 investors in your deals, it’s very difficult for a syndicator to do that because you’re basically carving off a piece of that syndicate and giving it to that 1031 exchange investor and the profits are being split at the property level. So whatever your syndicate purchased, whatever portion of that property your syndicate purchases, that’s the only thing that you’re entitled to. If you’re not buying the whole property, you don’t get an acquisition fee for 100 percent of the purchase price. You get an acquisition fee based on the portion of it that your syndicate purchased. Which maybe is only 50 or 70 percent of the purchase price. Then your carried interest is reduced accordingly.

What I frequently tell people who are in that situation and want to bring in a 1031 investor is, the only reason that it benefits you to do it as the syndicator is if the person is bringing in a significant amount of money and you don’t think you can raise the money another way. There definitely are some complications with 1031s that are eliminated when you use this Qualified Opportunity Fund structure. Let’s see. I talked about this. Talking about Qualified  Opportunity Zones and syndicates, I guess is rental real estate considered a Qualified Opportunity Zone business?

 

Matt Wills:

Yes. Thankfully, that was clarified in the second guidance note that was issued by the Treasury. Rental real estate is considered to be an active conduct of trade or business for Opportunity Zone purposes.

 

Kim Lisa Taylor:

So it works great for development but there’s this rule called Substantial Improvement Rule that makes it a little challenging for people who are buying existing properties. Can you talk to us a little about that?

 

Matt Wills:

So, when a real estate is purchased that has an existing structure on the land, there is a requirement for substantial improvements to be made to that structure in order for that acquisition to qualify for the Opportunity Zone relief. So this substantial improvement requires the investor to invest at least the same amount of the purchase price for the structure into renovating or redeveloping the structure. For example, if an apartment building is purchased for $4 million and then following a cost segregation it’s determined that the value of the land is 20 percent of the purchase price, so $820,000, and then the value of the building was 80 percent, so about $3.2 million, within 30 months of the acquisition, the fund would have to invest an additional sort of $3.2 million into improving that building. Obviously, this is going to cause some issues for a lot of syndicators who look to make value-add investments either through interior renovations or operational improvements to increase the value of the property.

 

Kim Lisa Taylor:

But I think there was an exception that said if the building had been vacant for five years, that’s one exception, right?

 

Matt Wills:

Yes. There’s an exception for buildings that have been vacant for five years. There’s no need to make substantial improvements to those.

 

Kim Lisa Taylor:

So if you can find one of those… What about if somebody went in and repurposed a building? Like say you find some old warehouse and you want to turn it into loss, is that something that you could do and perhaps meet that substantial improvement test?

 

Matt Wills:

Yes. I believe that’s the case. Again I think it comes down to, as long as the cost incurred in repurposing the building, I think they meet the substantial improvement requirement then repurposing the building should qualify as well.

 

Kim Lisa Taylor:

So that’s one way that it can be done, or the other way would be to look for properties that have a development component to them. So maybe there’s already an existing building there but there’s some vacant land where you can build something else that might help meet that requirement. So you’re not going to be able to look for the same value-add properties that you’re looking for out in the normal market rate world but you could potentially find some things that work. You just might have to get a little creative about it. All right. So can cash investors get Opportunity Zone benefits?

 

Matt Wills:

No. They can invest in an Opportunity Zone Fund but they will not receive the same tax benefits. Only reinvested gains receive benefits from the Opportunity Zone.

 

Kim Lisa Taylor:

So as far as for a syndicator, what this does is it really opens up your fund to those otherwise-1031 investors. But not just people who have real estate, also people that have gains from other types of assets would be eligible to invest directly with you and they can invest directly in your syndicate without depriving the syndicator of any of those normal carried interest or promote benefits that they would like to enjoy. You can have cash investors, as Matt said, but if you do then we need to segregate them from your gain investors. Then a way that we can do that is by having separate investor classes. One class would be for your gain investors. One class would be for your cash investors. So that you can record them correctly in their tax returns, your tax returns, all of that, so that there’s that segregation on who gets the benefits and who doesn’t. So I think that’s significant. Just understand that you can have cash investors invest in these deals but they still have to make sense.

Whereas some of your gain investors, maybe they’d be willing to take a slightly lower preferred return or split because of the fact that they’re going to get all these other benefits along with it where you might want to carve out a second class for your cash investors where maybe they get a little bit different returns or different benefits. Then the other thing that is not deferred or doesn’t receive the benefit of it is the carried interest of the syndicator or the sponsor. So you’re not going to get any great tax benefits on that. You’re going to pay the same tax as you would as if you had syndicated outside of one of these Opportunity Zones. Okay, so could a syndicator roll over gain from a previous investment into their own Qualified Opportunity Fund?

 

Matt Wills:

Unfortunately not. The rules prohibit transactions with related parties and so that would prevent sponsors from being able to roll over gains from other deals that they’ve done into their own QOF.

 

Kim Lisa Taylor:

Okay. And then I guess the last thing we’d want to add for syndicators is that these are IRS rules; they don’t change anything about your obligations under securities laws. If you’re raising money from private investors you still have to follow securities laws. You still have to either register your offering and get pre-approval before you sell it to investors or offer it to investors or you have to qualify for an exemption. That’s what your securities attorney is going to do for you, is help you understand what rules are: explain what registration or exemption rules are going to apply to your offering, help you select an appropriate exemption, make sure that you have the appropriate documents and filings so that you’re doing it legally, and then you can go about complying with the tax rules while you’re operating your company.

You’re going to want to make sure that you’re working with a CPA that has taken it upon themselves to learn about the Opportunity Zones. Not necessarily everyone has, so you want to make sure that your CPA understands Opportunity Zones if that’s where you’re going to go and you’re going to start doing Opportunity Zone deals. But I think we’ve covered a lot of the highlights that were covered during the event that I was recently at.

This is all described further in Matt’s article that’s available on our website. If you go to the library and then select the articles then you’ll see that there.

One just interesting note that we didn’t mention is that cannabis dispensaries are not considered sin businesses. They’re not on the list of sin businesses that are prohibited from operating within an Opportunity Zone. It was interesting when I was at the conference somebody said, “Why wasn’t that included?” I guess the legislator that was asked that question said, “Well we didn’t think we had to include it because it’s illegal.” But that is rapidly changing in various states as everybody knows.

So, let’s go to Q&A. Charlene, are you there? Has anybody been brave enough to ask us some questions about this?

 

Charlene Standridge:

Hi. We have a couple questions. If you want to raise your hand, I can unmute you and then you can ask your question yourself. So if you want to do that and you’re logged in, you can just raise your hand in your webinar panel.

So, a couple of the questions that have come in: “May we get those stats?” It was some stats that you were talking about at the beginning of the webinar.

 

Kim Lisa Taylor:

I would suggest that you go to GlobeSt.com, sign up for their newsletter, and see if you can find it in their archives. But if you’re not able to find it there I can forward you that article or Charlene can forward you that article if you email her at info@syndicationattornies.com. But you do want to get signed up for GlobeSt because they have some good information and it’ll keep you abreast of what’s going on in the multifamily market.

 

Charlene Standridge:

And then we had a question, “What’s the QIF?”

 

Matt Wills:

The Qualified Opportunity Fund?

 

Charlene Standridge:

There we go.

 

Matt Wills:

So that’ll be that setup.

 

Kim Lisa Taylor:

QOF. QOF.

 

Charlene Standridge:

Okay.

 

Matt Wills:

It’s probably my accent.

 

Kim Lisa Taylor:

That’s okay.

 

Charlene Standridge:

And then this person also is asking, “What exactly goes away?”

 

Kim Lisa Taylor:

What exactly goes away? I don’t think I understand that question well enough to be able to answer it.

So I think Rena asked that question. Rena, it’s really that the benefit is that if you hold the investment for 10 years, that whatever your original basis coming into that investment was for tax purposes, gets stepped up to the new basis that would be applicable at the end of the 10 years. So even if that property were to double or triple in value, then somebody who’d invested $1 million could get, in a property that doubled, could get a new basis of $2 million so they would effectively never pay taxes on that $1 million that they gained during that 10-year hold period while they were invested in the Opportunity Zone. And Matt, correct me if I’m wrong, any time.

 

Matt Wills:

No, sounds right to me.

 

Charlene Standridge:

And then Rena also wanted to know if a building has been vacant for five years, most likely it would need substantial improvements.

 

Kim Lisa Taylor:

Yeah sure. I think you’re right but yeah, what it means though, if it’s been vacant for five years, it’s considered now an original use so you can just treat it as if it was a new development. Whatever money you put in is going to count as  Opportunity Zone improvement money, whereas if the building has not been vacant for five years, then you have to go to that substantial improvement test.

I think I did see, Rena, your question got split up so you’re wanting to know what went away on December 31, 2019. The only thing that goes away is that seven-year benefit. So instead of getting the additional step up in basis after five years, you get a 10 percent step up in basis, and after seven years you get an additional 5 percent and then after 10 percent it jumps to 100 percent. So at seven years, that seven-year benefit is going to go away if you don’t make the investment by the end of the year.

 

Charlene Standridge:

Okay. Benjamin wants to know, “What do you mean by cash investor as opposed to gain investor?” and says, “Aren’t all investors cash investors, at least initially?”

 

Kim Lisa Taylor:

I’ll let you answer that one, Matt.

 

Matt Wills:

So a cash investor could be someone that’s either taking cash … either savings or some other form of revenue that they’re investing into the deal. Whereas a gain investor is one where they’ve actually sold a capital asset, whether it’s a short-term or long-term gain and they’d then be investing those proceeds into the deal.

 

Kim Lisa Taylor:

Right, and it has to be invested within 180 days of when that gain was achieved.

 

Matt Wills:

Right.

 

Kim Lisa Taylor:

Right.

 

Charlene Standridge:

I think that might have just answered David’s question. He wanted you to clarify the 180-day time limit between the capital gain and the investment in the Qualified Opportunity Zone Fund.

 

Kim Lisa Taylor:

Go ahead, Matt.

 

Matt Wills:

Yeah, that’s right. So as Kim just mentioned, there’s 180-day limit from the gain being realized to when it needs to be invested into the Qualified Opportunity Fund. And there’s a bunch of rules around when that 180-day time limit starts, depending on the type of asset and gain that’s being realized.

 

Kim Lisa Taylor:

There’s another time limit that we didn’t discuss during the main body of the call and that is this: Once someone makes the investment in the Qualified Opportunity Fund, then the fund has some time in which to deploy those funds, right? Can you tell us a little bit about those rules, Matt?

 

Matt Wills:

Yeah. The fund has, I think it’s 31 months to deploy the funds. And so a lot of those improvements would be carried out within that time frame. But if it’s a substantial development then there’s of course some difficulties that would need to be preplanned to deal with in order to meet that deployment time limit as well.

 

Kim Lisa Taylor:

Right, and there’s some rules on how you can get some extensions on that and certain things but basically it requires that you have a written plan on how that money is going to be deployed. So it’s not like you can just take the money and just sit on it and figure out later what you’re going to do with it. You really have to have a plan of how that money’s going to be deployed and then deploy it according to that plan.

And that also raises some complications, and this was one of the things discussed at the conference, about what do you do with money that’s sitting there for 31 months before it can actually be deployed? Do you actually owe your preferred return on that or do you not? You may want to make sure that it’s written into the documents that there’s a holding account and then there’s a deployed account and that the deployed funds earn preferred returns and un-deployed funds don’t.

But they’re entitled to receiving those benefits, so it’s probably worth it for these gain investors to go ahead and invest and leave the money sitting there. And you could always give them the interest on the account, so put it in an interest-bearing account and share that with them so that they’re at least getting the same return they would have gotten if they’d had it invested in their own account.

But before we go on to any other questions, I do want to say that Matt can be reached through us, right now. We will be setting up an email address for him at Matt@syndicationattorneys.com or you want to reach Matt you can email us at info@syndicationattorneys.com or you can email me. But the other thing I wanted to say is that we’ve got some tremendous programs for people who are not ready to syndicate yet. These are things where we can strategize, explore, figure out what you need to do if you’re dealing with Opportunity Zones, if you’re dealing with non-U.S. investors and you want to know how to structure your company, we can get Matt engaged. We can have some consultations under our pre-syndication retainer. So our pre-syndication retainer is $1,000. It gives you up to three hours of one-on-one legal consultation. In addition to that, you get an invitation to our Facebook Live group where we’re starting to do some live training.

We’ve already had our first one. It’s up. If you’re a client and you haven’t joined that group then you need to contact Charlene and ask her how to join. But we’re doing live training on developing your own investor marketing plan. We’re going to give you an investor marketing plan template if you do that pre-syndication retainer and an investor blueprint. So the whole point is, we want to help you get from where you are now to becoming the syndicator that you want to be. We can do that by helping you with the investor side of your business. You can get your training for how to buy what you want to buy. There are plenty of other sources but we want to be the source for helping you understand how to get those investors, have them ready, willing, and able when you need them and when you have deals. That will help you in the long run.

We also of course do syndication offering documents for a variety of things. For specified offerings, where you’re buying specific properties and for other types of funds when you are buying multiple properties. We have segregated offerings. We have a variety of things that we can offer you and we can set up these Qualified Opportunity Funds to help you buy in the Opportunity Zones. And a variety of other things. So all of your corporate needs, whether you’re dealing with joint venture partners or dealing with passive investors, we’d love to be your resource for that and we’re glad that you’re listening to us. And also you can always make an appointment with us at syndicationattorneys.com. There is a place there where you can click a button and schedule an appointment with one of us. All right. Let’s go on with the rest of the questions, Charlene.

 

Charlene Standridge:

Joseph had a question. He wants to know if a construction loan is used, how would that affect the fund or tax treatment?

 

Kim Lisa Taylor:

Matt?

 

Matt Wills:

It doesn’t. So the guidance states that debt financing can be used without jeopardizing the incentives.

 

Kim Lisa Taylor:

So it’s just like any other syndicate. You’re only going to raise the money that you can’t get from a bank. You’re going to get the rest of it financed from whatever institutional sources you can. The reason that you want to do that is because your institutional sources are going to want less interest than your investors will want, as a preferred return or as a share of your equity. Next question?

 

Charlene Standridge:

Linda wants to know, is there a good source where you can find Opportunity Zones for multifamily properties for sale?

 

Kim Lisa Taylor:

I think you probably have to do some sleuthing on your own right now. I would guess that the first thing you’d want to do is look into your target markets. So if you’ve been getting some real estate training in multifamily, one of the first things that you probably learned is that there are certain markets that work for you, certain markets that won’t. Whatever your target markets are, there are Opportunity Zone maps available online that you can go into those target markets and find out where the opportunities are. You can also contact the local municipalities and they have their own business development or economic development divisions. They may be resources for you but also, just start letting brokers in those areas know that, “Hey, I’m looking for properties in these Opportunity Zones. Show me what’s there.”

Again, you might have to get creative because if you’re looking for multifamily that’s existing, then you probably are going to have to think about, what can I repurpose? It doesn’t just have to be multifamily. You know you could be looking at repurposing a warehouse into an assisted living facility or some other kind of rental-income properties.

You can even do — and again Matt correct me if I’m wrong on this one — but my understanding is you could even do a single-family fix-and-flip fund as long as when you sell the properties you have to redeploy those funds within, I believe it’s 12 months. And those fix-and-flippers are going to redeploy them very quickly.

 

Matt Wills:

That’s right.

 

Kim Lisa Taylor:

Right, so as long as all the properties that you’re buying, or 90 percent of the properties that you’re buying are within these Opportunity Zones, then you could continue to flip properties, buy/sell, buy/sell, buy/sell, but as long as just continue to redeploy that money within the fund. So you’re not dispersing it out to your investors. You can still disperse profits.

So let’s talk about that a little bit, Matt. If you have an income property, a multifamily property or any kind of shopping center of whatever and you’re earning rent from that, you can still disperse all the rental income out to your investors just like you would in any other syndicate, right?

 

Matt Wills:

That’s right.

 

Kim Lisa Taylor:

And how is that going to be taxed?

 

Matt Wills:

That would be taxed in the same way as if the fund was not in an Opportunity Zone. So that would be dealt with as part of the K1 and through the investors’ individual tax returns.

 

Kim Lisa Taylor:

All right. I get this question a lot and it’s really unrelated to Opportunity Zones. But can depreciation be disproportionally allocated in a syndicate? Here’s the situation that was posed to me. The self-directed IRA investors are not entitled or able to take advantage of the depreciation benefits. So could the benefits that they’re not able to receive, be allocated to other cash-paying investors?

 

Matt Wills:

The answer to that one is possibly. So really it comes down to having to get everything structured correctly at the outset. There’s a bunch of tests, certainly to be considered for the depreciation allocation. So one test is called a Valid Allocation Test. So it’s basically seeing whether that depreciation allocation has or lacks sufficient economic substance to the extent they’ve been allocated to the respective investors. So I think the short answer to that question, Kim, is, it possibly can be achieved but that would all have to be documented at the outset. It’s not something you would be able to work off and refine dependent on the nature of the investors and what they can use the depreciation for.

 

Kim Lisa Taylor:

So I would say that if somebody wants to do that, that that’s one of the things we’d want to get on one of our consultation calls and include Matt on that so that we could talk about how we’re going to structure that syndicate up front that’s going to allow you to do that, hopefully without challenge. Okay. Charlene, go ahead.

 

Charlene Standridge:

Jeff has a question and I’m going to unmute you Jeff, so it’s Jeff H and I’m going to unmute you now.

 

Kim Lisa Taylor:

Hey Jeff. Jeff are you there? No. We lost him.

 

Charlene Standridge:

Maybe not. He also typed a question in also so I’ll go ahead and read it. Once you get the new stepped-up basis, can you then depreciate it?

 

Matt Wills:

Well the depreciation is based on your original investment so as that’s depreciating the asset, your basis from a tax income calculation would change but obviously once you’ve made the election after holding it for 10 years and you’ve made the election to have it stepped up to the full market value, certainly when it comes to disposal of the asset, it would be calculated based on that value. The subsequent question is around whether you can depreciate the new stepped-up value; that’s a great question. I haven’t seen anything on that yet so that’s something I’ll have to circle back and look into and maybe get back to Jeff offline to address that question.

 

Charlene Standridge:

Okay. Thank you.

 

Kim Lisa Taylor:

Jeff, that would be a really good question that you could ask if we had a pre-syndication retainer in place and then we can start to actually do the research and figure out the answers to that question. All right, go ahead, Charlene.

 

Charlene Standridge:

David wants to know in a 1031 exchange, can you take a 1031 exchange into a Qualified Opportunity Zone Property, single-family or a multifamily, is there a minimum investment?

 

Matt Wills:

There’s no minimum investment required in the law. That’ll be up to each syndicator to set that, depending on what they’re looking to achieve.

 

Charlene Standridge:

Okay. Carlton wants to know, for a newbie would it be smarter to invest in a Qualified Opportunity Fund or to start one?

 

Kim Lisa Taylor:

I guess that depends on your circumstances. Do you have enough money to buy something in a Qualified Opportunity Fund on your own? Do you need to bring in other investors or would you rather leverage? So if you’re investing your own money right, there’s a lot of single-member Qualified Opportunity Funds that just are for the purpose of not bringing in other people’s money. You’re just investing your own money in a Qualified Opportunity Fund. So, yes, if you have enough money to do that, why not do that? But if you want to bring in other investors, then you need to be able to create a syndicate that could allow you to do that. Do you have anything to add, Matt?

 

Matt Wills:

No. I think you covered everything.

 

Charlene Standridge:

The next question is from Chris P, and I’m going to unmute you. He has a pretty long question with multiple sections so I’m going to let him do it. So I’m un-muting you now, Chris.

 

Chris P:

Okay, can you hear me?

 

Kim Lisa Taylor:

Yeah. Hi, Chris.

 

Chris P:

Hi. So yeah my question is, it’s a little bit complicated but I’m just wondering, when you buy properties with the Opportunity Zone Fund and then if you were to sell that property, if you, you know, decided you don’t want to hold it five, seven or 10 years, when you sell it, do you have to realize that gain or can you just reinvest that capital or that gain into new properties? You kind of talked a little bit about flipping homes, so it sounds like you don’t have to realize that gain. I’m just wondering because I’m used to 1031 exchanges where you know, you’ve got all those limits on the timing and so on. But I’m just wondering, can you just keep reinvesting that over and over, and then does that five-year time frame start over where you’ll get the 5 percent discount off of the gain? And then does it also restart the 180 days you have to reinvest it? I heard you mention 12 months to reinvest it. So sorry, that’s a lot of questions. But that’s kind of what I was wondering.

 

Kim Lisa Taylor:

Go ahead, Matt.

 

Matt Wills:

Okay, so yeah, the fund could sell the asset, and then the fund would have 12 months to reinvest some or all of the sales proceeds into other Qualified Opportunity Zone Property. So more real estate that’s located in Opportunity Zones.

Your questions around the five-year time frame, that relates to the individual investor. And so that five-year time limit would start from the moment they invested into the fund. So that shouldn’t be affected by what the fund does with the asset once it’s invested the proceeds and then later sells the proceeds.

So the investor has 180 days from when they realize their gain to invest that gain into an Opportunity Zone Fund and then the fund has to deploy that capital within the time period, which is 31 months. But then the fund can then sell the asset and reinvest those proceeds into another asset.

 

Chris P:

Okay. Yeah, yeah. That totally makes sense. And then what about in 2026 when the capital gains have to be paid on that original investment? For example, if I set up a Qualified Opportunity Fund and I’m the sole owner basically and I do multiple deals within that fund, and the gain increased from what my original investment was in 2026, do I just pay the taxes on that original investment? The gain that was invested? Or whatever gain was added on to it through buying and selling properties within the fund. Does that have to be paid or at what point would the taxes be paid on that additional gain?

 

Matt Wills:

The original gain would be subject to tax December 31, 2026. Then the subsequent gains, the tax on those would only be payable either when the fund had sold all of the assets and not reinvested the proceeds or December 31, 2046.

 

Kim Lisa Taylor:

So this brings up a question that I have. What if somebody was to invest in an Opportunity Zone and QOF? What if it refinances the property? What happens then? So normally when you refinance a property in a regular syndicate, you would give back some of the capital to the investors. But you’re not going to be able to do that here, right? You’d have to keep that capital invested for the full 10 years wouldn’t you?

 

Matt Wills:

Yeah, so that’s a great question. I think that is the case, Kim.

 

Kim Lisa Taylor:

You’d almost have to go out and buy something else. Or don’t take the cash out of the refi. Just leave the gain in there. You know. Just do the refi, get the better terms but now you’re just refied at a different loan-to-value ratio but you didn’t take cash out. So unless you had all of your investors in your syndicate agreed that, “Let’s take the gain and buy something else,” then hold onto it. So it’s really about the time that those funds are invested. Charlene, go ahead. Next question.

 

Charlene Standridge:

Okay. The next question is from Ben. Could someone manage both the property and the Qualified Fund and be paid money, even if they have no ownership interest in the property?

 

Kim Lisa Taylor:

I think what you’re asking is, if you haven’t invested any cash in the property can you still run it and still earn money and yes, I think you could. There’s no prohibition on any of that. It just has to make sense for your investors for you to carve off a piece of both of those companies for yourself. Do you see any related-party issues with that, Matt?

 

Matt Wills:

No. Not from that piece, Kim, I think what you said makes sense.

 

Charlene Standridge:

Richard wants to know if a listing shows properties on market, does it have a field that shows if it’s in an Opportunity Zone?

 

Kim Lisa Taylor:

Okay, so I think what Richard is saying is that some listing sites do show properties that are on the market and seems like there might be some way to see if they’re in an Opportunity Zone as well. It wouldn’t surprise me that they’ve clued into this $50 billion that’s getting ready to be deployed to Opportunity Zones and made that information available. So that’s good information.

 

Charlene Standridge:

David has a question. Are, I think he means 1031 gain rather than capital gains, treated differently?

 

Kim Lisa Taylor:

Read that again?

 

Charlene Standridge:

It says, are 1231 gain rather than capital gains treated differently? I was thinking he meant 1031.

 

Kim Lisa Taylor:

No. I think he is talking about the 1231 gains.

 

Charlene Standridge:

Okay, sorry.

 

Kim Lisa Taylor:

Do you know the answer to that one, Matt?

 

Matt Wills:

Just trying to think. Not off the top of my head, Kim. I know that there are some technical rules around the 1231 gains.

 

Kim Lisa Taylor:

Can you just tell us what 1231 gains are?

 

Matt Wills:

So, a 1231 gain occurs when you sell a property that was used in a trade or business and that’s been held for over a year. So this is usually like an investment in a business entity like, for example, the syndication LLC. So when you sell your partnership interest, you’re triggering your gain. But the 180-day window for the exchange purposes, doesn’t start until the end of that tax year. So you know, December 31st with partnerships.

 

Kim Lisa Taylor:

Then I also know there are some really specific rules on when you first have to declare your designation as a Qualified Opportunity Fund. So again, that’s something I think you’ve got to be cognizant of. It’s not like you can just say, “Oh my fund is now a Qualified Opportunity Fund.” You’ve got to have some forethought to that. Make sure that you’re doing the filing within the right time frame, making the declaration at the right time to enjoy the benefits.

The biggest risk for a syndicator and for their investors in investing in a syndicate that’s investing in an Opportunity Zone is whether the operator or the syndicator screws it up and then everybody’s gain deferral is disallowed. So you’ve got to make sure that you’re working with experienced professionals when you initially set it up and as you’re running the company and making sure that you’re meeting the deadlines. Aren’t there forms that have to be filed twice a year that you have to declare that you are meeting the requirements of deploying the funds and all of that? Is that right, Matt?

 

Matt Wills:

That is right, although that’s subject to change. Congress is starting to be a bit more interested in maybe looking for some more information to be reported. So there could be some additional regulations that come out in relation to reporting for Opportunity Zone Funds.

 

Kim Lisa Taylor:

Yeah, and one of the things that was discussed at the conference was that one of the things they were asking is that the form be expanded to actually make the investors be identified. Somebody mused that perhaps that was so that those people could be shamed, investing in luxury apartments and Opportunity Zones and not perhaps following the spirit and the intent of the law. So, I mean, I don’t know. I have no idea what their motivation is for any of this. But there is some proposed legislation that would require some additional reporting. Charlene, have we answered all the questions?

 

Charlene Standridge:

We have just a couple more. Richard Hall has several questions.

The first one is, if a project in an Opportunity Zone also subsequently receives tax credits, TIRZ or other economic incentives, are those taxed to the fund partners or allocated disproportionately?

 

Kim Lisa Taylor:

I think that’s beyond the scope of what we want to discuss in this call so if that’s something that you want to know about, I think you probably want to become a pre-syndication retainer client and we can get you on a call where we can start discussing those very, very specific questions. Next one.

 

Charlene Standridge:

I think his follow-up question goes along with that so I’m going to skip that one.

 

Kim Lisa Taylor:

Okay.

 

Charlene Standridge:

David wants to know, is an international investor qualified to invest in a Qualified  Opportunity Zone Fund? Are there other rules for foreign investors?

 

Kim Lisa Taylor:

Good question, Matt.

 

Matt Wills:

Well, there’s nothing I think to stop them from investing in an Opportunity Zone Fund. The question is, are there any U.S. capital gains tax liabilities that they would have, that they would benefit from investing in the fund? And then its relation to the other rules … yes, there are lots of rules in place regarding foreign investors both in terms of from a securities law aspect and also from a tax law aspect that needs to be proactively managed to ensure that the syndication is set up in the most tax-efficient manner for both the fund itself and the foreign investor.

 

Kim Lisa Taylor:

And the ongoing reporting that’s required and withholding that may be required.

 

Matt Wills:

Exactly.

 

Charlene Standridge:

Okay, that’s all we have for the typed in questions. We have one more person with their hand up. Frenchie. I’m going to unmute you right now. Okay, Frenchie, are you there?

 

Frenchie:

Yes, I’m here. Can you hear me?

 

Charlene Standridge:

Yes, we can.

 

Kim Lisa Taylor:

Hi, Frenchie.

 

Frenchie:

Hi. How are you? Hello everyone. Quick question. In regard to the Opportunity Zones, the tax benefit, I know you’re supposed to hold it for 10 years and then you’re relieved of paying the … is it the income tax, I believe? But who is responsible for that with the Opportunity Zone Fund? Or if you have a project that’s being built in a QOZ zone, I believe the builders are the general partners and not responsible for paying for, I guess how is it done? Recording that. Is it just on the investors to go and register it to get the relief from paying the income tax on it? How is that procedure done?

 

Kim Lisa Taylor:

I think it depends on how the funding structure is set up for the development project itself. If you’re investing directly into that and they’re not treating it as fund, I would imagine that the onus is going to be on you to have your own Qualified Opportunity Fund that’s making investments. Matt, what do you think about that?

 

Matt Wills:

Yeah, I agree. I think if it’s set up as a fund, it’d be similar to a normal syndication where the fund would need to provide the investors with certain reports and schedules that then they would incorporate in their tax return. So each individual investor, they’re looking to benefit from the Opportunity Zone incentives when they’re reinvesting their gains, they would actually make the election on their tax return as well to indicate that this is a gain and this has been reinvested into a fund and then ultimately the reporting flows back to the individual investors if it is a fund.

 

Kim Lisa Taylor:

Yeah, so I think that’s complicated. If they’re a sole funder on a project and they’re in control of the project then perhaps they can do their own reporting, but if this developer, first of all, is taking money from multiple people who are passively investing, well whether they like to say they’re responsible or not, they’re becoming responsible. They’re certainly offering securities in the form of investment contracts, most likely and are probably going to be subject to securities laws as well as if they’re holding this out to be an Opportunity Zone investment, they would perhaps become liable for making sure that they met all the requirements.

 

Frenchie:

Okay. Okay. Thank you.

 

Kim Lisa Taylor:

So I think that you’ve just got to be cautious about it. And you know, one of the things that was really harped on at the conference is that, don’t just make investments in Opportunity Zones because it’s an Opportunity Zone. You’ve still got to do due diligence on the sponsor and the structure and the way that it’s going to be handled and whether it’s going to meet the criteria because in the situation you just described, with the developers taking the position, “Hey, I’m just a developer. I’m not responsible for all that stuff.” Well maybe that’s not a best choice for you because they could leave you hanging out to dry if all of a sudden they do something that is not in compliance with the Opportunity Zone regulations and now you have to figure out and scramble around and try to figure out how to salvage that. So I think you’ve got to be cautious about that. But do your own due diligence. Make sure the deal still makes sense and that it meets your objectives. And if your objectives are to have the Opportunity Zone benefits, then I would certainly try to invest with somebody who understood that.

 

Frenchie:

Okay. Excellent, thank you.

 

Kim Lisa Taylor:

You’re welcome. All right, well thank you so much, everybody, for joining us today. Thank you so much, Matt, for joining us. That was really a huge wealth of information and we look forward to having all of you as clients very soon.

 

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