WHAT DOES TAX REFORM HAVE TO DO WITH TITLE INSURANCE?

The answer is “Plenty!”

Congress’ passage of the Tax Cuts and Jobs Act of 2017 established  the Opportunity Zone community development tax incentive program.  Intended to encourage long-term investment and economic development in financially distressed areas of the United States,[1] the program will allow reinvestment of unrealized capital gains into certified Opportunity Funds dedicated to investing in the Opportunity Zones.[2]  The duration of deferral of tax on the original capital gains investment is eight (8) years. [3]  Investments must be made for a minimum of five (5) years, and the tax benefit increases the longer the money remains invested;[4]  if left in place for ten (10) years, any capital gains on an initial investment will be completely tax free.[5]

Notwithstanding the tax related benefits of this type of investment, when the “opportunity” at issue involves real property, investing will by necessity be contingent upon marketable title.   And that means title insurance professionals and underwriters will have their own opportunity to play a critical role in this program.

Background Information on Opportunity Zones

In order to determine which communities would benefit from the Opportunity Zone program, governors of each state (as well as CEOs of Washington, D.C. and U.S. possessions) nominated census tracts based on statutory criteria, keeping in mind the goal of adding jobs and economic growth in underserved areas.[6]   Opportunity Zone (“OZ”) designations were then approved and certified by the U.S. Treasury Secretary and will remain in place until December 31, 2028.[7] The Treasury Department and IRS recently completed the final list of Qualified Opportunity Zone designations,  designating zones in all 50 states, the District of Columbia and five (5) territories (this list is not official; the official list will be published in the Internal Revenue Bulletin at a future date).[1]

OZ’s are usually distressed communities or census tracts with household incomes below the national average of $59,000.00 per year and poverty rates of 20 percent or more.[2]  Governors were also permitted, however, to nominate a small number of otherwise non-eligible census tracts in order to “create a contiguous zone,” provided the median family income did not exceed 125 percent of that in the neighboring low-income census tract.[3]   “A qualified Opportunity Fund [the “Fund”] is any investment vehicle organized as a corporation or partnership with the specific purpose of investing in Opportunity Zone assets.  The Fund must hold at least 90 percent of its assets in qualifying property.”[4]  In addition to operating businesses and equipment, Opportunity Funds may invest directly  in real property if the original use of that property commences with the Fund or if the Fund substantially improves the property.[5]  For example, investors can pool their capital gains into a Fund which then invests in a local project such as multi-family housing developments that are an approved OZ.[6]

“At stake is $6 trillion in potential investments nationwide.”[7]  While investors await final rules and regulations from the IRS, there are several unknowns at this stage, as well as ambiguous policies and procedures, but once these uncertainties are resolved, investor groups including hedge funds, private equity firms and community development financial institutions should begin to establish Funds.[8]

That said, even with the capital infusion, “local government has to be willing and able, to work with developers to approve projects through its zoning code and permitting process.  There has to be a vision and a master plan in place and the local governments must offer incentives to assure that there are essential …services” in place for these areas.[9]

Role of Title Insurance

Risk is inherent in any commercial real estate transaction.  Therefore, “a key element of any commercial real estate transaction is due diligence on the part of the purchaser.  A thorough investigation into the fundamentals of the property, the seller, the financing and the deal itself is the most crucial form of protection a purchaser has. Such an investigation exists to prevent surprises that might arise post-transaction.”[10]   It can also prevent delays in closing a transaction.   The individuals comprising the entities that in turn make up the Funds will want protection and assurance that their investments are safe from losses due to title issues that could arise in regard to real property.

Therefore, once the OZ program gets underway, and Funds start investing in real property, title searches and policies will become an important part of the process.  Title exceptions arise all the more frequently in financially distressed neighborhoods.  Due diligence will necessitate title searches into the title of real property, searching recorded documents in the public record which affect title such as outstanding mortgages, easements, liens, covenants and restrictions, and other issues.   One can foresee transactional issues such as foreclosures, loan workouts and modifications, and other complexities as well as judgment and tax liens, and mechanics liens and other such title defects.  Title professionals will be instrumental in helping develop solutions to allow the transactions to go forward.[1]   A title report will set forth all exceptions, dictating which need to be cleared before closing, and which will remain in place even with a policy in place.  It will also turn up any concerns relating to commercial sellers, including judgments and lien searches, tax deficiencies, and other issues.

Finally, Funds will need to know what restrictions exist on the property in which they invest, for instance, easements and/or covenants and restrictions that run with the land.  They will want to make sure there is adequate access to the property, and that there are no encroachments that will interfere with the intended use of that property.

Upstate New York has a large share of Opportunity Zones.   In the Capital Region alone, there are 20, including six in Albany County (in the City of Albany), three (3) in Schenectady County (in the City of Schenectady), and three (3) in Rensselaer County (in  Troy).  The surrounding counties also have designated zones, including two (2) in Columbia County, one (1) in Greene County, one (1) in Saratoga County, two (2) in Warren County, and one (1) in Washington County.   The surrounding Mohawk Valley has numerous OZs as well, including three (3) each in Fulton and Montgomery counties, and two (2) in Schoharie.  Finally, the Mid-Hudson area of New York boasts 31 designated zones as follows:  four (4) in Dutchess County, six (6) in Orange County, 12 in Westchester County, three (3) in Sullivan County, four (4) in Ulster County, and two (2) in Rockland County.[2]

In sum, the Tax Cuts and Jobs Act of 2017 will have impacts far beyond the expected.  Many professional services will be called upon in order to bring economic development and growth to fruition within the Opportunity Zones.  Attorneys, surveyors, commercial real estate brokers and developers, as well as title agents and underwriters, all stand to benefit, and should become knowledgeable as to the details of the program and appraised of ongoing developments in relation thereto.

[1] Opportunity Zones,” http://eig.org/opportunityzones/See Section 1400Z-1 and 1400Z-2 of the Internal Revenue Code of 1986, as amended, cited in “United States: Opportunity Zones: A Preliminary Examination,” by Sherman & Sterling LLP, May 16, 2018, http://www.mondaq.com/unitedstates/x/701482/real+estate/Opportunity+Zones+A+Preliminary+Examination.

[2] Id.

[3] ”How the Opportunity Fund Rollover works,” https://www.opportunity-funds.com/the-basics/.

[4] “Trump tax reform’s Opportunity Zones yield big capital gains savings,” by Alison Fossyl, May 7, 2018, https://www.bizjournals.com/atlanta/news/2018/05/07/trump-tax-reforms-opportunity-zones-yield-big.html.

[5] “How the Opportunity Fund Rollover works,” supra.

[6] “Treasury, IRS Issue Guidance on Opportunity Zones to Spur Private Investment in Distresses Communities,” https://home.treasury.gov/news/press-release/sm0283.

[7] “Opportunity Zones,” http://eig.org/opportunityzones/faq.

[8] “Treasury, IRS Announce Final Round of Opportunity Zone Designations,” June 14, 2018, https://home.treasury.gov/news/press-releases/sm0414.

[9] “Opportunity Zones,” http://eig.org/opportunityzones/faq, supra.

[10] Id.

[11] Id.

[12] Id.

[13] “Trump tax reform’s Opportunity Zones yield big capital gains savings,” supra.

[14] Id.

[15] Id.

[16] “Opportunity Zones – Good Idea or Putting the Cart Before the Horse,” by David K. Blattner, April 23, 2018, http://floridarealestatelawandinvestmentblog.com/2018/04/.

[17] “The Basics of Commercial Real Estate Transactions: Due Diligence,” The National La Review, March 26, 2015, https://www.natlawreview.com/article/basics-commercial-real-estate-transactions-due-diligence.

[18] See   http://www.firstam.com/title/commercial/commercial-title-insurance/

[19] A complete list of the designated Opportunity Zones can be found at https://www.cdfifund.gov/Pages/Opportunity-Zones.aspx.

 

 

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SMPR Title Agency is a New York Title Insurance company. Our Title Insurance Agency is composed of real estate experts who provide our clients with comprehensive property transaction services including: Property Title Insurance, Mortgage Lender Insurance, Title Searches and Documentation Preparation Services.

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