If there were a U.S.-based real estate investment and development program that could eliminate capital gains tax and depreciation recapture upon the sale of a developed hotel asset, should that capture the interest of hotel owners, developers and investors? One would think so, provided they have the appetite, capacity and staying power to develop in a designated Opportunity Zone {OP Zone) area and hold for a minimum of 10 years in one of the 50 U.S. states or territories.
Obviously, the hospitality project must make sense from typical underwriting, demand and development standards, but if the project can pass that muster, why not develop in an OP Zone and reap significant tax benefits for owners, developers and investors?
Also, while large multi-asset and multi-jurisdictional opportunity zone funds have had great success developing through the OP Zone program, there is still plenty of room for specific OP Zone projects funded through single and multi-member LLCs. Even family offices can establish their own funds to invest in and develop Op Zone projects.
There is an urgency, however, which stems from the pending expiration of significant provisions of the OP Zone program as of Dec. 31, 2026. To reap the full benefits, OP Zone fund formation and development need to be started now. Here are key considerations:
What are the primary investment advantages of the US Opportunity Zone program?
No capital gain tax for asset sale after a 10-year hold; no depreciation recapture. For qualified OP Zone investment projects, investments in assets for development, made with qualified funds, will receive a “bump up” in basis after a hold of 10 years or more, meaning there generally will be no federal capital gains tax upon sale of those developed OP Zone assets. Nor will there be depreciation recapture at that 10-year-or-more time of asset sale.
Short-term deferment of capital gains tax for OP Zone investment. An investor who realizes capital gains proceeds from the sale of certain assets (such as stocks, bonds, real estate, etc.) and, who within 180 days of that sale, invests those proceeds into an OP Zone project, may presently defer the payment of capital gains tax, until the filing of the investor’s tax return in 2027. For now, pending Congressional extension, Dec. 31, 2026, is the last date for investment of such eligible capital gain, hence the inclusion of that gain in the 2027 return.
What structure must be established to constitute a valid OP Zone investment?
Valid OP Zone fund. The sponsor of an Opportunity Zone investment must establish a valid OP Zone fund to accept qualified investment for the OP Zone project. The OP Zone fund may have single or multiple members and a sponsor-manager.
Qualified OP Zone Business. The OP Zone fund must invest in property located in the OP Zone. The best, if not required, practice is for the sponsor to establish a Qualified Opportunity Zone Business (QOZB) to conduct the business within the OP Zone.
Percentage ownership and operation requirements. There are significant percentage requirements that apply to both asset ownership and business operation within the OP Zone. For straightforward, single hotel asset investment, development and operation, these threshold percentages might be easily met.
31-month written plan. While OP Zone investment funds are expected to be immediately deployed after funding into OP Zone assets and businesses, there is a 31-month “safe harbor” for investment fund deployment made pursuant to a written plan. This written plan could essentially mirror a typical development plan and expense/drawdown schedule that a sponsor would submit to a hotel construction lender, augmented with special and specific representations to meet OP Zone regulatory requirements.
What reporting requirements are necessary during the life of an OP Zone fund and a Qualified OP Zone Business?
Self-certification and ongoing record compliance. An OP Zone fund and QOZB do not need prior federal government approval or acceptance to be established or to operate. Each of those entities is subject to filing appropriate tax forms and complying with testing requirements, both upon formation and first-year operation, and then annually, all with appropriate review and documentation requirements.
What resources are needed to form an Opportunity Zone Fund and Qualified OP Zone Business?
Typically, such formation and operation compliance can be carried out by knowledgeable legal and tax professionals who are versed in the special requirements of OP Zones. Much of the cost of formation and establishing compliance systems is upfront, with internal comptrollers being able to manage tax reporting with annual testing and valuation assistance from outside advisors.
What are the consequences of an early exit or change in investors?
When special situations arise, such as early investor exit, investor substitution or certain financial restructurings, additional need for specific legal and tax advice will arise.
Bottom line
The basic OP Zone blueprint is not as complicated as the thousand-odd pages of federal rulemaking and amendments would make it seem, provided you have the right professional guidance and team to see you through.
For hotel developers, owner and investors who can set their sights on a 10-year hold horizon for urban or rural U.S. hotel development, the federal Opportunity Zone program is an extraordinary tax exclusion vehicle that can significantly augment total returns. While we hope Congress will renew and extend Op Zone provisions past the Dec. 31, 2026, deadline, time is of the essence to take advantage of this valuable program.
Paula A. Argento is a Washington, DC, corporate finance attorney and a global hospitality investment consultant. She represents public and private companies, boards and family offices, and has served as a staff attorney to the U.S. Senate Judiciary Committee. She can be reached at [email protected].
This is a contributed piece to Hotel Business, authored by an industry professional. The thoughts expressed are the perspective of the bylined individual.
