Phil Jelsma:0:02I like the shades of gray. I like that there aren't a complete set of set of rules that allow us to kind of say, okay, here are the rules we've got, now how do we move? How do we maneuver inside of that? That's probably often a different reaction than you get from a lot of people about this.
Announcer:0:23Tax attorneys Phil Jelsma tells us about the gray areas that the new Opportunity Zone law and how they can actually be very beneficial today on the Opportunity Zone podcast.
Announcer:0:38Welcome to the OZExpo podcast where we talk with the people who really know the Opportunity Zone market from investors, fund managers and developers to tax experts, politicians and attorneys. The most influential voices in the Opportunity Zone industry are here on the OZExpo podcasts.
Jack Heald:1:03Welcome back everybody to the Opportunity Zone Podcast. I'm your host Jack Heald. I'm here today with Phil Jelsma, who is an attorney with the firm CSG, did I get that right? CSG?
Phil Jelsma:1:17CGS3, it's a mouthful.
Jack Heald:1:21Well, welcome Phil. It's good to have you.
Phil Jelsma:1:24Thank you. I appreciate it, Jack.
Jack Heald:1:27Uh, I met Phil at the offices of the Opportunity Zone expo last week. He gave us some, what was to me, pretty impressive insight into the tax implications and investing implications of the Opportunity Zone program. And Phil, we're going to dig into that here in just a minute. But before we do that, I want to find out a little bit about Phil Jelsma, who are you? How'd you get started business?
Phil Jelsma:1:55Well, I, not surprisingly, I'm a tax lawyer. I've been doing this for a long time, um, over 30 years here in San Diego at, um, yeah, first a full service law firm called Loose Forward that was acquired by Mckenna Long and Aldridge and an I four years ago I made the move over to a smaller boutique firm here, CGS3, which is a real estate, a boutique firm in San Diego and Los Angeles. And so I am surrounded by real estate lawyers all day who loved to talk and think real estate. Um, and, um, I have, uh, taught now for 30 years out at us, a USD law school on initially on the taxation of real property. Now it's a little bit broader of course, because we do, uh, discussions of taxation of intangibles and personal property, but it's something that, um, I guess I'm naturally interested in the kind of the intersection of federal and state tax policy and, and, uh, ownership and management of property and, um, I guess is kind of a long time advocate for redevelopment and improving some of the urban infrastructure.
Phil Jelsma:3:12Um, I got interested when the 2017, uh, tax bill was, uh, first pushed through Congress and then signed by the president in December of 2017 and, um, happened to pick up, as I've mentioned last week, the first chapter in the last chapter in the last chapter of the 2017 tax act has three sections on Opportunity Zones. And so it seemed to me that was an interesting approach to try to help some of these lower income communities attract capital. Um, and we'll talk today about the real estate side. And as I mentioned, um, you know, the business aspects of Opportunity Zones I think are in some respects are a little bit of the unexplored territory, um, for, um, both investors and probably in some respects for tax people because we're still looking for some rules in terms of how these, how these attributes and these incentives necessarily work. When I, when I own, I own a business. So, um, I guess I'm referred to around here as a, as a tax geek because, um, I like, I like thinking about, I like planning for, and I like, uh, the, uh, the mental exercise of understanding how the tax rules work.
Jack Heald:4:31I will confess that until I heard you speak if somebody had said, oh, go talk to this tax attorney, I would have thought to myself, I'd rather sit and watch paint dry. But, that 45 minutes you gave us there in the office. It was absolutely riveting. And I think for the first time in my life I understood why this type of work would be fascinating to someone. You did a great job.
Phil Jelsma:5:01Well, thank you. It is. Um, you know, I think it's a matter of, um, in many respects, you know, I think it's a, it's a benefit to teach in law school we tend to often make simple concepts, complicated. And I think in many respects our job is actually to go the other way and that is to try to take complex issues and complex problems and communicate them so people really understand, you know, here what was the congressional intent, what can be done, what can't be done? You know, what are the benefits if you do it?
Jack Heald:5:37I'm fascinated. How did you end up actually being able to teach at the same time that you're practicing law?
Phil Jelsma:5:47Yeah, it's probably more of a, of a testament to my partners because they let me do it. What I, um, when I bring to the law school, um, is, you know, a practitioner's bend to, um, how we practice as opposed to an academic bend, which I think for better for worse traditionally is what's taught in law school.
Jack Heald:6:13Reminds me of Mike Tyson's famous quote. Everybody's got a plan so they get hit in the face.
Jack Heald:6:20If all you've heard in law school is academics, the real world's going to be a whole lot different. Well, let's dive into the Opportunity Zone market.
Jack Heald:6:33What, what kind of question is, does the person who shows up on your doorstep have when it, when it comes to um, the Opportunity Zone when they come to Phil Jelsma and say, hey, what do I do with here?
Phil Jelsma:6:46Some of them are people that are uh, they'd either have done transactions, are thinking about doing transactions and they're either nominally aware of Opportunity Zones or this gentleman was completely unaware, kind of thought 1031 was his only choices only avenue. And like I said, we'd had a conversation and why I thought that was going to be a difficult, a difficult road for him to pursue. But an Opportunity Zone would be an easier pass if he was interested in doing it. And so that's another place where you get people that either can't do a 1031 or they've got some, they can't find the right placement property or they've got issues or he just had, you know, a difficult problem inside is 1031 transaction that was going to make it make it hard to be able to, to get this done. Um, so there's that, you know, there's that piece as well.
Phil Jelsma:7:45Um, and um, you know, like I said the, so that's, that's kind of one category. You know. The other, the other category is the clients that already own property in Opportunity Zone. Either they recently acquired it or often it's the law works so that the, the Opportunity Zone fund has to acquire the property by purchase after December 31, 2017. So another avenue is people that own property in the Opportunity Zone that now want to develop it or redevelop it, but they already own it. And you know, kind of their questions are, what do I have to do? And the simple answer is we need to create a new entity and you need to sell it to the new entity. And you can't own 20% of capital or profits in the, in the, in the new entity, the buyer. But we can do some things to help you deploy your gain into multiple Opportunity Zones.
Phil Jelsma:8:43So there's, there's a category of clients that are aware of the law and either hopefully they're, they're coming in saying, hey, I'm looking, buying this property and then we can do something for them. We can form the Opportunity Zone fund and get it up and running. Sometimes they're coming in saying, well, you know, I bought this property at the bottom of the market 2010 and now I want to redevelop it and kind of what can I do? And the answer is, well, we need to, we need to change the ownership is the simple answer. We need to, we need to have kind of a new entity own the property, not the old entity. So that, you know, there are, there are categories of that. And then, um, you know, probably the last category is, you know, that's really the investor side is the developer side.
Phil Jelsma:9:31Um, where, uh, you know, a real estate developer has found a property and Opportunity Zone and you know, he or she knows, um, okay, this is it. This is what I want to do. Um, how do I go about attracting the capital to be able to, to, uh, to acquire and substantially improve the property. So, um, being at a real estate firm in some respects, you know, I tend to eh, that the clients here tend to be more along those lines is that they already, they, they develop property. Um, they build property, they do other things and so their questions tend to be much more kind of the mechanics of what do I have to do to qualify this for an Opportunity Zone Fund.
Jack Heald:10:23What's the best question you've gotten from a developer in terms of the Opportunity Zone, or maybe the most interesting question you've gotten with developers and Opportunity Zones recently?
Phil Jelsma:10:35Well, um, you know, the most interesting questions really get to an area that we don't have a whole lot of guidance on, which is really the question of ground leases. So we know that . . .
Jack Heald:10:47for those who are not tax attorneys define "ground lease."
Phil Jelsma:10:50A ground leases are really long longterm lease transactions and there's kind of two different benchmarks. The federal income tax rules talk about leases of 30 years or more property tax rules. California property tax rules talk about leases of 35 years or more, but the, um, but the, the Opportunity Zone legislation talks about that the fund, the new entity that's doing the improvements has to acquire the property by purchase. Um, and if it does that, the seller can't own more than 20% of the buyer. Um, you know, the question of whether or not rather than selling it, if I have our current owner, um, simply enter into a longterm lease with an Opportunity Zone fund that would either renovate or build a new property, um, in many respects kind of theoretically that's, that's the most, to me, that's one of the more interesting questions, which is, um, the law says if, you know, if it's acquired by purchase, here are the, here are the requirements, but it's really silent on the question.
Phil Jelsma:12:05Oh, what happens if the fund doesn't buy the property? But the fun merely enters into a longterm lease, um, and controls the property, like I said, for either 30 or 35 years. A lot of times you'll see these things, you know, 50 years, rarely 99 years. But sometimes those transactions I think are in some respects the most interesting because like I said, they, they seemingly fall into this void or gap, um, that the law doesn't really speak to. You know, I think the other thing that, that I find interesting and, or amusing is kind of the whole question of, um, if the fund has a subsidiary, there are limitations on what businesses the subsidiary can be engaged in, what we refer to as sin businesses. Um, like, uh, private, uh, private golf courses, um, massage parlors, hot tubs. So, uh, so kind of the whole question in California that, and the delineation of, uh, what's in businesses are, um, cannabis isn't included in being in a, in a state where, uh, where, uh, marijuana is, is legal.
Phil Jelsma:13:22Um, and whether or not that was an intentional or unintentional, uh, oversight. When you heard, uh, uh, Secretary Mnuchin's comments about it. Well, Gee, you know, I certainly wouldn't want to run a cannabis business in an Opportunity Zone. Okay, well I get that he's the Secretary of Treasury, so I understand why he would want to do that. But, um, whether, like I said, whether or not that's an indicator that that was an oversight and that they meant to include it in the definition of sins and didn't, or whether or not that was, um, you know, just, you know, we, we didn't include it because the states are in the process of, uh, gradually legalizing it state by state. So it's, that's another, that's another interesting debate or discussion inside the kind of the Opportunity Zone world is what, you know, what is omission, what does not including something mean mean that we meant to do it, which is kind of what he's saying. Uh, and therefore you should think it's in there or do you take more of a literal interpretation? While if you didn't say it, you didn't mean it. So that's another, uh, another kind of interesting that debate or discussion.
Jack Heald:14:40I would think that with literally every of previous administration failure to spell these things out could be taken as literally nothing more than a failure to spell it out. Whereas with the Trump administration given, uh, given his background as a developer, is it possible that it's more likely that the silence itself was intentional?
Phil Jelsma:15:06To be honest with you, I just don't think they thought about it. I think in some respects it was, it was an oversight. Now having said that, once you, once you leave it out and you want to try to bring it in, then of course, you know, the lobbying really, really comes about because the, you know, generally, I'm not sure other than kind of the, uh, the establishment of saying, yeah, it should have been in there. I think you're going to have kind of the forces in the western states that, um, that are part of this industry really move to try to prevent Congress from adding them in.
Jack Heald:15:47Well, that leads me to my next question, which is in light of all these, for lack of a better word, very ambiguous directions from the government. How do you manage the concerns that their silence raises for a potential Opportunity Zone investment?
Phil Jelsma:16:12Well, one possibility, which actually sometimes solves itself is the, um, for example, the prohibition on sin businesses really say that the Opportunity Zones subsidiary can't be engaged in these businesses. What it doesn't say is you can't lease to tenant's in those businesses. So, you know, oftentimes, um, if the, if the reaction is, well, gee, you know, the entity itself can't do it, then, um, that doesn't prohibit us from using having attended to it. And, and this, this almost gets back to the, to the ground lease discussion. You know, in many respects the IRS historically has tried to find ways to attribute activities of one party to another. And that's typically through related party rules, where they've always had a problem and they've always been reluctant to go. Uh, there is trying to attribute activities of tenants to landlords or from landlords to tenants because, you know, generally speaking, those people are in two separate businesses.
Phil Jelsma:17:19So as a result, um, like I said, the prohibition on, on sin businesses tells me that the, uh, Opportunity Zone sub can't be in the business but doesn't prohibit me from leasing that space to a tenant who's in that business. Um, and it seems to be silent on that. And like I said, I think that's a little bit of a reflection that historically, um, you know, the IRS and in some respects Congress, so the IRS has always found it difficult to say, well, just because your tenants doing something, you, the property owner is, is doing it. And so I think they've always been very respectful of that line. And so to get to the point of, well, Gee, you know, if I, if I, if I can't do it, does that mean that um, my sponsor or my lead investor or some someone can't form a business that, uh, let's say operates, um, a retail cannabis, a facility in California and that, um, that particular and, uh, investor, you know, forms an S Corp, C Corp, Partnership, LLC and that becomes a tenant in my space.
Phil Jelsma:18:37Um, there doesn't seem to be any prohibition on that. And then, you know, the kind of, the kind of close the loop is, there's nothing that would suggest that if I did that, that that entity, the S Corp, the C Corp, um, that owned the other, operated the cannabis business. As long as it's in the Opportunity Zone, it would seem to also be entitled to the same benefits that the real estate gets, which is it could be owned by a separate Opportunity Zone fund. Um, and um, that fund, could just invest in that particular business instead. So, um, so like I said, they're always, uh, you know, what kind of makes this, this area of law or in general kind of interesting is there's rarely black and white. It's always shades of gray. Um, and kind of, you know, if, if the prohibition is here and I can't do this, is there another way to structure the transaction that I don't, I don't run a foul of that prohibition and that, you know, that, you know, kind of saying, well, the Opportunity Zone sub can't do it, but you know, it, it doesn't prohibit, you know, it's tenants from doing those kinds of things.
Jack Heald:19:48You know, typically the folks I talked to are not on the tech side here. And so when I say to them, what's your single biggest concern about the Opportunity Zone, they talked to the areas where the law is vague
Phil Jelsma:20:03Uh huh.
Jack Heald:20:03And it's, I have to say, it's really nice to hear someone who doesn't seem to take the vagueness as uh, as a particularly overwhelming concern.
Phil Jelsma:20:20I like the shades of gray. I like working in that, in that world. Um, I like the fact that there aren't, there aren't, you know, bright line test. I, you know, unlike how, I mean I understand why the investors would like that and kind of complete assurance. But I think when you're a planner and you're a transactional lawyer and you're trying to put, put these deals together, you know, like I said, I, I like the shades of gray. Um, I like, you know, that there aren't, you know, you know, a complete set of set of rules that allow us to kind of say, okay, you know, here are, here are the rules we've got now how do we move? How, how do we move? How do we maneuver inside of that?
Jack Heald:21:06What has been the most pleasant surprise that you've encountered as you've dug into this law?
Phil Jelsma:21:10I used to work with a guy who always said, you know, it's always better to be lucky than smart. Um, and the most pleasant surprise I've had is, you know, the clients, the developers who didn't, you know, didn't get into an Opportunity Zone deal or get one under contract with the sinking of, Oh gee, you know, I'm really going to take advantage of this, but kind of, you know, it fell into their lap and kind of in some respects, whether it's the reaction, the joy or something else, it's like getting a Christmas present. Um, and it's like, it's fun for me to be able to deliver the Christmas present play Santa Claus and say, well, you know, maybe you didn't really think about this, but you know, here's an alternative for you.
Jack Heald:21:56What are the most important questions and investor needs to be asking before he gets involved with the Opportunity Zone program?
Phil Jelsma:22:05Well, it's, it's really fundamentally, you know, whether it's real estate or a business investment, it's an investment. And kind of what I'm constantly telling people are reminding them is it doesn't make any sense if you don't have gain on the property after 10 years. And I'm kind of constantly reminding people, well, you know, the answer, the right answer isn't just dump some money into an Opportunity Zone fund. Um, the right answer is to do your due diligence on the sponsor, on the developer and on the property. Um, because if you don't make money and it was all for not, it was all kind of just an academic exercise. So I think, um, to me, to me in, in, in some respects, um, you know, I think the thing that I'm constantly reminding people is it's just not a tax, it's not just a tax deferral payment.
Phil Jelsma:23:01It, you shouldn't be driven simply by trying to, um, defer paying your taxes. Um, it's a real estate investment and it's only as good as the real estate is. Um, you know, and if you're going to, you know, buy, buy a building and a bad neighborhood and spend, you know, a million, 2 million, $3 million renovating it. And the question is, can you raise the rents um enough to be able to pay those costs? If not, it's probably going to have negative cashflow and it's not, it's not going to be, it's, you know, it's not going to be close to stabilization and you're going to be putting, you know, more and more money into it. At its very simplest, at its very basic opportunity are sticks and bricks. This is, this is a brick and mortar type of investment that we're going to be talking about. And Yeah, there are mechanical rules, but I can't think of anything more simple than, you know, reminding people you got to buy the right property in the right neighborhood with the right contractor and the right developer and the right economics. And it is, it is as, as basic as real estate 101. Because if it's not, not a good property, if it's not a good project, you're not going to make money on it. If you don't make money on it, you're not gonna see any benefit from the Opportunity Zone.
Jack Heald:24:24So, what is it that you are best at?
Phil Jelsma:24:30You know, I think what I'm best at, and I think in some respects that's more of a reflection of, you know, having a practice tax law for 32 years. Um, what I think I'm best at is trying to assemble a complicated puzzle, uh, or development, um, and understand kind of how the various pieces either interact or interplay or don't interact. We've got to another real estate lawyer here that I work with a lot, Dennis Ship. And it was really fabulous at this really taking kind of a complicated set of problems and being able to assemble it so that you have a workable project. And I think that's, um, uh, to me that's, that's something that I enjoy. But I just think the reality is, um, you can't, uh, you know, that's literally the school of hard knocks. Those are the, those are the things that, that you have to learn by experience, by trying and failing and trying again and failing again.
Phil Jelsma:25:41And then, you know, maybe getting lucky and seeing, okay, well that works now. What's the next problem? And seeing how we can make that work. So anyway, that you learn a lot from going through the cycle and going through the bad times. And one you learn to appreciate the good times, but you also get to understand, you know, behind every silver lining is a dark cloud. And you also, you know, recognize that, you know, what goes up will go down and the market's kind of always on a roller coaster. And the fact that the roller coaster's going up or staying level doesn't mean it can't go down again.
Jack Heald:26:20Well, let's ask the opposite question. We would talked about what you're best at, what drives you crazy?
Phil Jelsma:26:29Sometimes what drives me crazy or drives me most crazy is where there is a common sense approach or a common sense answer. And someone says, well, we can't do that. Um, we do that because of this rule. We can't do this, that because of this regulation. You know, if, if someone's willing to step in and make the investment and take the risk, um, why are you opposing it? But, but you'll see, you'll see a lot of that go on. Um, and it's, you, you know, whether it's a form of nimbyism or it's just, you know, uh, you know, opposing change, well, you know, it's a, it's a broken down building. Yeah. But it's a historic broken down building while it's a broken down building is really what it is. That, that to me in some respects, that's the real, that's where I get, I get frustrated. Um,
Jack Heald:27:31Yea, so if you were a betting man. What part of the Opportunity Zone program do you think is most likely to be changed and I'm thinking particularly after we get past the end of 2020 where the tax benefits of 15% step up in basis at this point, anyway is going to go away?
Phil Jelsma:27:51That's a great question. I think it's going to be, it's going to be interesting. You heard in the first set of a commentary on the regulations that people said, well, wait a minute. You know, this kind of, there's a kind of a fundamental on the design that I have to pay the tax, uh, for the asset I sold in 2026, but I can't sell the Opportunity Zone own property for 10 years. So if I did it in 18, 2028 at the beginning, at the earliest, um, if I'm investing in 19, 2029 at the earliest, you know, that differential which causes, you know, a liquidity issue for both the investor and sometimes for the funds with the funds want to address it. You know, I think that, um, in some respects I think that a kind of a design flaw in my mind that I think ultimately there's going to be some pressure, um, to find a way to move the tax liability on the property I sold to when I'm selling the property in the Opportunity Zone. I think in some respects that's the, that's the piece that at, if there's going to be a change, I think there's going to be kind of a call for, well, you know, let me defer my tax, but let me, let me pay it when I saw my property in the Opportunity Zone.
Jack Heald:29:23Yeah, that makes a lot of sense. Well Phil it has been a really good conversation. I appreciate it. Is there anything else? Something else?
:29:32No, I mean I, no, no, no. I really enjoyed it. Yes, great, great questions. And um, I'd love to it again. You know, like I said, this is a, this is an area, I mean in an hour and an hour, you literally scratch, scratch the surface.
Jack Heald:29:51Our listeners get ahold of you. What's the best way to get ahold of you?
Phil Jelsma:29:55Well, it's really just my email address, which is firstname.lastname@example.org. So Charlie, Gordon, Sam, then the number three.com. Um, that's the best way to said to get ahold of me. I, I will try to, uh, I can't make any complete promises, but I always try to respond to all the emails by the end of the day. So I'm always happy I, and like I said, you know, new problems or are fun problems. I'm the same old thing is, is, you know, sometimes repetitive, but it's always, it's kind of always nice to hear from the audience, you know, what, what are they worried about? What are their concerns?
Jack Heald:30:41I do want our listeners to know that this information is also going to be available on the website so you can just click on it. You don't have to write it all down right now. We'll Phil, I have certainly enjoyed hearing from somebody who knows the ins and outs of the program the way that you do. I am Jack Heald. for the Opportunity Zone podcast. Thanks to Phil Jelsma for being here with us this week. We will talk to you next time.
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