Qualified Opportunity Funds (QOFs) are the vehicles that investors can use to participate in the Opportunity Zone program, which was created by the 2017 Tax Cuts and Jobs Act (TCJA). Opportunity Zones are federally designated areas in need of economic growth and investment. In exchange for directing investments in the targeted regions, taxpayers can defer and reduce their taxes on invested funds under certain circumstances. Here is how the program works:
- Investors who have capital gains from sources such as the sale of stock, real property, or other assets that they obtain before January 1, 2027, can direct those gains into a qualified opportunity fund (within 180 days of realizing the increase).
- By doing so, the investor can defer the payment of taxes due on the gain until the investment is sold (or otherwise experiences an inclusive event) or until December 31, 2026 (whichever is first).
- If the investor keeps the funds in the QOF for five years or more, the basis will be increased by 10% of the deferred gain. If the investor holds the QOF investment for seven years, the increase in the basis will be 15%. Maintaining the QOF investment for ten or more years will provide the taxpayer with the benefit of both the 15% increase in basis on the gain and will relieve the taxpayer of capital gains due on appreciation (if any) on the QOF investment. To be eligible for deferral, taxpayers must file Forms 8949 and 8997.
What Is a QOF?
The TCJA established rules governing Qualified Opportunity Funds as well. It must be set up as a corporation (LLC or C corporation is acceptable) or partnership to invest in QOZs. The QOF must file a Form 8996 annually and invest more than 90% of its assets in a designated opportunity zone.
Those investments can include property, equipment, and businesses, and at least 50% of the gross income must result from activities within the opportunity zone. In addition, from a practical standpoint, a QOF must satisfy the "original use" or "substantial improvement" test that is part of the opportunity zone requirements. The requirements include:
- The QOF must have acquired the property within the QOZ from an unrelated party after December 31, 2017.
- Either the original use of the property starts in the QOZ by the QOF, or the QOF must substantially improve the property.
- At least 70% of the use of the property by the QOF must be in the QOZ during the holding period.
What Kinds of Investments Are Typical?
Development of residential and commercial properties are common activities in QOZs, including rehabilitation of damaged homes for rental use and improvement of office and retail properties. Environmental and energy projects are also frequent, including clean energy and alternative farming enterprises.
While a REIT (Real Estate Investment Trust) can invest in a Qualified Opportunity Fund, just as other corporations and individuals can, the obverse is not available in that a REIT is not an eligible destination for the targeted investment of a QOF.
This material is for general information and educational purposes only. Information is based on data gathered from what we believe are reliable sources. It is not guaranteed as to accuracy, does not purport to be complete and is not intended to be used as a primary basis for investment decisions.
