Mentioning the term “Opportunity Zone Program” could bring up thoughts about ground-up real estate construction or building renovations in or near lower-income areas. If you’re interested in investing in one of those properties or projects, you need to put your capital gains into a Qualified Opportunity Fund (QOF). That fund collects capital gains from multiple investors, and then puts money into specific Qualified Opportunity Zone (QOZ) projects.
But what if the project in question has nothing to do with construction or renovation? What if a potential investment might be in a business located in an opportunity zone? Is it possible to directly invest in that Qualified Opportunity Zone Business – or QOZB – rather than investing in a QOF?
Technically, yes. You could certainly invest directly into a qualified opportunity zone business. But doing so means you automatically forfeit all the tax deferral advantages that come with the opportunity zones program. To ensure potential capital gains tax deferral, you need to invest in that business through an appropriate QOF.
Defining the Opportunity Zone Business
But before investing your capital gains into a QOF, you better make sure that the fund will be investing in an actual opportunity zone business. Basically, there is more to a QOZB than simply being in a QOZ.
The IRS has stringent rules when it comes to defining QOZBs. For one thing, that business must earn at least 50% of its gross income from business activities conducted within opportunity zones. To ensure this rule is followed, the IRS offers three safe harbors that QOZBs use to meet the test, with the businesses required to meet at least one of them:
- At least half of the aggregate hours of services received by the business are performed in a QOZ
- At least half of the aggregate amount that the business pays for services are for services performed in a QOZ
- If tangible property and business functions that earn income are in a QOZ
Be sure that the QOF you’re considering is investing in businesses that fulfill one of the above requirements and generates at least half of its income from QOZ activities.
Two Types of QOZB Investments
Moving on, when it comes to opportunity zones businesses, there are actually two types you can consider for investments. These are the Qualified Opportunity Zone Business Property and Qualified Opportunity Zone Stock.
Qualified Opportunity Zone Business Property
If you’ve been paying attention to our many blogs on this topic, you’re already familiar with some QOZBP investments. Specifically, real estate used by a business in a QOZ is considered a Qualified Opportunity Zone Business Property.
That renovated apartment complex or restaurant, or a to-be-developed store or warehouse in a QOZ can be considered opportunity zone business property if:
- The property’s original use began with either the QOF or QOZB launch or the property was substantially improved by either one, and
- During 90% of the time the QOF or QOZB had the property, at least 70% of its use took place in a QOZ.
Leased property also qualifies as QOZB property, if it is a market-rate lease entered into after Dec. 31, 2017.
But QOZP isn’t just real estate. Equipment and tools can be considered opportunity zone business property, as long as these are used to run the business. Forklifts bought for that warehouse, or a network system acquired for that apartment complex could also be considered QOZB property.
Qualified Opportunity Zone Stock
Most investors are familiar with the idea behind corporate stock. They buy “pieces” of a particular company and become part owners. Their reward can range from stock dividends (based on profits) to a profit upon sale, depending on the market value of a company.
Qualified Opportunity Zone Stock (QOZS) isn’t too different. In this case, the QOF buys “pieces” of a Qualified Opportunity Zone Business. In this case, the QOF operates as a kind of mutual fund which, in turn, has ownership in the business. Instead of investing in business property, the fund is putting direct equity into the business.
The main difference between QOZ business property and QOZ stock is tangibility. Specifically, business property is something that is used in a trade or business and can consist of “personal” property (things that can be moved, such as equipment or vehicles) or “real” property (buildings or land, which can’t be moved). Buying stock is more focused on providing funds to help business operations.
Invest in the Fund
Your investments in opportunity zones business property, stock or even partnership interests boil down to one thing: You must invest in a Qualified Opportunity Fund to take advantage of tax deferral strategies.
Furthermore, before considering any kind of QOF for investment, be sure it’s right for your strategy and portfolio. Talk with a tax advisor or financial expert for additional clarification.
There are material risks associated with investing in QOZ properties and real estate securities including liquidity, tenant vacancies, general market conditions and competition, lack of operating history, interest rate risks, the risk of new supply coming to market and softening rental rates, general risks of owning/operating commercial and multifamily properties, short term leases associated with multi-family properties, financing risks, potential adverse tax consequences, general economic risks, development risks, long hold periods, and potential loss of the entire investment principal. Costs associated with the transaction may impact investors’ returns, and may outweigh the tax benefits. Realized does not provide tax or legal advice. This material is not a substitute for seeking the advice of a qualified professional for your individual situation. 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. It should also not be construed as advice, meeting the particular investment needs of any investor.