Qualified Opportunity Zones (QOZs) were created as part of the Tax Cuts and Jobs Act (TCJA) in 2017. This legislation aimed to increase investment in economically disadvantaged areas of the country by encouraging investors to reinvest their capital gains from other successful ventures.
When an investor sells a property, for example, if the sales price is higher than the price the individual paid for it, the investor will realize a capital gain and must pay a tax on that amount. However, the investor can defer the recognition of that gain by reinvesting the proceeds into a Qualified Opportunity Zone. The reinvestment must be made within 180 days of the event that triggered the gain that the investor wants to defer. This opportunity is not limited to real estate profits but also applies to the sale of stock shares, partnership interests, and other activities.
How Do the Tax Benefits Work?
The zones are designated census tracts identified as low-income and in need of more significant economic investments. The Treasury Department has named 9,000 zones that were nominated by each state or territory.
Qualified Opportunity Zones (QOZs) offer tax advantages for investors. The three notable tax benefits are:
Tax Deferral Through 2026: Investors who reinvest capital gains to a Qualified Opportunity Zone Fund (QOZF or QOF) will receive a tax deferral on those gains until December 31, 2026, or when they dispose of the QOZ investment, whichever is first.
No Tax on up to 15% on Deferred Gains: If the investor holds the QOZ investment for five years, they can receive a 10% step-up in basis (which equates to a ten percent reduction in the taxable amount. Holding for seven years will reap a fifteen percent step-up in basis. (Note that due to the timelines, the investment would have had to be made by the end of 2019 to achieve the full fifteen percent step-up since the deferral period ends on December 31, 2026).
No Tax on Investment within the QOZ: If the investor holds the investment in the QOZ for a minimum of ten years, the gains made (if any) will be exempt from capital gains tax. Note that they will have paid the taxes on the original amount in 2026 when the deferment period ends, so this exemption applies to gains, not the initial investment.
What Is the Effect of Pulling Equity from a QOZ Investment?
Disposing of the investment to access equity would end the deferral period for the capital gains directed into the QOZ fund. This approach would probably be considered only in emergency circumstances (if the taxpayer had an urgent need for the funds, for example). If an investor is dissatisfied with a fund's management, they could liquidate and shift the capital to a different qualified fund without disqualifying the eligibility. However, this action would reset the clock on the cost basis, which would reduce the potential benefit for the taxpayer. The investor would forfeit the maximum deferral opportunity and should consult a qualified advisor before pursuing this strategy.
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. 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. All real estate investments have the potential to lose value during the life of the investment. An unfavorable tax ruling may cancel deferral of capital gains and result in immediate tax liabilities. No public market currently exists and one may never exist. These programs are speculative and suitable only for Accredited Investors who do not anticipate a need for liquidity or can afford to lose their entire investment.
