Can Individuals Invest in Opportunity Zones?

Posted May 10, 2023

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The passage of the Tax Cuts and Jobs Act in 2017 created the Qualified Opportunity Zone program. The program was designed to encourage investment in economically disadvantaged communities. When the legislation passed, each state and territorial governor had the opportunity to nominate specific census tracts as QOZ-eligible. The Treasury Department completed the final evaluation and determination; currently, over 8700 areas are eligible. The selection process considered median income and the pervasiveness of poverty.

The means of encouraging investment in these designated areas is a deferral of capital gains taxes when the gain is reinvested in a QOZ Fund and the potential to exempt capital gains earned within a QOZ Fund from taxation if the rules are followed. However, before we look at each of these opportunities, it's essential to be clear that while individual taxpayers invest in these QOZ Funds, the Fund must be organized as a partnership or corporation. So, individuals do invest in Qualified Opportunity Zones, but they do so through a QOF.

A qualified opportunity fund (QOF) must hold at least 90 percent of its assets in a QOZ and earn at least 50 percent of its income from activities conducted within the QOZ. Any property acquired by the QOF must be sufficiently improved within 30 months to experience a doubling of basis in that time. A QOF must follow other regulations, one of which prohibits the funds from investing in “sin” businesses, such as bars, casinos, and racetracks.

Opportunity for deferral of capital gains tax.

Suppose a taxpayer sells an asset (property, stock, or business) and earns a profit, called a capital gain. Ordinarily, that taxpayer would owe capital gains taxes on the appreciation. However, if the taxpayer reinvests the gain amount into a QOF within 180 days of the triggering event, they can defer the payment of capital gains until the end of 2026 (payment in 2027). If the taxpayer terminates the investment sooner, the tax would be due at the time of sale.

Opportunity for exclusion from capital gains taxes.

If the taxpayer invests in a QOF and keeps the money invested for at least ten years, they will not owe capital gains taxes on any appreciation the investment enjoys. For example, suppose you sell an asset with a capital gain of $100,000. Then, within 180 days of the sale, you reinvest that $100,000 into a QOZ Fund project. As a result, you can defer the tax payment due on the sale until the end of 2026. Moreover, if the $100,000 investment earns another $50,000 in appreciation, that amount will not be subject to capital gains tax if you leave the money in place for at least ten years.

Keep in mind that while you can invest money that did not derive from a capital gain, that amount won’t enjoy the same exemption from capital gains while invested in the 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. It should also not be construed as advice meeting the particular investment needs of any investor.

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.

Hypothetical examples shown are for illustrative purposes only.

Investors in QOFs will need to hold their investments for certain time periods to receive the full QOZ Program tax benefits. A failure to do so may result in the potential tax benefits to the investor being reduced or eliminated.

If a fund fails to meet any of the qualification requirements to be considered a QOF, the anticipated QOZ Program tax benefits may be reduced or eliminated. Furthermore, a fund may fail to qualify as a QOF for non-tax reasons beyond its control, such as financing issues, zoning issues, disputes with co-investors, etc.

Distributions to investors in a QOF may result in a taxable gain to such investors.

The tax treatment of distributions to holders of interests in a QOF are uncertain, including whether distributions impact the aforementioned QOZ Program tax benefits.

A QOF must make investments in Qualified Opportunity Zones, which carries the inherent risk associated with investing in economically depressed areas.

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