Can Opportunity Funds Invest in Companies?

Posted Sep 24, 2021


The Opportunity Zone program was created by the passage of the Tax Cuts and Jobs Act in 2017 as part of the Investment in Opportunity section of the legislation.  The action intended to encourage investment in economically challenged areas throughout the United States and its territories by designating specific places as Qualified Opportunity Zones. The investments would be spurred by deferral and potential reduction of capital gains for investors who directed their resources to projects in the targeted areas.

The specific zones were nominated by state governments and approved by the IRS and Treasury, and over 8,700 are currently approved. Any corporation or partnership can create an investment in an authorized opportunity zone by filing IRS Form 8996 and adhering to the strict rules outlined for the conduct of the investment. Many of the investments are in QOZBs (Qualified Opportunity Zone Businesses).

What Are The Applicable Rules For Investments?

First, the QOF must invest at least 90% of its assets in a designated Opportunity Zone, and at least 50% of the business's gross income must be earned from activity within the zone. The QOF can meet the 50% test in one of the following ways:

  1.     50% of the service hours are within the zone
  2.     50% of compensation is paid to staff working inside the zone
  3.     50% of property and business functions are inside the zone

Remember that QOZ businesses should not be involved in operations that fall in the category of "sin business," such as liquor stores, massage parlors, gambling operations, or even less apparent vices like golf courses or country clubs.

Substantial Improvement is also Required

One essential requirement for a QOF to meet is that after acquiring an asset within a QOZ, the fund must substantially improve it within 30 months. The IRS has defined the term “substantial improvement” as a doubling of the adjusted basis. This metric is straightforward when the project is property but nuanced when the investment is in a business. Yet, the QOZ must meet the standard to satisfy the requirements, or the fund investments might be determined ineligible.

What's at Stake For The Investor?

Investors can benefit from the potential opportunity to defer and reduce capital gains taxes by investing the gains into a QOZ. Holding the investment longer increases the deferral and may increase the possible decrease in tax by increasing the basis on which they must pay the tax. To benefit from deferral and potential reductions, the investor must direct the gain into a qualifying investment during the 180-day holding period following the asset's sale. The deferral can last until the investor sells or otherwise disposes of the QOF investment or until December 31, 2026. The opportunities for reduction are as follows:

  •       A five-year investment can yield an increase in your basis of 10% of the deferred gain.
  •       A seven-year investment can increase the basis by an additional 5% of the deferred gain.
  •       A ten-year investment will increase the basis by the 15% indicated above and eliminate any tax due on the QOZ gains.

Taxpayers should keep in mind that QOZ investments are considered risky.


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. An unfavorable tax ruling may cancel deferral of capital gains and result in immediate tax liabilities.

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