Can You Invest in an Opportunity Zone Without Capital Gains?

Posted Nov 20, 2022

can substantial improvement in an opportunity zone be personal property?-1333388026Qualified Opportunity Zone (QOZ) investments are complex, and investors considering participation should carefully investigate their options. The intention of the program, which originated with the Tax Cuts and Jobs Act of 2017, is to increase investment in lower-income areas by encouraging reinvestment of capital gains into federally designated Qualified Opportunity Zones.

The question “Can you invest in an opportunity zone without capital gains?" can be interpreted in two ways. First, can you invest funds other than those derived from capital gains into an opportunity zone investment? Second, can you avoid capital gains taxes on earnings from opportunity zone investments? Let's take a look at both.

Can you invest funds other than capital gains into a QOZ?

The QOZ program's foundation is to incentivize investors to direct their capital gains from other sources into long-term reinvestments in areas the federal government designates as in need due to economic distress. The program requires that gains be rolled over into qualified investments within 180 days of the sale that generated the profit.

Investors can mingle ordinary income with capital gains, but only the funds from selling a capital asset will receive the tax advantages established by the program.

Can you reduce or eliminate the gains from the investment?

The incentive for participating was originally twofold, but part of the program is no longer available for new investment due to expiration dates. First, investing capital gains into a QOZ within 180 days of the asset sale allows an investor to defer recognizing the gain until December 31, 2026. After that, the applicable taxes will be payable in 2027. Second, investors who acted early to reinvest their profits could also obtain a reduction in capital gains taxes through a step-up in basis by leaving the funds invested for 5, 7, or 10 years. However, since the program expires at the end of 2026, those step-up benefits are no longer available.

Those provisions refer to the original gain realized from an asset's sale and reinvested into a QOZ opportunity. If the investor moves the funds out of the QOZ before December 31, 2026, the gains will need to be recognized.

Gains earned within the QOZ can be exempt from capital gains taxes.

If an investor holds the investment in a QOZ for at least ten years, the gains earned within the QOZ investment will be exempt from tax due to an increase in the basis to the market value at the time of disposition.

Ten years is long-term, so QOZ investments are considered illiquid and risky. Investors should seek guidance before investing. Projects must meet the original use or substantial improvement standards to remain eligible. The sponsor is responsible for ensuring that the projects funded meet the program requirements. Investors may have to recognize the gains from the initial investments when the deferral expires in 2026 before the disposition of the QOZ fund can take place.

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. 

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. 

Download The Guide To Opportunity Zones

Download The Guidebook to QOZ's
Download eBook

 


Download The Guidebook to QOZ's

Download The Guide To Opportunity Zones

Learn More About Qualified Opportunity Zones Investments.

By providing your email and phone number, you are opting to receive communications from Realized. If you receive a text message and choose to stop receiving further messages, reply STOP to immediately unsubscribe. Msg & Data rates may apply. To manage receiving emails from Realized visit the Manage Preferences link in any email received.