There are more than 8,760 Opportunity Zones located in all 50 States, the District of Columbia, and five United States territories, many of which have experienced a lack of investment for decades. Qualified Opportunity Zones (QOZ) can provide investors with attractive tax advantages and there’s an ability for OZs to offer annual returns; however, there is no assurance of investment returns, profits, or property appreciation in an Opportunity Zone investment.
Qualified Opportunity Zone Investment Structure
Qualified Opportunity Zone investments require a specific structure to qualify for tax incentives. Investors are required to set up an investment vehicle known as a Qualified Opportunity Fund (QOF). A QOF is created by a corporation or a partnership and by filling out IRS Form 8996. The fund must invest at least 90% of its assets in designated opportunity zones to receive preferential tax treatment.
Investors must also make contributions (cash or other property) to the QOF in exchange for equity interest. Investors can contribute as much as they want, but only the portion equaling their capital gains will qualify for tax-free growth, known as qualifying interest.
Taxpayers can also defer taxes on previous investment gains if those gains are invested in a QOF within 180 days of the sale. Taxes are then deferred to either the day when the Opportunity Fund investment is sold, exchanged, or by December 31, 2026 — whichever comes first.
Opportunity Zone Return Potential
Potential returns are not guaranteed. In fact, investors can expect to pay fees associated with the OZF. Fees are generally paid to QOF managers, including product distribution fees, management fees, and development fees. Fee structures can mimic those of hedge funds and private-equity investments — investors pay an annual fee (1.5% to 2.0%) in expenses and when they sell, they may have to hand over another 20% of any excess return a fund earns above an amount promised to the investor, known as a preferred return.
The preferred return is a profit distribution structure that tells you how much priority return you are projected to receive, ahead of the QOF owner or manager. When this is met, fund managers may participate in the profits. A typical projected annualized rate of return is between 6% and 10% for funds with diversified portfolios; however, it may be more for funds that invest in a single project.
Location Can Impact Potential Returns
Just like with real estate, your potential return on your QOZ investment is all about location. Not every QOZ investment will be a great investment with the potential for returns. This is why your QOF and the fund manager must have experience in the locations in which it plans to operate.
Your targeted QOF should understand that local market’s population, economic, and demographic trends. Additionally, your targeted QOF should understand the characteristics of each QOZ. For instance, the requirements for a successful investment in rural Pennsylvania will be vastly different than the requirements for a successful investment in Los Angeles.
Whether you would benefit from investing in a QOZ depends on a variety of factors and expected returns are never guaranteed.
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. The actual amount and timing of distributions paid by programs is not guaranteed and may vary. There is no guarantee that investors will receive distributions or a return of their capital. There is no guarantee that the investment objectives of any particular program will be achieved. An unfavorable tax ruling may cancel deferral of capital gains and result in immediate tax liabilities.
