Qualified Opportunity Zones were created as part of the Tax Cuts and Jobs Act (TCJA) in 2017. The zones are designated census tracts that are identified as low-income and in need of greater economic investments. The Treasury Department has recognized over 9,000 after being nominated by each state and most U.S. territories.
Qualified Opportunity Zones (QOZs) offer several tax advantages for investors. Investments in opportunity zones offer a permanent capital gains tax exclusion for those willing to hold the investment long enough. Here are the three primary opportunity zone tax benefits provided:
Tax Deferral Through 2026: Investors can use their existing funds with accumulated gains to invest in a Qualified Opportunity Zone Fund (QOZF or QOF) and receive a tax deferral on those gains until December 31, 2026. Investors will be taxed on those deferred gains at the earlier of the disposition of the QOZF or December 31, 2026.
No Tax on up to 15% on Deferred Gains: This is also known as a step-up in basis, and the benefit you will receive will depend on how long your investment in an opportunity fund is held. Investments held for at least five years receive a 10% increase in basis, and those held for at least seven years receive an additional 5% increase in basis, for a total of 15%. These step-ups represent a reduction in your tax liability on the deferred capital gains due on December 31, 2026. In other words, if you hold your investment in a QOZF for at least five years, your tax bill on those deferred capital gains will be 10% less.
- To qualify for that additional 5% step-up in basis, the investment in a QOZF must have been made by the end of 2019. Otherwise, it won't be able to reach the seven-year requirement by December 31, 2026.
No Tax on Appreciation within the QOZ Fund: For those willing to hold their QOZF investment for at least ten years have the potential also to receive an exclusion for gains on the investment within the QOZF.
- Because investors will have already paid the capital gains tax in 2026 on the deferred gains initially invested into the QOZF, when their investment in the QOZF ends, they would not owe any capital gains tax on the QOZF investment funds.
How Are Opportunity Zone Funds (QOFs) Created?
Investments in QOZs must be channeled through Qualified Opportunity Funds (QOFs). These funds can be single- or multi-investor funds. Taxpayers who want to invest in a Qualified Opportunity Fund must be careful to choose a fund that meets the IRS requirements and invest within the 180 days allowed after the triggering event. A QOF must invest at least 90% of its funds in Qualified Opportunity Zone Property, which must meet the following requirements:
- Must be acquired (or have been acquired) by purchase from an unrelated party after December 31, 2017.
- “Substantially all” (defined as at least 70%) of the use of the property must be within a QOZ during “substantially all” (defined as 90%) of the holding period.
- Either the original use of the property must begin in the QOZ by the QOF, or the QOF must substantially improve the property.
QOFs can be organized as corporations or partnerships and do not require pre-approval by the IRS. However, the QOF sponsors must complete IRS Form 8996 annually to maintain eligibility. The fund sponsor is allowed to acquire QOZ properties using cash or by arranging financing (but lenders are not eligible for the tax benefits that investors have access to).
When the taxpayer enters the QOF to defer the eligible gain from a property sale or other qualifying event, they report the deferral using IRS Form 8949. The same form is used when the taxpayer disposes of a QOF investment and realizes the gain for tax purposes. QOF transactions are complicated, and you should consult your tax advisor.
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. There is no guarantee that the investment objectives of any particular program will be achieved. The income stream and depreciation schedule for any investment property may affect the property owner’s income bracket and/or tax status. An unfavorable tax ruling may cancel deferral of capital gains and result in immediate tax liabilities.