How Does Opportunity Zone Financing Work?

Posted Apr 2, 2023


Since its introduction as part of the Tax Cuts and Jobs act of 2017, the Opportunity Zone Program has generated a great deal of press (some good, some bad). It’s also generated interest among investors, especially those interested in economic revitalization.

But Qualified Opportunity Zones (QOZs) represent a different kind of investment prospect than, say putting money into direct real estate or a Delaware Statutory Trust. Specifically, you don’t find a designated Opportunity Zone and finance it on your own.

There are two things required for the financing of, and investing in, a QOZ:

  • Capital gains
  • A qualified opportunity fund

What follows is a more specific explanation of each of these aspects.

Capital Gains: What to Invest

The Opportunity Zones concept was the brainchild of the Economic Innovation Group, among others. The theory was that private capital (in the form of capital gains from the sale of capital assets) could be used to help support economic revitalization in communities that were struggling financially.

As such, the rules are pretty specific. Namely that the only type of funds allowed for a Qualified Opportunity Zone are the gains realized from the sale of a capital asset. This program isn’t geared for extra money that’s lying around. It’s focused specifically on using capital gains as the investment. Additionally, you must invest those gains within 180 days of realizing them

In response, you, the investor, can benefit from some useful tax advantages.

Qualified Opportunity Funds: Where to Invest

The other aspect of QOZ financing is that you can’t go find a federally designated Opportunity Zone and directly hand over your money to a QOZ business or developer. Rather, you need to invest those capital gains into a Qualified Opportunity Fund (QOF). A QOF is defined as an entity (corporation or partnership) that has as its sole purpose investment in QOZs. As mentioned above, investing your capital gains into a QOF can provide some positive tax benefits. 

You could also form your own QOF. To do so, you would need to organize as a corporation, LLC, or partnership for the sole purpose of investing in a QOF. You would also need to hold 90% of the assets in a QOZ. The IRS has other filing and information requirements involved with setting up and maintaining your own QOF.

Should I Finance a QOZ?

Investing in a Qualified Opportunity Zone falls under the category of “doing well to do good.” Tax advantages can also make this type of investment appealing. But there are also many rules and regulations surrounding QOZ investments and financing. As such, you shouldn’t undertake such a move without advice from your tax professional. 

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.

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.

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.

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