Thanks to the Tax Cuts and Jobs Act, real estate investors who have capital gains income can benefit from tax incentives offered through the Qualified Opportunity Zone (QOZ) program. Investors can defer or even possibly eliminate a portion of their capital gains tax liability.
The QOZ program was created to spur economic development and job growth in low-income communities by encouraging investors to reinvest capital gains into Qualified Opportunity Funds (QOFs) that make investments into business or investment properties in these zones.
However, reinvestment of capital gains earned before January 1, 2027, is required within a 180-day window. Here’s what real estate investors should know about Qualified Opportunity Zones and the 180-day reinvestment period.
The 180-Day Reinvestment Period
Capital gains that are eligible to be reinvested in a QOF must be made within 180 days of realizing those gains, which begins on the first day those capital gains were recognized for federal tax purposes. Depending on the source of the gains, recognition is defined by two types:
- Partnership gains: Recognized at the time of the gain or at the end of the partnership tax year (December 31). If the sale is earlier in the year, the 180-day window begins when the gain is recognized at the end of the year.
- Stock of business: 180 days from the date of sale.
For taxpayers who recognize capital gains through a Schedule K-1, there’s the option to start the 180-day investment period on the following dates:
- The last day of the partnership taxable year
- The same date that the partnership’s 180-day period begins
- The due date for the partnership’s tax return (without extensions) for the taxable year in which the partnership realized the gain
Once these gains are reinvested in a QOF, the Fund must invest 90% of its assets into the QOZ property. Failure to meet the requirements will result in tax penalties for the QOF.
Which Gains Are Eligible?
There are two types of capital gains — short-term and long-term capital gains and both qualify for reinvestment in a QOF. Investors can defer gains on the sale of stocks, bonds, business sales, real estate, and other assets.
Keep in mind that capital gains recognized on the sale or exchange of property only qualify if the transaction is with an unrelated party. If the QOZ entities are partnerships for tax purposes, the parties will be considered related if they directly or indirectly own more than 20% of the capital interests or profit interests.
Time Your Investments
Investors can take advantage of one or more of the three following tax benefits by following QOZ investment guidelines:
- Deferral: By placing existing assets with capital gains income into Opportunity Funds, these capital gains aren’t taxed until December 31, 2026, or upon the sale of the asset.
- Step-up in basis: Capital gains placed in a QOF for at least 5 years receive a step-up in basis on the original investment by 10%. If placed in a QOF for more than 7 years, the step-up in basis increases by 15% on the original investment.
- Exclusion: For investments held for at least 10 years, investors pay no taxes on accumulated capital gains through their investment in the QOF.
If you’re thinking of reinvesting your realized gains into a QOZ, make sure you time it accordingly and follow the 180-day rule. By following the requirements, you can potentially defer, reduce, or be permanently excluded from capital gains tax liability.