Opportunity zones (OZs) have brought investors (who have been lucky enough to invest in them) generous tax benefits. A lot has been discussed about investing in qualified opportunity zone funds (QOZFs) and the tax benefits investors get from such investments.
But what about the other side of this transaction — the OZ businesses that investments go into? After all, nothing happens if there is no business for the fund to invest in. Those businesses, called qualified opportunity zone businesses (QOZBs), must meet certain requirements to participate in the OZ program. We’ll shed light on what those qualifications are and the relation between QOZBs and QOZFs.
The Relation Between QOZFs and QOZBs
First some clarification between the terms QOZB and QOZBP (qualified opportunity zone businesses property). These are not interchangeable terms. A QOZBP is operated in a QOZ and must be used in a trade or business.
A QOZF can use a QOZBP within an OZ. To qualify for the OZ program, a QOZF doesn’t need to add a QOZB to a QOZBP. The QOZBP can be any business or trade.
With a little background on QOZBPs, the remainder of the article will focus on QOZBs.
A QOZB uses investment funds from a QOZF to purchase a QOZP. The business must be a qualified OZ business. This means it meets safe harbor parameters and is eligible for QOZFs to invest in it.
When a QOZF invests millions of dollars into a business, it purchases equity. This is similar to a VC (venture capital) investment model. QOZF investors may receive distributions (i.e., K-1 tax filings) during the holding period.
Money invested into a QOZF comes from investors putting capital gains into the fund for tax deferral reasons. After being in the fund for ten years, investors get a full step up in basis on the exit of the investment.
After the ten years, the QOZB can structure an equity buyback from the fund to buy back its equity (from 10 years ago). If agreements were set in place at the initial investment, the business could buy back the equity at a discount to the current market value.
Opportunity Zone Business Requirements
A QOZB must be an operating business within a QOZ and meet safe harbor parameters to be eligible for QOZF investments.
The following safe harbors determine eligibility:
- At least 50% of gross income from business activities within a Qualified Opportunity Zone.
- Nonqualified financial property must attribute to less than 5% of the average aggregate unadjusted bases of its property.
- QOZ business property must be at least 70% of owned or leased property.
QOZBs also can’t be sin businesses such as dealings in alcohol, tobacco, gambling, and weapons manufacturers.
Becoming eligible as a QOZB isn’t a one-time thing. It is a process. The business must meet the initial parameters and work toward the others over time, such as the gross income restriction.
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.