Congress created the Qualified Opportunity Zone (QOZ) program when it passed the 2017 Tax Cuts and Jobs Act (TCJA). The TCJA had several miscellaneous provisions, but the primary focus of Subchapter Z was the creation of the QOZ program. This new investment opportunity offers investors tax advantages for investing capital gains into economically challenged areas.
There are over 8700 designated QOZ census tracts. They were selected based on economic conditions and recommendations from each state or territory. The program offers tax benefits to encourage investment in these designated zones, but the investments must be channeled through QOZ Fund projects. In addition, those who invested capital gains early in the program benefitted from a step-up in basis, which effectively reduced the capital gain if they held the investment for five or seven years. However, the time for investing with eligibility for those reductions has expired.
Still, any gains invested into a QOZ Fund project maintain a deferral of the taxes until the end of 2026. In addition, if the investor keeps the funds in the QOZ project for ten years, they won’t owe taxes on gains made within the QOZ Fund. As with the earlier provision, this outcome is achieved through a step-up in basis. It’s worth noting that investors will owe the deferred capital gains tax due on the previous investment in 2027, while their funds will remain committed to the project until at least 2029 if they want to obtain the maximum available benefit (elimination of tax on gains made in the fund).
Where does financing come in?
The QOZ funds are overall investment opportunities, not just vehicles for investing capital gains. In fact, some advisors remind potential participants that the tax benefit should be viewed as a bonus on an otherwise-attractive investment rather than as a reason to choose the project. In addition, because of the economic challenges that qualify the areas for inclusion and the program’s requirements, these projects may be riskier than some others.
Nonetheless, financing is essential for these projects and typically subject to similar terms as would be available for non-QOZ-related developments. Remember that any tax advantages apply only to capital gains invested in the QOZ Fund, not to other money or debt financing. Lenders will evaluate the project as they would any other, with no anticipated positive or negative impact on financing terms due to the QOZ eligibility.
According to American Banker, larger institutions like PNC have leaned into the investments. But, at the same time, smaller banks remain hesitant while hoping for a more significant opportunity to participate when they reach a comfort level with the QOZ deals and see some results.
Can I get a HUD Loan for a QOZ?
The US Department of Housing and Urban Development (HUD) offers multifamily loans for investment in QOZ fund projects. HUD loans may provide lower interest rates, longer terms, and higher leverage than alternate funding sources. QOZ fund managers or developers may also consider using the Low Income Housing Tax Credit program, also available through HUD.
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.
All investments have an inherent level of risk. The value of your investment will fluctuate with the value of the underlying investments. You could receive back less than you initially invested and there is no guarantee that you will receive any income.
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.
