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).
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.
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.