What is IRC Section 1400Z-2 Gain?

Posted Jan 23, 2023


The Qualified Opportunity Zone Program was introduced under the Tax Cuts and Jobs Act of 2017. The focus is to funnel capital gains toward federally designated Qualified Opportunity Zones (QOZs) by way of Qualified Opportunity Funds (QOFs). Investors, in turn, benefit from tax incentives which encourage them to invest in QOFs.

These incentives and benefits are under the auspices of the IRS and the U.S. Treasury Department. This, in turn, led to its inclusion in the Internal Revenue Code.

Lodged under 26. U.S. Code Subchapter Z, § 1400Z-1 describes the definition of Qualified Opportunity Zones. Meanwhile, 26. U.S. Code §1400Z-2 delves deeper, focusing on the treatment of capital gains invested in QOFs.

Combining Qualified Opportunity Zone language and capital gain tax deferral instructions, §1400Z-2 specifies the following:

  • Taxpayers can defer the recognition of capital gains from the sale of assets, as long as gains are invested in a QOF within 180 days beginning on the date of the capital gain recognition. 
  • The capital gain is taxed on the date of the QOF sale or Dec. 31, 2026, whichever comes first.

Additionally, § 1400Z-2 notes that the gain included is defined as:

  • The lesser amount of the excluded gain or the fair market value of the investment either when sold or on Dec. 31, 2026
  • The taxpayer's basis in the investment

Furthermore, § 1400Z-2 outlined the determination of basis connected to investments held for five and seven years (which expired) and those held for at least 10 years. Specifically, Qualified Opportunity Zone Property held for at least 10 years is equal to the fair-market value of the investment on the date of sale or exchange. This means that any gain affiliated with the investment could be excluded from taxes.

The subsection also reiterates the definition of QOZP and reiterates that a QOF is responsible for maintaining its investment standards.

While § 1400Z-1 and § 1400Z-2 are straightforward in outlining and presenting Opportunity Zone definitions, requirements, and treatments, the Opportunity Zone program can be complex. As such, before directing capital gains toward a QOF, it's a good idea to work with a tax professional to obtain the maximum of such an investment.

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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