The Qualified Opportunity Zone Program (QOZ) allows investors to “do good” by putting their capital gains into economically challenged areas. The program, introduced in 2017, also offers various tax benefits to QOZ investors. One of these is the step-up in basis, which ended in late 2021.
Another potential goodie is tax deferral. The tax deferral benefit allows investors to put their capital gains into a Qualified Opportunity Fund (QOF). This move, in turn, will enable investors to potentially defer the generated taxes on those gains.
But the Opportunity Zone program will eventually come to an end. This will also mean the end of the investment deferral period. Investors should be prepared for this deadline because it could mean an increase in the tax bill.
The Deferral Period
According to rules issued by the IRS, investors can defer taxes on eligible gains until the earlier of these two:
- An inclusion event takes place; this reduces or ends a qualifying investment in a QOF
- The current “conclusion” of the QOZ program, on Dec. 31, 2026.
If someone wants to invest their qualified gains into a QOF, they could defer taxes on those gains for up to another three years as long as the QOF remains active. But, once the deadlines mentioned above occur, the investor must pay taxes on the deferred gains.
The IRS defines QOZ “eligible gains” as capital gains and qualified 1231 gains that are recognized for income tax purposes before Jan. 1, 2027.
Extension Potential?
There’s been frequent talk about extending the program from its current end date. To that end, various members of Congress continue to introduce Opportunity Zone legislation to extend the program and encourage more investments into areas that would benefit from economic growth.
One of these is the Opportunity Zones Transparency, Extension and Improvement Act, which would extend the incentive by two years. This would mark the program’s end date as Dec. 31, 2028.
But to date, none of the legislation has passed. Because of this, it’s safe to assume that the deferral period will conclude at the end of 2026. But QOF investors should keep an eye on the calendar and news coming from Washington, DC, to ensure they’re prepared for an extension or the QOZ program’s conclusion.
It’s also good for QOF investors to work with experienced tax advisors. This helps ensure that a QOZ strategy makes sense from an investment and tax viewpoint.
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.
