What Is The Opportunity Zone 10-year Rule?

Posted Dec 3, 2022

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Since its introduction five years ago, the Qualified Opportunity Zone program has been described as an economic revitalization program, as well as one offering potential tax-deferral investment opportunities. But from an investment standpoint, some might question whether it’s worthwhile investing in a program that has an end date of Dec. 31, 2026.  

While some of the tax deferral “goodies” have already expired, the Opportunity Zone 10-year rule can still offer a tax-advantaged strategy for patient investors interested in social improvement. 

A Brief Background 

The Opportunity Zone program was introduced under the Tax Cuts and Jobs Act of 2017. The idea behind the program is to encourage accredited investors with capital gains from the sale of assets to invest that profit into Qualified Opportunity Funds (QOFs). Those QOFs, in turn, are investing these monies into federally designated Qualified Opportunity Zones (QOZs), thus spurring economic revitalization. Investors, in turn, have been rewarded with tax-deferral incentives, assuming they followed the precise investment deadlines required by the IRS and U.S. Treasury Department.  

But some of those incentives expired. At this time, the contribution deadlines for step-up in basis provisions are behind us. But this doesn’t mean it’s too late to reap some benefits from a QOF investment. 

A Decade-Long Hold 

The Opportunity Zone program takes the long view. In other words, it’s a long-term strategy to help spur investment in businesses and properties situated within the QOZs. This is where the Opportunity Zone 10-Year Rule comes into play. 

First of all, there’s no tax on any appreciation generated by a QOF investment. Furthermore, according to the IRS, investors holding their QOF investments for 10 years or longer could permanently exclude capital gains that result from the sale or exchange of that investment. This means any gain attributable to depreciation recapture or ordinary income assets might go away—as long as the investor holds that asset for 10 years or longer. 

But some confusion about the program is that QOZ designations will go away at the end of 2026. This means that investors must recognize their initially deferred gain at this time. But it doesn’t mean that investors have to sell their interest in QOFs at that time. The program’s tax benefits remain available until the end of 2047. Additionally, June 28, 2037 represents the earliest date during which the last QOZ investments can be sold to qualify for that 10-year gain exclusion. This gives investors up to 2027 to divert capital gains into QOFs. 

The Need for Patient Capital 

The focal point of the QOZ program is that it’s not a quick turnaround, short-term-hold investment. The program instead takes a longer view, encouraging investors to keep their funds in QOFs for years. This strategy requires patience and might not be for all investors. As such, before investing in QOFs, it’s essential to work with tax advisors that are familiar with the program. 

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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