Opportunity Knocks for Taxable Investors

Last year’s Tax Cuts and Jobs Act created the Qualified Opportunity Zone (QOZ) program, designed to encourage investments in low-income census tracts or census tracts contiguous with low-income census tracts. This blog post provides a high-level overview of the program, including its scope and potential tax benefits.

(Estimated reading time: 2 min 31 sec)

There are more than 8,500 opportunity zones nationwide, as certified by the Treasury Department, located in a mix of urban, suburban, and rural geographies. Investments in opportunity zones must be made through a partnership or corporation, commonly known as a Qualified Opportunity Fund. The program also requires that sponsors of opportunity funds provide “substantial” investment into the qualified asset(s) within 30 months after purchase or startup (if investing in a new business within an opportunity zone) for a fund to qualify for tax benefits (i.e., no less than $1 of capital improvement for every $1 of purchase price).

The QOZ program generally offers three potential forms of tax relief to investors who may be looking to reap the gains from appreciated assets, either from an existing investment (e.g., publicly traded stock, business assets, personal assets, or any other property qualifying for capital gains tax treatment) or opportunity zone investment.

Existing Investment

  1. Capital Gains Deferral: Realized capital gains that are reinvested in an opportunity fund within 180 days can be deferred from taxable income until the earlier of Dec. 31, 2026, or the date the opportunity fund is disposed of.
  2. Step-up in Cost Basis: An investor can exclude up to 10% of the original realized gain if the opportunity fund is held for five years and up to 15% of the original gain if the opportunity fund is held for seven years (i.e., only 85% of the original gain will be included in taxable income if the opportunity fund is held for seven years).

 Opportunity Zone Investment

  1. Forgiveness on Capital Appreciation: If an opportunity fund is held for 10 years or more, the investor may elect to treat the cost basis as equal to the fair market value. The election permits an investor to exclude any gain on the sale of the opportunity fund from taxes.

As a reminder, these tax benefits are limited to those investors who reinvest capital gains into an opportunity fund, while other sources of funding are not eligible for these tax benefits.

Needless to say, the program is not without significant detail, nuance, and minutia, so investors and their advisers must pay careful attention to the specifics surrounding the eligibility of existing (to-be-disposed) assets, individual tax circumstances and liquidity needs, and ultimately the investment opportunities themselves.

Further, the process through which the details and rules for this program have come to light has been somewhat slow and challenging to both sponsors and prospective investors. Thus, while the real estate community has expressed great interest in creating funds, product launches have been tepid to date as sponsors await additional guidance from the IRS on a number of technical issues.

IRS Opportunity Zone FAQ Link: