Qualified Opportunity Zone Funds - Investments for Financial and Social Benefit

September 06, 2019

If you’re not in the commercial real estate business, you may not have heard of Qualified Opportunity Zones (or QOZs). Defined under the 2017 Tax Cuts and Jobs Act, according to the IRS, a QOZ is “an economically-distressed community where new investments, under certain conditions, may be eligible for preferential tax treatment. They are designed to spur on economic development and job creation in distressed communities”[i]

There are more than 8,700 QOZs that have been identified within the USA affecting 35 million Americans.[ii] This, along with the tax benefits of investing in these areas have attracted a lot of attention not only in the commercial real estate industry - but also amongst investment fund sponsors who want to attract individuals looking for a tax-advantaged, passive real estate investment to compliment or further diversify a traditional portfolio of stocks and bonds.

Qualified Opportunity Funds (QOF) must invest at least 90% of its assets into Qualified Opportunity Zones. Investors in a QOF are eligible for favorable tax treatment in the form of both tax-deferral and tax-forgiveness. Individuals who have realized capital gains from the sale of just about any type of property (stocks, mutual funds, bonds, real estate, a business, jewelry, art) may be able to defer all (or any portion) of the gains by reinvesting the amount of the gain they wish to defer into a QOF within 180 days of the sale. Furthermore, by meeting certain holding requirements, the investor may be able to significantly reduce their capital gains tax. Let’s use an example.

Sally, a business owner, sells her business for $3 million which generates a capital gain of $2 million. Within 180 days of the sale, she invests the $2 million gain into a Qualified Opportunity Fund, which results in deferring the taxes owed on the gains. (Her tax-basis in the QOF is considered to be zero at this point).

After 5 years (assuming her investment into the QOF was made before 12/31/2021) Sally receives a 10% tax basis step-up (or $200,000 in this case). Then, in Year 7 (assuming she invested into the QOF before 1/1/2020) Sally receives an additional 5% step-up in basis ($100,000 in this example). So, in our example, after 7 years she has totally eliminated $300,000 of capital gains from the initial sale of her business.

The tax deferral period (on her $2 million gain from the sale of her business) ends on 12/31/2026. So, she would owe the capital gains tax (reduced by any step-up in basis given in Year 5 or Year 7) when she files her taxes in 2027. At this point in time the basis of her investment in the QOF now equals the total amount of the gains originally deferred. Finally, if she holds her investment in the QOF for at least 10 years, then she will not owe any capital gains tax on the appreciation (over basis) in the QOF investment.

Here is a diagram[iii] of the timeline:

Please understand that this is not specific investment advice and investing in a QOF may or may not be an appropriate investment for your situation, time horizon and risk tolerance. Lastly, as you can see, there is some complexity to this, so you’ll definitely want to consult with your tax and/or legal advisors before investing.



[iii] Source: Inland Private Capital Corporation