Investing in the Zone
A Brief Overview of the Tax-Advantaged Investment Strategy
The Qualified Opportunity Zone Program (“QOZ Program”), created by the Tax Cuts and Jobs Act of 2017 (“TCJA”), is a tax-incentive program designed to encourage long-term private sector investments in designated communities known as Qualified Opportunity Zones (“QOZs”) by delivering certain tax benefits to investors through investment vehicles called (“QOFs”).
- QOZs are designated census tracts throughout the United States that have been selected by state governors for inclusion in the program.
- A QOF is an investment vehicle organized as either a partnership or corporation that holds at least 90% of its assets in QOZ property. QOFs can invest in a wide variety of real estate and new or existing businesses and can hold single or multiple assets. QOZ property includes interests held by the QOF in a Qualified Opportunity Zone Business (“QOZB”).
- A QOZB is a business in which at least 70% of tangible assets qualify as QOZ business property owned or located in a QOZ. At least 50% of the gross income earned by the business must be from the active conduct of the business in the QOZ and generally may not be a “Sin Business.”
- Taxpayers with eligible capital gains from the sale of a prior investment may invest those gains within a 180-day period in a QOF and achieve potential tax benefits.
- Investments in QOFs are intended to help drive real estate development, job creation and overall economic growth in lower income communities.
Understanding Eligibility
What is an “Eligible” Gain?
A capital gain is eligible for deferral if it is from the sale or exchange of property with an unrelated party (not more than 20 percent common ownership) and the gain is treated as a capital gain (short-term or long term) for federal income tax purposes, including gains from:
What is an “Eligible” Taxpayer?
QOZ regulations provide that taxpayers eligible to elect gain deferral include:
Potential Tax Benefits of Investing in a QOF
Potential tax benefits associated with the QOZ Program fall into two main categories:
Deferral
Generally, if a taxpayer invests the capital gain from the sale of a qualifying asset into a QOF within 180 days of recognizing the gain, taxes on such proceeds may be deferred until the earlier of December 31, 20261 or the disposition of the QOF interest.
Elimination
Investors who hold their investment for at least ten years receive a step-up in basis which means they pay no tax on the appreciation of their QOF investment upon disposition (so long as such disposition occurs prior to January 1, 2048), regardless of the size of the potential profit.2 In addition, the step-up in basis eliminates any depreciation recapture tax that would otherwise be owed upon sale.
All investments involve risk, and the realization of the benefits is dependent on proper structuring and the structure and performance of the future investments selected. Not all investments will provide all of these benefits.
1 A 10% step-up in basis was available for investments made prior to December 31, 2021, and an additional 5% step-up in basis was available for investments made prior to December 31, 2019.
2 Assumes that the investor is a resident of a state that conforms with the QOZ Program or a no state income tax state, otherwise the investor will owe tax on any realized gain in investor’s state.