Qualified Opportunity Zones: Structure
How are Qualified Opportunity Zone funds structured?
A QOZ fund is an investment vehicle that files either as a partnership or a corporation for federal income tax purposes, is organized for the purpose of investing in QOZ property, and self-certifies as a QOZ fund. LLCs that likewise file as partnerships or corporations and invest in QOZ property can also be QOZ funds.1
QOZ funds can hold single or multiple assets, but at least 90% of those assets must be QOZ property. These properties are often commercial real estate, but they can also include housing, infrastructure, and start-up businesses. QOZ property includes interests held by the QOZ fund in a qualified opportunity zone business.
Which gains are eligible for deferral?
Only capital gains are eligible for deferral as part of the QOZ program. All types of capital gains qualify, including those generated from the sale or exchange of property with an unrelated party (when both entities share no more than 20% common ownership), and the gain is treated as a short- or long-term capital gain for federal income tax purposes. These can include gains from:
- Stocks, bonds, options, hedge funds
- Primary and secondary residences
- Businesses, commercial buildings, and other real estate
- Land, livestock, art, wine, automobiles
QOZ timeline
It’s important to understand the timelines surrounding investments in QOZs.
- Investing Realized Capital Gains: The deadline to invest realized capital gains (all or part) – not limited to real estate assets – into a QOF is 180 days after the gain is recognized. This investment can span across calendar years.
- Deferring Capital Gains Taxes: Any realized capital gain that was timely invested in a QOF can be deferred until December 31, 2026.
- Reducing Capital Gains Taxes: If an investment was made in a QOF by the end of 2019 and 2021, the capital gain that was subject to tax at the end of the deferral period can be reduced by 10% if held for at least five years before the end of 2026 and a total of 15% if held for at least seven years before the end of 2026.
- Tax-Free Growth: Investors who hold their interest in a QOZ fund for at least 10 years pay no federal income tax on the appreciation of their QOZ fund investment once it’s sold, regardless of the amount of potential profit. Investors may remain invested in a QOF until December 31, 2047 under current regulations.
What is a Qualified Opportunity Zone (QOZ) business?
A QOZ business is a business in which at least 70% of its tangible assets qualify as QOZ property that is owned or located in a QOZ. At least 50% of the business’ gross income earnings must come from its active conduct in the QOZ and generally cannot be a “sin business” as defined in Code Section 144(c)(6)(B) (golf course, racetrack, etc.). Further, no more than 5% of business assets can constitute nonqualified financial property such as debt, stock, partnership interests, options, futures contracts, etc.
Timeline Example – 2023 QOZ Investment
Want to learn more about QOZ funds?
There are several reasons why accredited investors might be interested in a QOZ fund investment:
- Potential for significant tax incentives
- Position portfolios for long-term growth
- Less complicated than completing a 1031 Exchange
1 https://www.irs.gov/credits-deductions/opportunity-zones-frequently-asked-questions#general
2 Capital gains deferral, step-up to fair market value, and elimination of long-term capital gain taxes on QOF asset appreciation are applicable to federal and most state taxes, but some states have not conformed to this federal legislation. Investors should consult their own tax advisor to determine their individual benefits in a QOF investment.