What is an Opportunity Zone? by Alex Keneiby, CPA
Posted on October 11, 2022
At the end of 2017, the Tax Cuts and Jobs Act introduced the concept of Qualified Opportunity Zones (QOZs) to help incentivize private investment into revitalizing economically distressed communities throughout the U.S., the District of Columbia and five U.S. territories. In return for their investments into these state designated QOZs, private individuals and businesses can receive significant tax benefits, including temporary deferral and potential exclusion of capital gains tax stemming from the sale of a broad range of investments. The key to earning and maximizing these benefits, however, comes down to how you structure your QOZ investment.
How Do I Invest in an Opportunity Zone?
To receive the tax benefits of QOZ investments, individuals and businesses must invest eligible gains into qualified opportunity funds (QOFs), which are investment vehicles organized for the sole purpose of investing in QOZ property, including stock or interest in a qualified opportunity zone business (QOZB). Eligible gains are those that result from the sale or exchange of stocks, bonds, collectibles, real estate, businesses or other investments to unrelated third parties that taxpayers then roll over into a QOF within 180 days of the sale or exchange of those assets. There are more liberal reinvestment rules that apply to the gains of a partnership or S corporation that pass through to their partners/shareholders on Schedule K-1.
Taxpayers may also create and self-certify their own QOFs to help fund specific projects located in QOZs, including, renovations to existing commercial property, new real estate development and/or the expansion of existing businesses. To qualify as a QOF (and to ensure your investment in a QOF will qualify for beneficial tax treatment), special care should be taken under the guidance of experienced advisors and CPAs to meet very specific and stringent requirements.
For example, a QOF must be structured as a partnership or corporation (or an LLC that chooses treatment as a partnership or corporation for federal income tax purposes), and it must hold at least 90 percent of its assets in QOZ property, including QOZ stock, partnership interests and qualifying business property. If a QOF fails to meet these requirements, its members may be subject to significant tax penalties.
What are the Tax Benefits of Investing in an Opportunity Zone?
To help attract private investment and spur economic development in low-income communities, the QOZ program was developed to offer investors the following unique tax benefits:
- Defer federal tax liabilities on capital gains (including section 1231 gains) properly reinvested into a QOF until as late as Dec. 31, 2026, or the date you sell your interest in the QOF, whichever occurs first;
- Exclude from federal tax up to 15 percent of the original gain rolled into a QOF by Dec. 31, 2019, and held for seven years, or 10 percent of a gain rolled into a QOF by Dec. 31, 2021, and held for five years (Note that QOF investments made after Dec. 31, 2021, no longer qualify for these benefits);
- Exclude from federal tax future gains on the appreciation of an investment in a QOF (including gains that may be related to depreciation and other deductions available during the holding period) after holding the QOF investment for at least 10 years.
That final benefit is significant. After a 10-year holding period, investors may sell their interests in a QOF and elect to increase the tax basis of the QOF investment to fair market value prior to the sale, essentially giving them a tax-free gain. Assuming the 10-year holding-period requirement is satisfied, the gain exclusion option is also available with regard to pass-through gains from the sale of qualifying properties by QOFs and qualified OZ businesses.
While the QOZ program does come with a broad set of complex rules and regulations, it is not limited to sophisticated investors. Rather, there are opportunities for investors at all levels to reap the intended benefits of the program. The decision to invest in or to form a QOF, however, should be made with your short and long-term goals in mind. To help you navigate the law and ensure you and your investment meets all the QOZ eligibility requirements, it is important to work with professional advisors and CPAs with proven experience and proficiency in these matters.
About the Author: Alex Keneiby, CPA, is a senior manager of Tax Services with Berkowitz Pollack Brant where he provides tax planning, compliance and consulting services to high-net-worth individuals, real estate developers and entrepreneurs. He can be reached at the CPA firm’s Miami office at (305) 379-7000 or at firstname.lastname@example.org.