Opportunity Zone Fund Investments

A Qualified Opportunity Zone is a census tract designated by the U.S. Treasury Department and the Internal Revenue Service (IRS) as economically distressed, where new investments, under certain conditions, may be eligible for preferential tax treatment. These zones were created as part of the 2017 Tax Cuts and Jobs Act to spur economic development and job creation in these communities.

QOZs are generally low-income communities. They are typically census tracts where the poverty rate is at least 20% or the median family income does not exceed 80% of the statewide median family income (or, in metropolitan areas, 80% of the metropolitan area median family income). Some contiguous non-low-income census tracts can also be designated as QOZs if they are contiguous to and economically integrated with a low-income tract.

The U.S. Department of the Treasury and various real estate and investment websites provide interactive maps of designated Qualified Opportunity Zones. You can search online for "Opportunity Zone maps" to find these resources.

Yes, the QOZ designations are currently set to expire on December 31, 2047. However, the tax benefits for investments made within the designated timeframe have their own specific timelines.

Generally, the boundaries of designated QOZs are fixed for the duration of their designation period, which ends on December 31, 2047.

A Qualified Opportunity Fund is an investment vehicle organized as a corporation or partnership for the purpose of investing in QOZ property (QOZ business property, stock, or partnership interests). To maintain its QOF status, the fund must hold at least 90% of its assets in QOZ property, as measured semi-annually.

Any corporation or partnership can self-certify as a QOF by filing Form 8996, Qualified Opportunity Fund, with their federal income tax return. There is no formal approval process required by the IRS.

• QOZ Business Property: Tangible property used in a trade or business within a QOZ, acquired by purchase after December 31, 2017, where the original use in the QOZ commences with the QOF or the QOF substantially improves the property.

• QOZ Stock: Stock in a domestic corporation that is a QOZ business.

• QOZ Partnership Interests: Capital or profits interest in a domestic partnership that is a QOZ business.

Substantially improve means that during any 30-month period after the acquisition of the property, additions to the basis of the property (excluding the basis of land) exceed an amount equal to the adjusted basis of the property at the beginning of that 30-month period.

A QOZ business is a trade or business that meets several criteria, including:

• At least 50% of its total gross income is derived from the active conduct of business within the QOZ.

• A substantial portion of its tangible property is used in a QOZ.

• A substantial portion of its intangible property is used in the active conduct of business within the QOZ.

• Less than 5% of the average aggregate unadjusted basis of its property is attributable to nonqualified financial property (e.g., excessive cash holdings, stocks, bonds outside the QOZ business).

• Certain "sin businesses" (e.g., private or commercial golf courses, country clubs, massage parlors, hot tub facilities, suntan facilities, race tracks or other facilities used for gambling, or any store the principal business of which is the sale of alcoholic beverages for consumption off premises) are generally excluded.

Yes, QOFs can vary significantly in their investment strategies, focusing on different asset classes like real estate development, operating businesses, or a combination thereof. They can also differ in their structure, fees, and minimum investment amounts.

Any taxpayer who realizes capital gains from the sale or exchange of property with an unrelated party can potentially invest those gains into a QOF and be eligible for the tax benefits. This includes individuals, corporations, partnerships, and certain other pass-through entities.

Virtually any type of capital gain, whether short-term or long-term, is eligible. This includes gains from the sale of stocks, bonds, real estate, businesses, art, collectibles, and more.

You need to invest the amount of your capital gain (not the entire proceeds from the sale) into a QOF within 180 days of the date you realized the gain. This is a crucial deadline to adhere to.

No, you can invest any portion of your capital gain into a QOF. Only the amount invested is eligible for the tax benefits. The portion of the gain not invested will be subject to immediate capital gains tax.

The IRS has provided guidance clarifying that investments held within certain retirement accounts, like IRAs and 401(k)s, do not generate eligible capital gains for QOF investment. The tax benefits are generally intended for gains realized at the individual or entity level.

Typically, you will need to provide standard investor information, including your tax identification number, the source and date of your capital gain, and the amount of the gain being invested. The QOF will provide specific subscription documents outlining their requirements.

The primary tax benefits are:

• Temporary Deferral: You can defer paying capital gains tax on the amount reinvested in a QOF until the earlier of the date the QOF investment is sold or exchanged, or December 31, 2026.

• Step-Up in Basis:

  • If the QOF investment is held for at least 5 years, the basis of the original investment is increased by 10% of the deferred gain.

  • If the QOF investment is held for at least 7 years, the basis of the original investment is increased by an additional 5% of the deferred gain (for a total of 15%).

• Permanent Exclusion of Capital Gains: If the QOF investment is held for at least 10 years, any capital gains realized from the sale or exchange of your investment in the QOF are permanently excluded from federal income tax. This applies to the appreciation of the QOF investment itself, not the initially deferred gain.

The deferred tax is due when you sell or exchange your QOF investment, or no later than December 31, 2026, whichever comes first.

Initially, your basis in the QOF investment is zero. It is then increased by the amount of the deferred gain when the deferred tax liability is recognized (either upon sale or on December 31, 2026), potentially with the step-up in basis if the holding period requirements are met. For the 10+ year gain exclusion, your basis is stepped up to the fair market value of the QOF investment on the date of sale.

If you sell before 5 years, you will still defer the capital gains tax until the date of sale or December 31, 2026, whichever is earlier. However, you will not receive any step-up in basis.

If you hold your QOF investment for at least 10 years and then sell it, the capital gains generated by the QOF investment itself (the appreciation over your adjusted basis after the deferred gain recognition) are not subject to federal income tax.

No, investors must make elections on Form 8997, Qualified Opportunity Funds Investing in Qualified Opportunity Zones, which is filed annually with their federal income tax return to claim the deferral, basis step-up, and exclusion benefits.

Investing in QOFs carries several risks, including:

• Liquidity Risk: QOF investments, particularly those in real estate or private businesses, can be illiquid and difficult to sell quickly.

• Market Risk: The value of the underlying investments within the QOZ can fluctuate based on market conditions.

• Development Risk: Real estate development projects within QOZs may face construction delays, cost overruns, or difficulties in achieving projected returns.

• Business Risk: Investments in operating businesses within QOZs are subject to the typical risks associated with running a business.

• Regulatory Risk: Changes in tax laws or regulations related to Opportunity Zones could impact the anticipated benefits.

• Lack of Precedent: As a relatively new program, there is limited legal and regulatory precedent, which could lead to uncertainty in interpretation and application of the rules.

• Tax Risk: Failure to meet the specific requirements of the QOZ program could result in the loss of expected tax benefits.

• Valuation Risk: Determining the fair market value of QOF investments, especially illiquid ones, can be challenging.

• Geographic Concentration Risk: Investing in a specific QOZ exposes you to the economic conditions and risks specific to that geographic area.

No, QOZ investing is generally considered more suitable for sophisticated and long-term investors who understand and can tolerate the associated risks, including illiquidity.

Thorough due diligence is crucial and should include:

• Understanding the QOF's investment strategy and track record (if any).

• Evaluating the specific projects or businesses the QOF intends to invest in.

• Assessing the experience and expertise of the QOF's management team.

• Reviewing the QOF's fees, expenses, and organizational structure.

• Analyzing the potential risks and rewards of the investment.

• Consulting with your financial and tax advisors.

Yes, you can generally use capital losses to offset capital gains before investing the net gain into a QOF. The amount invested in the QOF is the net capital gain after applying any allowable capital loss deductions.

Some QOFs, particularly those focused on real estate, may strategically plan for potential liquidity events or refinancing of the underlying property around the 2026 deadline. The idea is that a refinance could provide capital to investors, allowing them to potentially cover their deferred tax obligations without needing to sell their QOF interest. However, this strategy carries risks, including the ability to secure favorable refinancing terms, the potential for increased debt on the property, and the tax implications of the refinance itself. It's not a guaranteed solution and depends heavily on the specific fund, its assets, and market conditions at the time. Investors should carefully review a fund's strategy for addressing the 2026 tax deadline.

While the location of a property within a designated Opportunity Zone is a prerequisite, merely purchasing existing property in a QOZ typically does not automatically unlock the significant tax benefits. The QOZ legislation incentivizes new investment and substantial improvement of assets within these zones.

To qualify for the QOZ benefits through direct property ownership, the investor generally needs to meet the "substantial improvement" test. This means that within a 30-month period after acquiring the property, the additions to the basis of the property (excluding the land) must exceed the adjusted basis of the property at the beginning of that period. This requires significant capital expenditure and active management.

No, unfortunately, California does not currently conform to the federal Opportunity Zone tax benefits.

While the federal program offers significant advantages like deferral and potential elimination of federal capital gains taxes, California has not enacted state-level legislation to provide similar tax breaks for investments in QOFs.  

This means that California investors in QOFs will still be subject to California state capital gains taxes, even on gains that are deferred or potentially excluded at the federal level due to the QOZ investment. While the federal benefits can still be substantial, California residents will not see any reduction in their state tax liability specifically due to their QOZ investments.

Therefore, when evaluating the overall tax advantages of investing in an Opportunity Zone Fund, California residents should primarily focus on the federal benefits, as their state tax obligations will likely remain unaffected by this program. It's crucial for California investors to factor this lack of state conformity into their investment decisions and consult with their tax advisors to understand the complete tax implications.