Qualified Opportunity Zones

As part of the Tax Cuts and Jobs Act of 2017, Opportunity Zones were created as an investment option for a property or business in a location the government deems as an economically distressed community. These zones are designated by state or territorial authorities, with final certification conducted by the Secretary of the U.S. Treasury and reported to the Internal Revenue Service (IRS). Opportunity Zones encompass a wide array of regions nationwide, including rural areas, suburbs, major cities, and industrial zones.

Functioning as a strategic economic development tool, Opportunity Zones can facilitate job creation and foster economic progress in underserved communities. Investors channel funds into projects within these zones to enhance housing, support businesses, and uplift the overall community, thereby stimulating local economies and fostering area improvement.

A Qualified Opportunity Fund (QOF) serves as an investment entity structured as either a partnership or corporation, mandated to allocate at least 90% of its assets into Qualified Opportunity Zone (QOZ) property. These funds offer investors the flexibility to invest in diverse sectors, spanning from commercial real estate and housing to infrastructure and start-up ventures. QOFs have the capacity to hold single or multiple assets, including interests in Qualified Opportunity Zone Businesses (QOZBs).

Investors may contribute new capital gains or defer taxes on previous eligible gains, contingent upon the extent to which the funds are invested in QOZs. Contributions to a QOF afford investors the opportunity to defer capital gains taxes until December 31, 2026, or until an inclusion event occurs. Eligible capital gains for inclusion in a QOF must be recognized for federal income tax purposes and originate from sources other than relatives. Additionally, investors must adhere to filing requirements and investment timelines to participate.

To receive the benefits of an Opportunity Zone, the area and fund you’re invested in must be in a Qualified Opportunity Zone, which is nominated and certified by the U.S. Treasury Department. Thousands of Opportunity Zones are scattered across the country. From inner cities to rural areas, you can find Opportunity Zones that pique your interest.

QOF investments, like any other investment vehicle, require careful consideration. If this is your first time investing in Opportunity Funds, perform your own due diligence before making any investment decisions.

Look for properties that meet IRS (Internal Revenue Service) regulations for Opportunity Zones. For example, properties should be able to undergo substantial improvements. This includes properties with deferred maintenance issues that need addressing.

Qualifying for These Tax Benefits 

• Location: QOF property must be located in an IRS-identified opportunity zone.
• Structure: A QOF can be structured as a corporation or partnership and must self-certify with the IRS and fulfill annual reporting duties.
• Timeline: Investments of eligible gains in a QOF must be made within 180 days of realizing the gain.
• Asset Requirements: Generally, the QOF must hold 90% of its assets within a qualified opportunity zone.

Investing in an Opportunity Zone comes down to your financial goals and feelings about the process. It’s crucial to fully understand the process and complete research to ensure the Opportunity Zone you choose to invest in has the potential to provide a return.

QOFs come with inherent risk, but they can also offer several advantages to consider, including:

• Deferral until December 31, 2026: If a taxpayer reinvests the capital gain from the sale of any property into a QOF within 180 days of recognizing the gain, taxation on those proceeds can be deferred until either December 31, 2026 or the disposition of the QOF interest, whichever occurs first.
• Step-up in Basis: Investors who hold their investment for a minimum of ten years receive a step-up in basis. This means that the cost basis of the QOF will be equal to the fair market value on the date of the sale.
  • Therefore, investors are exempt from taxation on the appreciation of their QOF investment upon disposition, regardless of the profit size. This step-up in basis eliminates any depreciation recapture tax that would otherwise be due upon sale.
  • In the past, investors who made investments in QOFs before December 31, 2021, were eligible for a 10% step-up in basis, and those who made investments before December 31, 2019, were eligible for an additional 5% step-up in basis.
  • Although these benefits have since expired, there is still value in investing in QOFs.
• Benefits communities: This investment vehicle can deliver invaluable resources to economically distressed communities, contributing to the area’s growth.
• Broad investment criteria: You can defer taxes on capital gains from several assets along with real estate, until December 31, 2026, including business sales, stocks, cryptocurrency, REITs and bonds.

Due to the relatively recent introduction of opportunity zones, much of the inherent risk is associated with the uncertainty surrounding regulation. Although the Treasury Department has clarified several times, opportunity zone qualification still depends on strict compliance with new and sometimes ambiguous regulations.

If a fund does not comply with these requirements, its favorable tax status may not be applicable, thus creating an unintended tax liability for the investor. Additionally, some states do not fully conform to the federal opportunity zone tax benefit, so there may be state capital gain tax considerations.

Also, it’s important to recognize that when investing in a multi-asset QOF, the sponsor has discretion over the allocation of funds. To better manage multiple timelines, the sponsor can allocate funding to different projects as funds come in.

Since opportunity zones are typically designated in economically depressed areas, investing in a QOF can be speculative.

The characteristics of an Opportunity Zone help investors decide where to invest their funds to maximize tax incentives and community impact.

When examining an area’s metrics, consider the factors that mean the most to you. This research will help you determine where growth is possible and how efficiently your money can impact an Opportunity Zone.

Look into the projected growth of an Opportunity Zone and how it can possibly impact a return. When looking into locations, evaluate:

• Current population of the area
• Historical growth trends
• Location demographics
• Income levels
• Current rental rates
• Number of available properties

Investing in an Opportunity Zone comes down to your financial goals and feelings about the process. It’s crucial to fully understand the process and complete research to ensure the Opportunity Zone you choose to invest in has the potential to provide a return.

1031 Crowdfunding is a real estate investment platform for 1031 exchanges and alternative investments focused on tax deferral, including QOFs. Our platform provides the information and documents needed for investors to perform their due diligence, and our expert representatives will walk you through investments in Qualified Opportunity Funds. To view all our offerings, register for a free investor account.