Qualified Opportunity Zones can potentially provide investors with a powerful tax-advantaged investment vehicle for reinvesting capital gains.
By rolling over eligible gains into designated Opportunity Funds, investors can potentially defer taxes, receive a basis step-up, and even potentially achieve permanent exclusion from certain capital gains taxes.
Based on our specific experience with business owner wealth management over the years, we’ll cover how to identify, invest in, and maximize the tax benefits of Qualified Opportunity Zones.
Table of Contents:
- What Are Qualified Opportunity Zones and Why Were They Created?
- The Triple Tax Advantage of Qualified Opportunity Zone Investing
- Eligibility Criteria
- How to Invest in Qualified Opportunity Zone Funds
- Leveraging Opportunity Zones for Business Expansion
- Integrating Opportunity Zones into Your Tax Strategy
- QOZs: Your Next Steps as an Investor
What Are Qualified Opportunity Zones and Why Were They Created?
Qualified Opportunity Zones (QOZs) are defined as “economically distressed communities” designated by the U.S. Treasury for investment and development. (See IRS.Gov article here) They were established in the 2017 Tax Cuts and Jobs Act to spur economic growth and job creation in underserved areas.
The program provided a tax incentive for investors to reinvest capital gains into qualified opportunity funds. These funds directly invest in real estate projects, operating businesses, equipment, and other development within designated QOZ census tracts.
The goals of the QOZ program include revitalizing struggling communities through private investment, improving affordable housing, generating employment opportunities, and creating businesses and services in areas lacking resources. By attracting new capital, opportunity zones aim to facilitate lasting economic renewal.
Investors stand to benefit from major tax advantages for participating, while distressed communities can receive an economic stimulus from the program's incentivized investments.
Overall, it creates an innovative public-private partnership model to target development where it's most needed.
The Triple Tax Advantage of Qualified Opportunity Zone Investing
Investors who strategically roll over capital gains into Qualified Opportunity Funds can potentially receive a trifecta of possible tax benefits:
- Temporary Tax Deferral:
By reinvesting an unlimited amount of capital gains from a prior investment into a QOZ fund within 180 days, the taxes typically due on those gains get deferred until as late as December 31, 2026. This allows more capital to keep compounding tax-free.
Brian Liedel CPA/CFP®/PFS, who focuses on Business Tax Consulting at Kerkering Barberio, shares his insight, “On the tax return for the year of the gain, it is shown in full, and the gain is shown as “excluded” from income, with a code for QOZ. It is then reported on the 2026 tax return.”
- Basis Step-Up:
It used to be that In addition to tax deferral, investors would receive a 10% step-up in basis on the rolled over capital gains if held in a QOZ fund for at least 5 years. Also, if held for 7 years, the step-up increases to 15%, permanently reducing taxes due.
This is no longer applicable, due to the time this is being published (May 2024). We felt it was important to include this point.
Brian shares, “These two time periods (5 & 7 year holding) needed to be met on or before the 12/31/2026 recognition date; therefore, they no longer apply. It had to be from a gain realized on or before 12/31/2019 to achieve the full 15% step up, and a gain realized before 12/31/2021 for the 10% step up.”
- Permanent Exclusion:
Here's the kicker - any new capital gains achieved from the gain on the QOZ investment is 100% exempt from federal taxes if held for at least 10 years. All appreciation after the 10 year holding period can also be captured tax-free.
Brian confirms, “It is all gain on the QOZ investment, not just the appreciation after 10-year holding. For example, if someone had a $1mil gain on the sale of stock in 2024, they could invest that $1mil amount in a QOZ fund, defer the gain on the $1mil until 2026. Then, after holding the new investment for 10 years (sell in 2034), they can exclude all gain on the sale.”
Brian goes on to clarify, “In the example, the original $1mil is taxed in 2026, which becomes the new tax basis for the investment. If it’s held for 10+ years, and then sold for $10mil, they would have a $9mil gain, but it would be excluded from income.
This combination of tax deferral, up-front discount via basis step-up, and potentially avoidance of future gains taxation creates an advanced wealth-building opportunity.
Eligibility Criteria
To take advantage of the tax benefits of investing in Qualified Opportunity Zone (QOZ) funds, investors must meet certain eligibility requirements:
What Qualifies as an Eligible Capital Gain?
Almost any capital gain from a prior investment can be rolled into a QOZ fund. This includes long-term or short-term gains from assets like stocks, bonds, businesses, real estate, collectibles, and more. The key requirement is having an eligible capital gain event to reinvest.
Brian Leidel CPA/CFP®/PFS again confirms, “Any capital gain, from securities, closely held business, real estate, etc. can be invested in the QOZ fund.”
180-Day Reinvestment Deadline
Investors have just 180 days from the date capital gains are realized to roll over those proceeds into a QOZ fund. Miss this 6-month window and the ability to defer taxes is permanently lost on those specific gains.
Accreditation Rules Apply
While the QOZ program aimed to open up certain opportunities to non-accredited investors, most QOZ funds still require meeting accredited or qualified investor standards. This generally means having $1 million+ net worth or $200k+ annual income.
Careful tracking of capital gain events and prompt action during the 180-day window is crucial to ensure eligibility and maximize the available tax advantages. Consulting experienced QOZ financial planning, legal, and tax experts is highly recommended.
How to Invest in Qualified Opportunity Zone Funds
Once capital gain eligibility is confirmed and the 180-day clock is ticking, the next step is evaluating and selecting specific QOZ funds to invest in.
Evaluating Opportunity Zone Funds
Here is a good starting point for finding qualified opportunity zones in your area from hud.gov:
https://opportunityzones.hud.gov/resources/map
Not all QOZ funds are created equal. Investors should scrutinize factors like:
- Fund manager experience and track record
- Specific QOZ areas and projects being targeted
- Asset class focus (real estate, operating businesses, etc.)
- Alignment with personal investment objectives and risk tolerance
- Fees, costs, and profit/loss allocation structure
Due Diligence Requirements
Qualifying for the tax benefits requires extensive due diligence by the investor on both the fund and underlying QOZ businesses/properties. This includes reviewing:
- QOZ fund compliance and certification details
- Proof of "sin business" qualifications for QOZ investments
- Fund timing projections to hold investments for 10+ years
- Economic substance and viability of QOZ projects
Tax Forms and Reporting
Special IRS forms are required to properly report QOZ fund investments and defer/exclude gains, including:
- Form 8997 for initial investment into QOZ fund
- Form 8949 for reporting deferred capital gains
- Basis adjustments and K-1s from fund for tracking holdings
Careful adherence to the required reporting and documentation from both investor and fund is critical to ensure the tax benefits are supported if audited.
Leveraging Opportunity Zones for Business Expansion
While much of the attention around QOZs focuses on the investment tax benefits, the program also provides incentives for businesses to actively operate and develop properties within designated opportunity zones.
Tax Benefits for OZ Businesses
Businesses headquartered and deriving at least 50% of their gross income from within an opportunity zone are eligible for significant tax preferences, including:
- Ability to currently deduct the cost of qualified property
- Exclusion of capital gains on OZ business assets held over 10 years
- Deferral of gains reinvested into OZ qualified property
This makes launching or expanding operations into an OZ potentially very appealing.
Using QOZ Funds for Development
Qualified Opportunity Funds are also actively investing directly into commercial real estate development and operating businesses located within OZs. This unlocks financing for new construction, property rehabs, equipment purchases, and startup capital injections.
Community Impacts of OZs
Beyond just the tax incentives, opportunity zones aim to revitalize economically distressed areas through new business formation, job creation, and real estate investment. Bringing new capital can stimulate lasting economic renewal and upward mobility.
Investors aren't just capitalizing on tax benefits, but playing a role in public-private community partnerships targeting underserved regions through development and growth incentives.
Integrating Opportunity Zones into Your Tax Strategy
Opportunity Zone investing should not be viewed in a vacuum, but rather incorporated as one component of a comprehensive tax minimization plan.
Coordinating with Other Tax Strategies
QOZ investments can complement other tax planning strategies for business owner, such as:
- Timing capital gain events to meet 180-day QOZ windows
- Leveraging QOZ basis step-up with estate planning goals
- Balancing QOZ funds with tax-loss harvesting in other assets
- Offsetting business income with QOZ deductions and exclusions
Investors can work with advisors to build models for how QOZ benefits layer with other tactics for a holistic tax strategy.
Selecting QOZ Funds
Given the long-term nature of QOZ commitments, choosing the right fund is paramount.
Advisors can help:
- Screen for funds with proven managers and viable strategies
- Assess fee structures, liquidity terms, and reporting transparency
- Stress test projections and gauge alignment with investor goals
- Determine optimal asset allocation to QOZ investments
Planning Exit Strategies
While QOZ benefits are maximized at 10+ year holding periods, investors still need clear exit plans, such as:
- Evaluating QOZ fund life cycles and extension options
- Identifying potential buyers for underlying QOZ assets
- Projecting after-tax returns of cashing out at different intervals
- Exploring tax-efficient ways to transfer or gift QOZ assets
QOZ investments can be powerful tax tools but require thoughtful integration, selection, and exit planning to optimize. Experienced advisory is strongly recommended.
QOZs: Your Next Step as an Investor
Qualified Opportunity Zones present a unique chance to potentially defer and reduce capital gains taxes while participating in the economic redevelopment of underserved communities.
Recap of Key QOZ Benefits
As covered in this guide, the major benefits of rolling capital gains into QOZ funds include:
- Deferring gains until 2026 to boost compounding returns
- Stepping up basis by 10-15% to reduce taxes owed on gains
- Excluding all future gains on QOZ investments after 10 years
Further, QOZ investments can allow generating income and appreciation from the underlying operating businesses and properties within these designated zones.
Your QOZ Action Plan
If you're an investor, business owner, or real estate developer with eligible gains or interest in Opportunity Zones, your next steps should be:
- Consult your financial advisor and tax professional
- Evaluate specific Qualified Opportunity Funds
- Conduct thorough due diligence on QOZ investments
- Assess how QOZs integrate with your overall tax strategy
To further explore Qualified Opportunity Zones and other tax planning strategies for business owners, here are more resources to explore:
- Our guide: Tax Planning for Business Owners: 15 Strategies to Consider
- 2024 Tax Planning Strategies for Business Owners Event with 2 CPAs
- Schedule a consultation with our CEO David Silver, CFP®, CEPA®
Not an Offer, Recommendation or Professional Advice: This document does not constitute advice or a recommendation or offer to sell or a solicitation to deal in any security or financial product. It is provided for information purposes only and on the understanding that the recipient has sufficient knowledge and experience to be able to understand and make their own evaluation of the proposals and services described herein, any risks associated therewith and any related legal, tax, accounting or other material considerations. To the extent that the reader has any questions regarding the applicability of any specific issue discussed above to their specific portfolio or situation, prospective investors are encouraged to contact Instrumental Wealth or consult with the professional advisor of their choosing.