What is an Opportunity Zone?
Established by Congress as part of the 2017 Tax Cuts and Jobs Act, a Qualified Opportunity Zone (QOZ) is an economically-distressed community designated by a state for preferential tax treatment on select new investments. QOZs are designed to spur economic development and job creation while providing substantial tax benefits to investors.
Who Can Invest?
Any accredited or qualified investor with appreciated property can choose to invest the capital gain from the sale of their asset into a QOF and realize the tax benefits.
What is a Qualified Opportunity Fund?
A Qualified Opportunity Fund (QOF) is an investment vehicle structured as either a partnership or corporation created to invest in an eligible property located in an Opportunity Zone. The QOF provides unique tax benefits that allow investors to roll gains from a prior investment into the QOF, reducing, and in some cases eliminating, capital gains taxes.
Timeline
A QOF investor will follow a carefully defined timeline to achieve the maximum tax deferrals afforded by the QOZ legislation.
Exchange vs. QOZ
A 1031 Exchange is a similar tax-advantaged investment structure for individuals with highly appreciated assets; however, a QOF provides many distinct advantages.
| 1031 | QOZ | |
|---|---|---|
| Timing | 45-day identification period and 180 days to complete the exchange | 180 days from the sale of the asset to invest in a QOF |
| Qualifying Assets | Exclusive to proceeds from the sale of real estate assets | Few limitations; qualifying assets include capital gains from real estate, stock, and partnership interests |
| Investment Opportunity | Limited to properties identified during the 45-day window | Can invest in businesses, real estate and business assets located in QOZs |
| Tax Benefits | Capital gains tax completely deferred until the sale of the property | Capital gains tax deferred until the earlier of the sale of the QOF or 2026, plus a step up in basis: - 5 years: 10% step up in basis on original gain - 7-years: 15% step up in basis on original gain - 10 years+: 100% step up in basis on gains from the QOF investment |
| Investment Amount | Reinvest entire basis and capital gains in the new property | Only capital gains available for reinvestment |
| State Tax Legislation | Typically state and federal law are consistent and tax is deferred | Many states have not yet declared whether or not they will follow the federal law, meaning state capital gains taxes may not be deferred |
| Tax on Investment Income | Deferred until property is sold | Deferred until the earlier of: i) sale of the property, or ii) December 31, 2026 |
Case Study
An industrial development project located in a Qualified Opportunity Zone.
Sample Tax Situation
An investor with high appreciated real estate elects to defer capital gains taxes from the sale of their asset by investing $15 million of capital gains proceeds into the project.
Assumptions
- Total acquisition and development costs: $40,000,000
- Hold period: 10 years
- Sale Price: $50,000,000
Traditional Investment vs. QOF
| Traditional | QOF |
|---|---|
Under a non-QOF tax structure, an individual would pay $5.8 million of total capital gains tax if the property is sold in 10 years. These taxes include:
| Assuming a 10-year hold period under a QOF structure, the investor’s capital gains taxes would be reduced by $3.25 million to $2.55 million.
|
The case study is for hypothetical and illustrative purposes only and should not be relied upon as a statement of actual or projected returns or any form of legal or accounting advice.
Conclusions
- $5.8 million total capital gains taxes under a traditional tax structure
(assuming capital gains at 20%) - $2.55 million total capital gains taxes under the QOF structure
- Total tax savings = $3.25 million