Qualified Opportunity Zone (QOZ) investing has been a hot topic in the financial press this year. As 2019 draws to a close, we’ve rounded up the facts and the lessons learned from QOZs and explained them below. Important deadlines are fast approaching, so if you’re planning to invest, it’s best to act on it soon. Remember that December 31, 2019 is the final date you can invest in a QOZ and see the maximum potential tax benefit.
What is an Opportunity Zone (OZ)?
An OZ is a designated economically distressed area identified by the State where the area is located and that is approved by the Treasury. In the state of Washington, 15.8% of commercial assets are located in OZs, with 139 zones at last count.
What is a Qualified Opportunity Fund (QOF)?
A QOF is an investment vehicle, organized as a Corporation or Partnership, that invests at least 90% of its assets in Qualified Opportunity Zone Property.
Qualified Opportunity Zone Property (QOZP) means property which is:
- Qualified opportunity zone stock,
- Qualified opportunity zone partnership interest, or
- Qualified opportunity zone business property.
Who can invest in a QOF?
Any investor can invest in a QOF. However, it’s best for real estate professionals, entrepreneurs, and people who have a strong local knowledge of the specific investment zone. Many funds are available only to accredited investors (net worth in excess of $1.0m or annual income over $300,000 (MFJ).
It is important to note that the tax benefits are only available to investors who have invested eligible capital gains. If your investment is part eligible capital gains and part non-eligible, your investments will be tracked separately. The increase in basis to fair market value after ten years will only apply to your eligible investment.
There are a number of tax advantages to investing in OZs, these include:
Deferral of capital gains:
- Taxpayers may defer tax on eligible capital gains by making an investment in a Qualified Opportunity Fund (QOF). The deferred capital gain is recognized on December 31, 2026, or earlier if the investment is sold.
Reduction of capital gains:
- If a taxpayer holds its QOF investment for at least five years, the taxpayer may exclude 10% of the original deferred capital gain.
- If a taxpayer holds its QOF investment for at least seven years, the taxpayer may exclude an additional 5% of the original deferred capital gain. To meet the seven year holding period requirement, the funds must be invested no later than 12/31/2019.
Elimination of all or a substantial amount of gain on appreciation of the QOF investment:
- If the taxpayer holds the QOF investment for at least ten years, the taxpayer may elect to increase its basis in the QOF to the fair market value upon sale.
Individuals, corporations, partnerships, and trusts can elect to defer eligible capital gains by investing such gains into a QOF. The gain must be from a sale or exchange with an unrelated person. The investment into the QOF generally must be made within a 180-day period beginning on the date of such sale.
For gains flowing from a partnership or S-Corporation interest, the date of such sale can be the partnership or S-Corporation year end.
There is a special rule for IRC Section 1231 gains (gains from sale of business property). The deferral of Section 1231 gain is only available to a taxpayer for investments made within the 180-day period following year end. Thus, if a taxpayer has Section 1231 gain from a sale that occurred on March 31, 2019, the date for the 180-day period to invest begins on December 31, 2019. Investments made within 180 days of March 31st, will not qualify for deferral of the March 31st gain.
As noted above, the deferral of recognition of the gain is through December 31, 2026. However, if the investment is sold, the original deferred gain will be recognized at the date of sale of the QOF.
How do you Invest in QOZ and What are the Pros and Cons?
There are a couple ways you can begin investing in QOZs, each with their own pros and cons:
Directly (set up your own fund):
- Limited diversification,
- Potentially risky,
- Low or no fees,
- Success depends on investor’s knowledge of the QOZ, and
- Only an option for wealthy investors.
- Relatively easy,
- Can be diversified,
- Potential high fees, and
- Fund manager expertise drives the potential success of the investment.
Is a QOZ Investment Safe?
Investors need to do their due diligence when investing in QOZs. Tax benefits should be considered as an added incentive to invest in an otherwise sound deal. If you have further questions about investing in Qualified Opportunity Zones, contact a Clark Nuber real estate professional.
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