As Interest in Opportunity Zone Investing Grows, So Does the List of Investor Questions
When Opportunity Zones were created under the 2017 Tax Cuts and Jobs Act and signed into law by the President, urban planners, developers, investors and politicians all had reason to be optimistic about what this new piece of sweeping legislation could mean for driving growth and development in economically distressed communities throughout the U.S.
And while the COVID-19 pandemic has certainly had an impact on what some might have expected to be an avalanche of new development, Opportunity Zones have still proven to be resilient investment opportunities that continue to generate wide interest. As with any new law, there are bound to be questions, and investors interesting in Opportunity Zones have had plenty.
In this post, we highlight a few of the more common questions we hear.
What are Opportunity Zones?
By definition, Opportunity Zones (or, Qualified Opportunity Zones (QOZs) as they are formally known), are economically distressed communities in urban, rural, suburban and tribal areas where new investments, under certain conditions, may be eligible for preferential tax treatment. QOZs have been selected by each state’s or territory’s governor and officially designated by the Department of the Treasury. The QOZ’s generous tax incentives are intended to stimulate new job creation and economic growth in these communities.
How do I Invest in a QOZ?
Investors interested in QOZ opportunities can only participate by using a Qualified Opportunity Fund (QOF) which is defined as an investment vehicle that files either a partnership or corporate federal income tax return and is organized for the purpose of investing in QOZ property and holds at least 90% of its assets in the property.
Qualification for becoming a QOF by either a corporation or partnership occurs by self-certifying and annually filing Form 8996 with its federal income tax return.
What do I need to invest?
For a QOZ, investors only need to invest their capital gain, not their cost basis. This is key differentiator from the requirements of a 1031 exchange.
What are the tax benefits of QOF investments?
The tax advantages of a QOF investment are a primary reason why there has been so much interest among investors. While the rules governing these investments are complex and must be strictly followed, the tax advantages are enticing and can include the ability to defer, reduce or even eliminate tax obligations that would normally apply to any capital gains on appreciated property.
As explained by accounting firm Anchin Block & Anchin at its annual Construction and
Development Forum last year:
“A certain portion of the deferred gains will be excluded from taxation if the QOF investment is held up to five years, with an even greater amount excluded from taxation if the investment is held up to seven years, and all
appreciation in an investment (above the deferred gain recognized no later than 2026) can be excluded from taxation if the investment is held for 10 years.”
What are tax exclusion rules?
If the investment in a QOF is held for at least five years, the investor can defer payment of capital gains and exclude 10% of the taxable gains from the original amount invested. If held for at least seven years or longer the investor can exclude and additional 5%. And as mentioned above, if held for at least ten years, any capital gains generated solely from the opportunity zone investment are tax-exempt.
What shelters does a QOZ investment provide?
QOZ investments only shelter capital gains. Other taxes like depreciation recapture on real estate is not sheltered.
What types of assets qualify for tax-deferral in a QOF?
Unlike the popular 1031 exchange which enables real estate investment property owners to sell property and exchange for “like-kind” property while deferring capital gains tax, property that qualifies for similar tax treatment in a QOF can include stock, art, real estate (including personal residences), bitcoin and other assets.
How much time do I have to invest a gain in a QOF?
According to the IRS, you generally have 180 days to invest an eligible gain in a QOF. The first day of the 180-day period is the date the gain would be recognized for federal income tax purposes if you did not elect to defer the recognition of the gain.
Can non-capital gains money be invested in a QOF?
In general, only original capital gains in a QOF qualifies for the preferential tax treatment. Invested cash is not eligible for capital gains tax exclusion.
What are IRS reporting requirements?
IRS Form 8949 is used for reporting any capital invested in an QOF. Taxpayers enter adjustments to their gains in Part 1 (short-term gains) or Part II (long-term gains). Capital gains or losses on the QOF investment are reported on K-1 forms.
Can I liquidate my investment at any time?
While certain QOF investments may allow investors to liquidate without restriction, they may be forfeiting some or all of the tax benefits to sought when first investing. QOF investments should be considered long-term.
Are there common mistakes QOF investors make?
The regulations which apply to Opportunity Zone investments are complex, and with the IRS and Treasury issuing a second set of proposed regulations as recently as April 2019, they are obviously still evolving. For that reason alone, it is important you only work with experienced and knowledgeable QOF professionals when you are considering investing.
There are a few potential potholes to be aware of that often trip up investors, including the failure to adhere to the 180-day reinvestment timeline, investing in multi-asset funds (while regulations are still unclear), and mistakenly investing in an area that is not recognized by the Treasury as an actual Qualified Opportunity Zone.
These are just a few of the more frequently asked questions we hear from potential QOF investors. There are many more you may want to familiarize yourself with from the Opportunity Zone section of the IRS website.
Additional Information on this topic can be found here: Understanding Qualified Opportunity Zones (Blog Article)