How to Obtain Maximum Benefits of Opportunity Zones
To obtain the maximum benefit still available from the Qualified Opportunity Zone program, taxpayers need to make qualified investments before December 31, 2021. Opportunity Zones offer tax benefits to business or individual investors who can elect to temporarily defer tax on capital gains if they timely invest those gain amounts in a Qualified Opportunity Fund (QOF). The primary benefits are:
- Deferral of your gain until December 31, 2026. If you sell the investment before then the tax is due in the year of the sale;
- For gains invested prior to December 31, 2021 you get a 10% exclusion on the original deferred gain if held for 5 years; and for investments held more than 10 years, the appreciation on the original gain is tax free. Depreciation recapture is also excluded after the 10 year holding period.
How to get started
Recognizing a capital gain is the first step. The source of the gain (within your business, on a brokerage statement, or somewhere else) will determine when your 180-day clock starts to reinvest the gain in a Qualified Opportunity Zone Fund (QOF). There are also elective start dates for the 180-day window when the gain is reported to you. The gain must have otherwise been subject to U.S. taxation as well. Partnerships with foreign and tax-exempt investors should use caution when making a gain deferral election.
What is a QOF?
A QOF is a corporation or partnership that has elected to be treated as such. It must be organized for the purpose of making investments in Qualified Opportunity Zone Business Property (QOZBP), must have at least 90% of its assets be QOZBP, be the original owner of the QOZBP or make significant improvements to the acquired property, and meet a myriad of other rules and reporting requirements to ensure its investors get the full benefits of the program.
Assume you have a $100,000 gain, invest it in a QOF, and 10 years after your investment receive $300,000 on a subsequent sale. You’ll pay tax on $90,000 of gain on your 2026 tax return and nothing more.
Who can invest in a QOF?
Eligible taxpayers are individuals, C-corps, RICs, REITs, partnerships, S-corps, trusts, and estates. The investment must be made with cash to qualify. Non-gain dollars can be invested, but they won’t qualify for all the benefits of the program. You can also make an investment that is a mix of gain and non-gain dollars.
If I want to sponsor a QOF, will my carried interest qualify for the tax benefits?
If I have property in an opportunity zone that I want to develop, can I sell it to a QOF that I’m a partner in?
Yes, but if you own more than 20% of the QOF it’s going to cause issues for the Fund.
Can I take out debt on my assets and distribute the proceeds?
Yes, but close attention needs to be paid to shareholder basis and timing of the debt financed distribution to prevent it from being a taxable inclusion event. Inclusion events accelerate the recognition of the previously deferred gain and there are several transactions listed in the Regulations that are defined inclusion events.
Can QOF’s invest in businesses as well?
Yes, a Fund can invest in a Qualified Opportunity Zone Business. These entities have three additional benefits:
- Only 70% of a QOZB’s tangible property needs to be QOZBP. QOZB has a 31-month grace period to deploy its working capital for purposes of meeting the asset tests and can utilize an additional 31 month period for a second injection of working capital. There is no annual reporting to the IRS.
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