A New Investor’s Guide to Qualified Opportunity Zones

Do you know one of the investment world’s best-kept secret? It is called qualified opportunity zones (QOZ), and most investors don’t yet know all the facts behind the zones. That’s due in part because the federal government keeps updating the rules and criteria.

But the QOZ’s offer much in the way of tax benefits. QOZ’s were created by the Tax Cuts and Jobs Act of 2017. The opportunity zone’s purpose is to draw investment dollars which help the economic development in the area.

Investment dollars help economic development in the area by creating jobs in distressed communities. The tax benefits given to investors is a deferment on their taxes for any capital gains owed for that tax year.

Specifics of Qualified Opportunity Zones

Now you know the definition of the qualified opportunity zone. But you may need more information about the zone’s specific criteria. Opportunity zones are a new investment vehicle being offered by the US government.

These investment vehicles require at least 90% of the investment be made from unrealized capital gains. These unrealized capital gains can be via stocks and mutual funds. In the US economy, there are trillions of dollars currently untapped and unrealized.

The economic tax benefit tool allows for this untapped money to be put in distressed communities which need it most. There is more information about the opportunity zone qualifiers provided by this article. The main three incentives of these QOZ’s are:

  1. Investors are given a temporary tax deferral
  2. Step-up in basis
  3. Investors can get a permanent exclusion from income taxed via capital gains

These benefits help provide the desperately needed capital in low-income, at-risk communities. But what are the specifics of these tax benefits?

Qualified Opportunity Zone Investment

There are currently over 8,700 low-income communities that qualify as an opportunity zone (QOZ). The tax benefits of the QOZ, are listed below.

Temporary Tax Deferral

The temporary tax-deferred gain must be recognized on the date the opportunity zone investment is sold or at the latest, December 31, 2026. What this means in practical terms is once you invest in a QOZ your tax benefits are tied to how long your investment stake is active in the QOZ.

The investment providing the most tax benefit is for investors who hold their investment for ten years or more. In dollar terms, what this means is an investor can see an additional $44 for every $100 of capital gains reinvested into a QOZ.

Step-Up in Basis

A step-up in basis is when capital gains that reinvest in an Opportunity Fund. When the reinvestment occurs, the original investment increases by 10%. When you want to receive 10%, the investment must go into a QOZ and be held there for at least five years.

The investor receives an additional 5% if the QOZ investment is held onto for at least seven years. But the 15% total the investor now has after seven years excludes up to 15% of the original gain from taxation.

Permanent Exclusion From Income Taxed via Capital Gains

If a QOZ investment is held for at least ten years the investor receives a permanent exclusion from taxable income in capital gains. They receive this permanent exclusion in any exchange or sale of the investment. This exclusion applies to the gains the investor accrued from the investment in a QOZ, not their original gains.

Timing of QOZ Reinvestment of Funds

Any investor who wants to defer their eligible gains has to reinvest the gains into a Qualified Opportunity Fund (QOF). They have to invest the gains into the QOF within 180 days from the date of their sale or exchange in the QOZ. Many times partnerships or S-corporation investors think they have 180 from their date of sale for eligible gains.

But if the investor is in a partnership or S-corporation the deferred taxes on their eligible gains, doesn’t begin on the date of the sale in the QOZ. Rather the deferral begins on the last day of the entity’s tax year.

Permitted QOZ Entities for QOF Funds

If an entity is a corporation or partnership, they may serve as a QOF fund. They can serve as a QOF fund if it can meet all the applicable requirements of the Opportunity Zone Incentives (OZ). The OZ Incentives state an LLC is eligible to serve as a QOZ fund if it’s taxed as a corporation.

Most of the time, a single-member LLC doesn’t qualify as a QOZ fund unless it is taxed as a corporation. The same is true of real estate investment trusts (REIT’s) and regulated investment company (RIC’s). The REITs and RIC can be a QOZ fund if they meet the OZ entity requirements.

What Is QOF’s Compliance Criteria?

The tax form 8996 is used to help verify the QOF compliance. The foundation piece of criteria for compliance under a QOF is 90% of the QOF’s investments must be used in QOZ projects. The 90% requirement is determined by measuring the percentage of the QOZ that’s held in the fund at the six-month mark and the last day of the tax year.

The government takes the average of those two marker times, and if the company fails to meet the 90% criteria test, they face monetary penalties every month until they do comply.

The Intent of Opportunity Zones

The overall government intent in the creation of the opportunity zone is to help improve communities that need dollars the most. Communities throughout the US that are underserved rural and urban areas. The QOZ is intended to attract private capital.

QOZ’s help finance small businesses, develop community services, and increase social enterprises. The only problem which may arise in QOZ communities is if the investments go to high end, expensive real estate projects. Projects that don’t need a dime to succeed.

If that happens, then the legislation failed to deliver true investment opportunities for low-income, high-need communities. The qualified opportunity zones created should encompass living wages through jobs. Opportunity zones need to help build community economic impact in places forgotten or overlooked for many years.

Turner Investment Corporation helps investors assess real estate investment opportunities. Keep browsing our site and determine how you want to help build stronger and better communities.

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