Opportunity zones are census tracts that have been designated by America’s governors as lower income communities. There are more than 8,700 of these qualified opportunity zones in urban, suburban, and rural communities across the United States. Under provisions of the 2017 Tax Cuts and Jobs Act, which created the QOZ program, new investments in these areas are eligible for preferential tax treatment.
QOZ funds are unique investment vehicles that provide tax incentives for individual investors who invest new capital in businesses owned or located in opportunity zones. Investors looking to position their portfolios for long-term growth and favorable tax treatment often invest in QOZ funds. Since the QOZ program was enacted, QOZ funds have raised approximately $37.21 billion in capital across 1,848 QOZ funds as of September 30, 2023.1
Potential Benefits
An individual who invests in a QOZ fund is eligible for favorable tax treatment in the form of both capital gains deferral and federal income tax elimination on appreciation. Current law allows QOZ fund investors to defer paying taxes on their investments for realized capital gains that occurred on or before the 2026 tax year. If a QOZ fund investment is held for10 years, investors receive a step-up in basis and any appreciation on their investment becomes tax-free (through the end of 2047).
Gains Eligible for Deferral
Only capital gains are eligible for deferral as part of the QOZ program. All types of capital gains qualify, including stocks, bonds, options, and hedge funds; primary and secondary residences, businesses, commercial buildings, and other forms of real estate; land, livestock, wine, art, and automobiles. Both short-term and long-term gains qualify. The deadline to invest realized capital gains (all or part) into a QOF is 180 days after the gain recognition. Gains realized through a partnership may have an extended timeline to invest.
Investment Timeline
It’s important to understand the timelines surrounding investments in QOZs.
- Investing Realized Capital Gains: The deadline to invest realized capital gains (all or part) — not limited to real estate assets — into a QOF is 180 days after the gain is recognized. This investment can span across calendar years. Certain entities may have an extended deadline.
- Deferring Capital Gains Taxes: Any realized capital gain that was timely invested in a QOF can be deferred until December 31, 2026.
- Tax-Free Growth: Investors who hold their interest in a QOZ fund for at least 10 years receive a step-up in basis and pay no federal income tax on the appreciation of their QOZ fund investment once it’s sold, regardless of the amount of potential profit.
Furthermore, after a 10-year hold, investors are not subject to depreciation recapture. Like many alternative investments, QOFs have long investment timelines, are illiquid, and involve risk.
1https://www.novoco.com/notes-from-novogradac/novogradac-tracks-111-billion-additional-qof-equity-third-quarter-continuing-tough-year