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Step-by-Step Guide to Investing in Qualified Opportunity Zones
The advantages of investing in qualified opportunity zones are clear: powerful tax incentives, including deferral of capital gains taxes until December 31, 2026 (with a likely payable date of April 2027), as well as a potential elimination of the capital gains tax on the QOZ investment itself; and the ability to make a positive impact by spurring economic growth in underserved communities across the country.
Deciding to make a QOZ investment is the easy part. As with most investments, the devil is in the details. So let’s take a look at the process of investing in a qualified opportunity zone, from start to finish.
Step One: Sell Something
No matter how many millions of dollars you may have at your disposal, it’s important to remember that the creation of qualified opportunity zones lies in the Tax Cuts and Jobs Act of 2017, a bipartisan piece of legislation that held tax incentives as one of its primary goals (as the name implies).
QOZ investments are meant to defer capital gains taxes; as such, ordinary income is disallowed, and an investor must have a recent capital gain to reinvest in order to contemplate a QOZ investment.
Remember that a capital gain is simply the result of selling an asset at a higher price than its original cost. The asset in question can be real estate, stocks, bonds, cryptocurrency, fine art, livestock, or virtually any other investment that can be sold at a profit.
The statute is quite clear in its definition of a “recent” capital gain, too, as an investor has no more than 180 days from the creation of a capital gain to the reinvestment of the gain in a QOZ.
On day 181, with limited exceptions, the opportunity to reinvest that money in a QOZ, and enjoy all the tax benefits that accompany it, is lost forever.
Step Two: Get In The Zone
With capital gain firmly in hand, the clock is ticking. You have 180 days to find the opportunity zone of your choice.
Fortunately, there’s no shortage of options; there are more than 8,700 qualified opportunity zones in the U.S., including all fifty states, the District of Columbia, and U.S. territories. So accredited investors can find one in the state of their choosing, though admittedly it will be an easier search in the QOZ-plentiful states of Texas, Arizona, and New York.
An interactive map showing all current QOZs is maintained on the website of the Department of Housing and Urban Development. The massive array of geographic options means that it’s possible for a discerning investor to choose to put money to work close to home, 3,000 miles away, or any place in between.
Step Three: Find a Fund
The next step is crucial: investing in qualified opportunity zones means creating a qualified opportunity fund, or simply choosing one that is accepting investment capital. A qualified opportunity fund (QOF) is an investment vehicle, structured as a partnership or REIT, established with the specific goal of investing in QOZ assets. To qualify as a QOF, the fund must hold and invest at least 90% of its assets in QOZ properties and businesses.
While it may seem counterintuitive that an investor hoping to take full advantage of the tax benefits of QOZ investing can’t simply invest in an existing property or business within an opportunity zone, the fact is that all opportunity zone investments must pass through a qualified opportunity fund to qualify for the associated tax incentives. And with 8700+ qualified opportunity zones across the country and its territories, the number of funds accepting investments at any given moment is a moving target. Working with an experienced advisor is strongly recommended as investors sort through the myriad of possibilities in this field.
An advisor could also be instrumental in assisting with the setup of a new fund. While the process is more complex and labor-intensive than simply placing an investment in an existing fund, it is nevertheless possible for any taxpayer to create a new fund simply by filling out IRS Form 8996 and submitting it alongside their federal tax return. The form certifies partnerships or corporations as organizations established for the purpose of investing in qualified opportunity zones.
Step Four: Invest in the Fund
Once a QOF is selected (or created), it’s time to make the investment itself. The fund can choose to deploy it in stocks, partnership interests, or individual business properties, provided that the overall investment meets the 90% rule (and that in the case of existing properties, the funds serve to significantly improve the qualifying property). While many funds choose to focus on a single QOZ, there is no limitation for doing so, and many funds choose to hold investments across several opportunity zones.
It bears repeating here that in order to realize all the tax benefits of the QOZ investment (especially the tax-free gain after the ten-year holding period), only realized capital gains, not ordinary income, are eligible to invest in qualified opportunity funds; it’s also critical that the IRS’ deadline of making the investment within 180 days of the realization of the capital gain be strictly followed.
Step Five: Sell Your Investment… Someday
While steps one through four all take place in a whirlwind interval of no more than 180 days, step five is designed to take place years later. How many years, of course, is up to the investor. But to leverage the tax incentives, the Qualified Opportunity Fund (QOF) investment will be held at least until December 31, 2026. At present, that’s the maximum deferral offered for the payment of the capital gains tax on the original investment in the fund. (Legislation is currently under consideration to extend that date another two years or more; your advisor should keep you apprised of any developments in this regard.)
Holding the Qualified Opportunity Fund (QOF) investment for a minimum of ten years offers the elimination of any further capital gains taxes entirely, so it stands to reason that a decade-long investment is a practical goal when contemplating opportunity zone investing. The combination of an initial tax deferral, followed by the promise of a tax-free investment, is a compelling advantage of QOF investments over other traditional forms of investment that are accompanied by taxes on investment gains and dividends.
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