In 2017, Congress established the Qualified Opportunity Zone (QOZ) program as part of the. The purpose of the new program is to improve the economies of underdeveloped areas throughout the country. The QOZ program provides tax benefits to investors who meet certain requirements. Here’s how you can take advantage of the new program:
What is a Qualified Opportunity Zone?
A QOZ is a distressed community that has been nominated by its state government and certified by the Department of Treasury as an underdeveloped area. All 50 states, U.S. territories, and the District of Columbia have QOZ’s.
How can I find QOZ’s?
The Treasury Department, acting through the Community Development Financial Institutions Fund, provides a website with. You’ll need to have Adobe Flash Player installed to view it. There are more than 8,700 zones on this map. The whole of Puerto Rico is a QOZ.
What qualifies as QOZ property?
The law is very clear on this issue. Business property located inside a QOZ qualifies as QOZ property. Stock and partnership interests in that business also qualify. Tangible property must be “substantially improved” to qualify. Specifically, that means investors must spend 100% of the purchase price of the property on upgrades within 30 months of the original purchase. Under current law, golf courses, race tracks, liquor stores, country clubs, or similar facilities do not qualify as improvements.
What is an O Fund?
An Opportunity Fund, also known as an O Fund, is an investment vehicle set up as a partnership or a corporation for the sole purpose of making investments in QOZ property. An O Fund can also be established as an LLC that is taxed as an S-corp. Under federal regulations, a minimum of 90% of a fund’s assets must be invested in QOZ properties.
What tax benefits are available?
The IRS is granting tax deferral (and tax reductions in some cases) for capital gains that are invested into an O Fund. According to IRS guidelines, the capital gains must be deposited into the qualifying O Fund within 180 days of being realized. Under current law, the tax deferral expires at the end of 2026.
If the capital gains are held in the O Fund for at least five years, the IRS takes 10% off its regular tax bill. If gains stay in the fund for at least seven years, 15% comes off. To meet the seven-year deadline and get the 15% step-up in cost basis, you’ll have to make an O Fund investment by the end of 2019.
Let’s say you put $2,000,000 of capital gains in an O Fund in 2019. None of these funds are taxable on your 2019 return. For the next five years, you leave the $2 million in the Fund, and the investment remains nontaxable. If you decide to withdraw your investment after 5½ years, the taxable amount will be $1,800,000 ($2 million × 90%), assuming no gains or losses. At a tax rate of 20%, you will realize a saving of $40,000 ($200,000 × 20%).
Possible drawbacks of QOZ investments
While the tax advantages are definitely appealing, you need to be aware of some of the possible downsides of O Fund investments. For example, locking up money in an illiquid investment vehicle for roughly ten years requires a high degree of confidence in the potential profitability of the enterprise. Combined with the fact that the areas where these properties are located carry increased downside potential, the total risk level involved is significant. Also be aware that developer fees as high as 3% or more can be required for a QOZ property. Minimum investments to enter the fund are also extremely high.
Due to the complexity of the federal regulations surrounding this new investment opportunity, obtaining all the right deferrals and exclusions while remaining within the boundaries of the law will be a challenge. This situation of course can be managed by building a partnership with a qualified financial or tax expert who has experience working with QOZ’s.
Securities offered through Triad Advisors, LLC, member FINRA/SIPC. Advisory services offered through Glass Jacobson Investment Advisors, LLC. Glass Jacobson Investment Advisors is not affiliated with Triad Advisors, LLC.
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