24 Jan Qualified Opportunity Zones: A New Tax Incentive
As you may have heard, the Tax Cuts and Jobs Act of 2017 (the Act) passed by Congress and implemented in 2018 brought about some significant changes to the tax code. One change created the ability to invest in Qualified Opportunity Zones and achieve tax incentives.
Qualified Opportunity Zones (QOZ) are low-income census tracts nominated by governors and certified by the Secretary of the U.S. Treasury. Investors can now put capital to work in these Qualified Opportunity Zones in exchange for certain federal capital gains tax advantages. The country has over 8,700 Qualified Opportunity Zones across every state and populated territory.
What are the tax incentives offered by the program?
- Temporary Deferral of Capital Gains Taxes: Within 180 days of generating capital gains, investors may reinvest the capital gains from any existing investment into a Qualified Opportunity Fund (QOF) and defer those capital gains taxes until the investment in the QOF is sold or 12/31/2026, whichever is earlier.
- Partial Exclusion of Prior Investment Gains: If the QOF investment is held for longer than 5 years, 10% of the prior (deferred) gain is completely excluded from capital gains taxes. If held for more than 7 years, the exclusion is 15%. (So to get this full benefit, the investment into a QOF must be made by December 31, 2019, which is seven years before 12/31/2026.)
- Permanent Exclusion of QOF Investment Gains: If the QOF investment is held for at least 10 years, all investment gain in the QOF on invested deferred gains is tax-exempt.
What is a Qualified Opportunity Fund (QOF)? A QOF is a corporation or partnership that is created for the purpose of investing in QOZ property and that holds at least 90% of its assets in QOZ property. QOZ property consists of the following:
- Stock or partnership interests in a business that holds substantially all of its tangible assets in QOZ property.
- Tangible property acquired after December 31, 2017, that is first used in the QOZ after acquisition by the QOF or which is substantially improved by the QOF after acquisition.
What is the purpose of Qualified Opportunity Zones?
- Investments in Qualified Opportunity Zones stand to help distressed communities. The injection of new investment in these communities could be very significant, as current unrealized gains are estimated in the trillions of dollars. The impact from even a small portion of this amount can spur substantial change. Community improvements may come in the form of new businesses, growth of existing businesses, new real estate development, improvement of existing properties, the creation of higher and better uses for underutilized properties, increased services, increased affordable housing, and other unforeseen benefits.
What is the best way to participate in the program?
- Congress created the Qualified Opportunity Zones as an incentive to invest in certain low-income urban and rural communities nationwide, even while many of the sites are prime opportunities for investment with or without additional tax incentives. In fact, many current projects were planned prior to the Act and stand on their own merits without the tax incentives. We believe these previously-planned projects will be the most attractive Qualified Opportunity Zone projects. There will likely be a first-mover advantage for those who can secure access to this early round of previously-planned projects. Investment prospects for future (later) projects may suffer from having the cart firmly in front of the horse as investors settle for questionable projects in order to obtain tax incentives.
Can I invest my capital gains directly in a Qualified Opportunity Zone business or real estate and qualify for the tax incentives?
- In order to qualify for the tax incentives, investors must invest through a Qualified Opportunity Fund.
Investors should consider a Qualified Opportunity Fund investment if, at a minimum, they meet three requirements:
- Holding substantial unrealized capital gains
- Having a long-term investment horizon, and
- Considering adding development real estate to their portfolio.
Qualified Opportunity Zones present a rare chance to reduce current taxes, invest in real estate, and improve underserved communities with a single investment action. With the potential tax benefits and investment incentives in mind, investors should consider whether participating in the program is right for them.
Patrick Nolan, MBA, CAIA®
Portfolio Manager – Private Markets
The above article is intended to provide generalized financial information; it does not give personalized tax, investment, legal or other professional advice. Before taking any action, you should always seek the assistance of a professional who knows your particular situation for advice on taxes, your investments, the law, or any other matters that affect you our your business.