Claim These 3 Qualified Opportunity Zones Tax Benefits

When it comes to investing and building wealth, maximizing returns while minimizing tax liabilities could be considered “The Holy Grail.” For those seeking the grail, investing in Qualified Opportunity Zones (QOZs) offers a unique opportunity to put your capital to good use in underserved areas where investment is needed — all while getting a few tax breaks for doing so.

Let’s talk about opportunity zones tax benefits and what those mean for you as an investor.

What are Qualified Opportunity Zones?

Qualified opportunity zones are distressed communities created under the Tax Cuts and Jobs Act of 2017 as a way to encourage economic development and stimulate the economy by injecting much-needed capital into areas that meet particular low-income criteria. There are more than 9,000 designated QOZs in all 50 states and territories. This U.S. Department of the Treasury resource page even provides an interactive map for viewing QOZs.

Tax incentives are offered to those who invest their capital in these zones through a Qualified Opportunity Fund (QOF) — and you don’t have to live, work, or have your own business in the zones to take advantage of those benefits.

What is a Qualified Opportunity Fund?

Qualified opportunity funds (QOF) are simply avenues of investment in opportunity zones. They’re established so that corporations or partnerships can invest in real estate or existing businesses within the QOZs. To be eligible for opportunity zone tax benefits, you must self-certify your QOF when filing your federal income taxes and invest a minimum of 90% of your assets in QOZ property.

There are two types of QOZ properties. First, the “QOZ business property” is an investment in real estate or other physical property involved in the trade or business of a QOZ. To qualify, it must have been purchased after 2017 by a QOF or QOZ business and either be “original use” or “substantial improvement” — which means it should more than double its adjusted basis in the span of 30 months.

The other is equity interest in “QOZ businesses” that themselves invest in “QOZ business properties” and meet particular requirements. These businesses must have “substantially all” (70%) of their assets in QOZ property.

What qualified opportunity zones tax benefits are offered?

Deferral of Capital Gains:

Investors can roll over capital gains from the sale of any asset into a QOF within 180 days. That means you can defer the payment of capital gains taxes until the earlier date of either when you sell your QOF investment or December 31, 2026. Not only are capital gains on the initial investment deferred, but any additional gains realized from investing in the QOZ are exempt from capital gains tax.

Reduction of Deferred Capital Gains:

If, as an investor, you hold your QOF investment for at least five years, you become eligible for a 10% reduction in the deferred capital gains tax liability. This increases to 15% if you do so for at least seven years.

To take advantage of this particular benefit, investors need to have reached the five- or seven-year mark in QOZs by 2026. New projects can no longer receive this step-up tax benefit. This is not the case for investors who hold their investment for 10 years, however. More on that below.

Cost Basis Adjustment:

A significant benefit comes to investors who continue their QOF investment for at least 10 years, in which case, any appreciation in the QOF investment becomes tax-free. The cost basis of your initial investment will adjust to the fair market value as it is on the investment’s date of sale, effectively reducing the amount of taxable gain. This investment period can reach the 10-year mark after 2026, so investors can make use of the permanent exclusion tax benefit for new projects.

The best part? You can take advantage of multiple of these opportunity zones tax benefits.

What types of gains are eligible for deferral if I invest in a QOF?

Eligible gains include capital gains as well as qualified 1231 gains (reported on Form 4797), and, per the IRS, “gains that would be recognized for federal income tax purposes before January 1, 2027, and that are not from a transaction with a related person.” For more information, see this FAQ sheet from the IRS.