Practitioners, operators and investors in the commercial real estate space are well familiar with Opportunity Zones and how they can be utilized for preferential tax treatment on investments. First created under the 2017 Tax Cuts and Jobs Act, these Qualified Opportunity Zones “QOZs” were designed to spur economic development and job creation in distressed communities.
With the deadline for deferred tax treatment scheduled to expire on December 31, 2026 and the talk within the new administration of extending this deadline, a brief primer on what this all means is below.
The QOZs
The initial list of QOZs was created in April 2018, with 8,764 QOZs eventually being identified in U.S. states, territories and Washington D.C. Under the regulations, states and territories are permitted to designate up to 25% of low-income census tracts as QOZs (or exactly 25, if any state had less than 100 low-income census tracts). Under Section 1400Z-1(e) of the Internal Revenue Code, states and territories may also designate certain census tracts that are contiguous to a low-income census tract as a QOZ, so long as not more than 5% of such state’s tracts are so designated.
The Basics
Investment into Qualified Opportunity Zone Property (“QOZP”) in any of the QOZs may be eligible for favorable tax treatment. QOZP can take any one of three forms, with of course some further complexities involved in each: (i) qualified opportunity zone stock (“QOZ Stock”), (ii) qualified opportunity zone partnership interest (“QOZ Partnership Interest”), or (iii) qualified opportunity zone business property (“QOZB”).
Once an eligible QOZP is identified in a QOZ, a corporation or partnership can be formed as the Qualified Opportunity Fund (“QOF”) through which the qualified investment will be made. To be considered a QOF for federal tax purposes, 90% of the QOF entity’s assets must consist of QOZP. This is determined by the average of the percentage of Qualified Opportunity Zone property held in the Qualified Opportunity Fund as measured on:
- The last day of the first 6-month period of the tax year of the QOF, and
- The last day of the tax year of the QOF.
The entity whose QOZ Stock or QOZ Partnership Interest is issued to the QOF must be a QOZB at the time of such issuance (or, in the case of a new entity, be organized for purposes of being a QOZB). The entity must remain a QOZB for substantially all of the time the QOF holds the stock or partnership interest.
The Treatment
Generally speaking, an investor who would otherwise need to recognize a gain from the sale of stock can invest that gain in QOZP or a QOF and defer the taxes on those gains, potentially until December 31, 2026. Depending upon the investor’s date of acquisition and holding period of the investment, there are varying tax benefits.
- Capital gains on investments held fewer than 5 years can be deferred until the earlier of December 31, 2026 or the date the investment in the QOF is sold or exchanged.
- Capital gains on investments held for between 5 and 7 years also receive a 10% reduction in the deferred gain.
- Capital gains on investments held for between 7 and 10 years receive an additional 5% reduction in the deferred gain (for a total of 15% reduction in the deferred gain).
- Investors who have held their investments in the QOZP or QOF for more than 10 years can elect for the basis of the QOZ investment to be the fair market value on the date of sale/exchange, resulting in a tax-free gain on disposition of the QOZP.
While the IRS has issued some limited guidance providing various extensions and exceptions, each investor’s particular situation will be unique.
The Data
According to analysis from the Economic Innovation Group earlier this year, more than $100 billion was invested in QOZs through 2022. The number certainly increased in the ensuing years as well. Novogradac recently reported that the QOFs it is tracking raised more than $40 billion in equity through the end of 2024. This investment in residential and commercial development brought significant benefits to a number of the country’s poorest zip codes. As noted in the Economic Innovation Group analysis, Erie, Pennsylvania and Detroit, Michigan have seen significant results. The story is similar all around the country.
The Future
The Opportunity Zones Transparency, Extension, and Improvement Act was a bipartisan, bicameral proposal introduced in Congress in 2022, but it has not become law. Among other changes, this bill proposed to extend the deadline from 2026 through December 31, 2028.
The Trump administration is proud of the QOZ legislation and its results, and the president himself has stated his support for an increase in the program. With Republican control of the House and Senate and the previous bipartisan support for extensions, expansions and improvements to the QOZ regulations, investors can reasonably expect further favorable developments related to QOZs.
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