The 2017 Tax Cuts and Jobs Act established the Qualified Opportunity Zone program, an initiative designed to lift Americans out of poverty and revitalize struggling areas. The program spurs economic development and job creation in more than 8,700 census tracts by offering significant tax advantages to those investing certain eligible capital gains into Opportunity Zones through Qualified Opportunity Funds.
If you choose to reinvest capital gains into a Qualified Opportunity Fund, what are the federal tax benefits? Let’s dive into the details.
What is a Qualified Opportunity Zone?
A Qualified Opportunity Zone (QOZ) is a designated geographical area where investors can develop real estate projects, or a business operating within a QOZ, to obtain significant tax advantages. QOZs are typically located in economically underprivileged communities across the United States.
What is a Qualified Opportunity Zone Fund?
A Qualified Opportunity Fund Zone (QOZF) is an investment vehicle organized specifically to invest in Opportunity Zone assets. To become a QOF, an eligible investment vehicle must self-certify by filing IRS Form 8996. QOFs are often organized as limited partnerships but can also be set up as corporations.
What are the tax benefits of investing in Qualified Opportunity Zones?
There are multiple tax benefits to investing in Qualified Opportunity Zones, including the ability to defer and meaningfully reduce—or even eliminate—certain capital gain tax liabilities.
Deferred payment of reinvested capital gains
If you reinvest eligible capital gains into a QOF, you can defer paying taxes on those gains until December 31, 2026, or until you have an “inclusion event,” whichever happens sooner. An inclusion event is an event that reduces or terminates your investment in a QOF, such as selling your investment. A full discussion of inclusion events is provided in the IRS final regulations for investing in Qualified Opportunity Funds.
The underlying tax on the original gain can be deferred as far as April 15, 2027 when filing your calendar year 2026 tax returns.
Reduction of deferred capital gain tax liability
Not only can you defer your capital gains taxes by investing in a QOF, but you may also be able to shrink them. This benefit depends on the length of time you hold the QOF investment.
If you hold the QOF investment for at least five years before December 31, 2026, then you can reduce your deferred capital gains tax liability by 10% through a step-up in basis. To capture this benefit, you must have invested your eligible capital gains in a QOF by December 31, 2021*
*Currently, you can no longer claim these tax benefits if you invest today. However, there are discussions sweeping through congress about potentially renewing the date to another one in the future to allow more people to invest in the QOZ program.**
Elimination of capital gain tax liability on appreciated QOF investment
If your QOF investment is held for 10 or more years, then the appreciation of the QOF investment is excluded from federal capital gains taxes. The exclusion occurs if you elect to increase the basis of your QOF investment to its fair market value on the date of the sale or exchange. The QOF investment must be sold or exchanged by December 31, 2047, when the tax benefit sunsets.
Tax benefits of investing in Qualified Opportunity Zones: Sample scenarios
Let’s say you realized a $100,000 eligible capital gain in July 2019 [SDM1] and invested the entire capital gain in a QOF that same month.
- Five-year holding period: If you hold the QOF investment at least five years, you’ll get to enjoy a 10% basis increase. The tax owed on your original capital gain would be reduced from $20,000 to $18,000, assuming a Federal long-term capital gains tax rate of 20%. (You’ll owe 20% on a $90,000 gain instead of 20% on a $100,000 gain.)
The $18,000 tax liability owed on the original capital gain could be deferred as far as April 15, 2027 when filing your calendar year 2026 tax returns. Any new capital gain generated by the QOF investment would be handled separately.
Ten-year holding period: If you hold the QOF investment for at least ten years, then the tax on the original capital gain would still be $17,000 and could still be deferred as far as April 15, 2027. If you sell the QOF investment for an appreciated value—say, $175,000—you can enjoy a step-up in basis to the fair market value, i.e., the price at which you sold the QOF investment. This means you can eliminate any capital gains tax liability on the $75,000 appreciated QOF investment.
Eligible gains and the 180-day rule
Gains that may be deferred by investing in a QOF are called “eligible gains.” They include both capital gains from asset sales and qualified Section 1231 gains that would be recognized for federal income tax purposes before January 1, 2027.
To defer tax on an eligible gain, you’ll generally need to invest in a QOF within 180 days of realizing the gain. The first day of the 180-day period is the date the gain would be recognized for federal income tax purposes if you didn’t elect to defer the gain.
Let’s look at a simple example: Say you sold some stock for an eligible capital gain. Your 180-day period begins on the date of the sale. If you invest all or part of the eligible gain in a QOF during the 180-day period, you may elect to defer the tax on that amount.
Check out our previous article to learn more about the 180-day rule for opportunity zone investments, including how the rule applies to pass-through entities.
Reporting a deferral
To elect to defer tax on an eligible gain, you’ll need to complete Form 8949 for the taxable year in which the gain would be recognized if you didn’t defer it. The form shows that you made a qualifying investment: First, you had an eligible gain to defer; second, you invested within 180 days of realizing that eligible gain; and, finally, you invested in a QOF. You’ll also need to submit Form 8997.
- IRS: Opportunity Zones Frequently Asked Questions
- IRS: Facts About Opportunity Zones
- IRS: Tax Cuts and Jobs Act Opportunity Zones Webinar
- US Department of Housing and Urban Development (HUD) Opportunity Zone Reports
- SEC: Staff Statement on Opportunity Zones
- SEC: Spotlight on Opportunity Zones
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If you would like to learn more about Opportunity Zone Investing, Caliber has put together a special guide that cuts through the myths and misconceptions and outlines the benefits, the risks, and the upcoming deadlines you must know to be able to participate. Get access to the guide here.
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