Wealth Management

The A to Z of QOZs: The Facts about Qualified Opportunity Zone Investments

Qualified Opportunity Zones (QOZs) are communities that Congress designated as economically distressed as part of the Tax Cuts and Jobs Act (TCJA) of 2017. QOZs offer investors a chance to reinvest proceeds from property sales into businesses that engage in redevelopment projects in those strategic areas. The incentive is that gross income from capital gains on property sales or 1031 exchanges does not get taxed when investing entities meet the criteria outlined in IRS rules. The tax deferment only works when investors reinvest gross income from the previous sale of a property. New investment capital in QOZs does not qualify as tax-deferred investments. If you’re considering QOZs as a potential investment opportunity, here’s what you need to know.

Who qualifies for the benefits of investing in QOZs?

The IRS allows a wide range of persons to benefit from investing in QOZs. That includes:

  • C corporations
  • Regulated investment companies (RICs)
  • Real estate investment trusts (REITs)
  • Partnerships
  • S corporations
  • Trusts and estates

Just like 1031 exchanges, property investors have up to 180 days to reinvest gross income from capital gains on sales and exchanges in QOZ properties without being taxed. The government has set a time limit of December 31, 2026, for the reinvestment to occur if the investment property has not already been sold. The investment horizon is a minimum of 5 years, but to achieve the maximum benefit of never paying taxes on gross capital gains resulting from the original QOZ investment, the investor must hold the property for ten years.

Also, your relatives can’t buy property from you or for you. Some guidelines are still under consideration, including the fair market valuation (FMV) of QOZ assets, self-certification standards, and the types of businesses formed within QOZs.

As an investor, you should be aware of inclusion events, which can trigger a capital gain recognition prematurely. Check with an investment advisor or tax expert to become familiar with all the rules regulating special tax treatment within QOZs.

QOZ investment horizons and IRS forms

Once you reach the five-year mark, then the IRS allows you to retain a partial tax benefit. Beginning with a $0 value basis, if you sell after five years, 90% of the capital gain attribution of your investment becomes recognized. At seven years, the IRS only recognizes 85% of the capital gain attribution. When you hold your investment a full ten years, you get the maximum benefit that all capital gains attributable to your investment become untaxed. NAR provides its interpretation of some QOZ scenarios as well.

You will need to fill out Form 8949 to record the untaxed gains for which you qualify. Every investment partner must receive a record of capital gains attributable to the QOZ investment. If you are a capital manager or principal investor, then you must distribute Form 1099-B to all investors or partners when a property is sold or disposed of.

Filing to become a Qualified Opportunity Fund (QOF)

Before partnerships or corporations can begin acquiring QOZ property, they must self-certify on Form 8996 of an intent to create a qualified opportunity fund (QOF). Ninety percent of holdings for a QOF must be assets within a qualified opportunity zone property. Amazon Web Services (AWS) News identified three types of assets with interests as a QOZ:

  • qualified opportunity zone stock
  • qualified opportunity zone partnership interests
  • qualified opportunity zone business property

Secondary QOZ investing

The IRS allows you to track the reinvestment of gross capital gains from the sale or exchange of one QOZ property (or more) into another QOZ elsewhere. It doesn’t matter what QOZ you choose; you must reinvest within 180 days as you did with the original QOF.

Record the original gains that you reinvested in the first property. When the time comes for you to sell the newer investment, the difference between the purchase price and the appreciation of the asset becomes the new (secondary) capital gains. You have the option to defer all or part of the capital gains from the secondary investment. If you receive income distributions over the life of the investment, you will likely pay taxes which will depend on the kind of business it is.

Concerns and drawbacks of QOZs

Forbes suggests a word of caution on QOZ investing. Here’s one example. A properly executed multifamily property venture can be developed and sold in under five years. If the managing partners wanted to sell the property at five years, they would only be able to reap a 10% reduction in taxable capital gains for their partners.

Let’s consider a repositioning scenario. If a capital manager purchases a Class “C” multifamily property to renovate and reposition it as a Class “B” building within a QOZ to sell at seven years, private investors would realize only a 15% reduction in taxable capital gains. Rental income from a QOZ property may not be considered a QOZ qualifying business. You may be taxed on earnings like a non-QOZ area. Is the worth the added upside risk of an economically disadvantaged area if QOF income is taxed the same? There are many questions still since the IRS is still defining rules and the program is still new.

A better way to invest in real estate

Everyone knows real estate is an important asset to consider for investing. The tricky part is making the best choice for real estate investing QOZ or not. Wealth managers at a firm like SD Mayer can help you to determine what classes of real estate can add diversification and value to your portfolio. The best advisors in business have a holistic view of your overall goals for wealth generation or preservation long-term, and can help you figure out which investments will suit you best.

SD Mayer is a full-service advisory and accounting firm located in the Financial District of San Francisco. With decades of combined experience at work, our wealth managers can help you to make some key decisions about investing in QOZs to put your mind at ease. Contact us to get started with an initial consultation.

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