Utilizing a Qualified Opportunity Zone Fund as a Tax Mitigation Strategy
Despite its potential to offer benefits for all kinds of capital gains taxes, the qualified opportunity zone (QOZ) program is often overlooked by investors.
What is the Qualified Opportunity Zone (QOZ) Program?
The QOZ Program was created by the federal government in 2017 as part of the Tax Cuts and Jobs Act to encourage investment in lower-income communities across the United States. The program provides tax incentives in exchange for the commitment of long-term capital to these communities through investment vehicles known as Qualified Opportunity Funds (QOF).
Selected by a state governor for inclusion in the QOZ Program, each qualified opportunity zone is a designated census tract that meets the program requirements and is certified by the U.S. Department of Treasury for inclusion in the QOZ Program. There are more than 8,700 qualified opportunity zones across the United States.
How does the Qualified Opportunity Zone (QOZ) Program work?
A Qualified Opportunity Fund (QOF) is an investment vehicle that is organized as either a partnership or corporation and holds at least 90% of its assets in QOZ property. QOFs can hold single or multiple assets and are able to make investments in a wide variety of real estate. These investments include Class A apartment buildings, industrial warehouses, life science facilities, self-storage, student housing, and hotels.
Investors that are considering including QOFs in their investment portfolio have the option to set up and manage their own QOF or skip the set up work and take advantage of professional management services through a company like Legacy. Those that choose to use the DIY method will be responsible for creating the entity (typically a partnership LLC, S-corp, or C-corp), filing the required IRS forms, covering any associated formation costs, and ensuring that their QOF meets the various compliance requirements at regular intervals. Legacy’s partnership with leading sponsor companies provides investors with access to an inventory of professionally managed QOFs.
How can you benefit from the Qualified Opportunity Zone (QOZ) Program?
The Qualified Opportunity Zone (QOZ) Program could be beneficial to investors with sizable capital gains and an interest in:
Reducing their federal income tax liability
Deferring capital gains recognition
Potentially eliminating future capital gains taxes altogether
Tax deferral vs. tax elimination in a Qualified Opportunity Fund
The potential tax benefits of investing in a QOF Program can be organized as either tax deferral or tax elimination.
Tax Deferral
If a taxpayer invests the capital gain from the sale of any property into a QOF within 180 days of recognizing the gain, taxes on such proceeds may be deferred until December 31, 2026 or the disposition of the QOF interest, whichever comes first.
To be eligible for deferral, the capital gain must be treated as such for federal income tax purposes and must be from the sale or exchange of property with an unrelated party that shares less than 20% common ownership. This includes gains from stocks and bonds, hedge funds, primary or secondary residences, businesses, land, livestock, and commercial buildings.
Tax Elimination
Investors that hold their investment for a ten-year minimum receive a step-up in basis. This means that they pay no tax on the appreciation of their QOF Investment upon disposition of that QOF Investment, regardless of the size of the potential profit. The step-up in basis eliminates any depreciation recapture tax which would otherwise be owed upon the investment’s sale.
To receive the QOF Program tax benefits, the eligible capital gains need to be reinvested into a QOF within 180 days from the sale of an asset.
What can you invest in a Qualified Opportunity Fund?
Only capital gains can be invested in a Qualified Opportunity Fund.
Capital gains are generated when a capital asset is sold for a price that’s higher than its purchase basis. This includes, but is not limited to gains from the sale of:
Stocks
Closely held businesses
Real estate
Art
Livestock
Ordinary income cannot be invested in a Qualified Opportunity Fund.
Ordinary income consists of wages and interests. This includes, but is not limited to income gained from:
Salary
Interests on savings
Interests on certificate of deposit accounts
Dividends on stocks
QOZ Funds as Solution for a Failed 1031 Exchange
Many investors are familiar with the concept of utilizing the 1031 Exchange as a solution for mitigating the capital gains tax that results from the sale of an investment property.
However, few are aware that QOZ funds can offer a solution for a failed 1031 Exchange. Investors with a failed exchange could be required to pay up to 30% in taxes on debt and/or the profits from the property sale. In this situation, QOZs may help investors defer and manage their tax liability.
1031 Exchanges vs. Qualified Opportunity Funds Comparison
1031 Exchanges
Investors must invest all proceeds from the sale of the property to defer all taxes
Replacement property must be identified within the 45 day timeline and closed on within 180 days
Qualified Intermediary must be involved in the transaction
Qualified Opportunity Funds
Investors only need to invest the gain (including any unrecaptured depreciation treated as a capital gain), which allows the individual to pull their basis out
No identification requirement, but the gain must be invested in a QOF within 180 days
Qualified Intermediary is not required
Determining when to utilize a Qualified Opportunity Fund, perform a 1031 Exchange, or implement a combination of both tax-advantaged tools requires a holistic understanding of an investor’s personal finances.
At Legacy, we work with you to build an investment strategy tailored to your unique goals, schedule, skill level, and finances. Give our knowledgeable team a call to learn more about the potential benefits of the Qualified Opportunity Zone Program and if they align with the legacy you want your investments to build.
Legacy Investments & Real Estate is your 1031 Exchange replacement property partner.
Our sole purpose is to guide real estate investors through the 1031 Exchange process. Armed with a deep understanding of our clients’ unique needs and goals, we help identify and secure replacement properties that align with the legacy they want their investments to build.
Ready for professional, tailored guidance on your 1031 Exchange needs?
Other resources you might find helpful
Because investor situations and objectives vary this information is not intended to indicate suitability or a recommendation for any individual investor.
This is for informational purposes only, does not constitute individual investment advice, and should not be relied upon as tax or legal advice. Please consult the appropriate professional regarding your individual circumstance.
Potential cash flows/returns/appreciation are not guaranteed and could be lower than anticipated.
Diversification does not guarantee a profit or protect against a loss in a declining market. It is a method used to help manage investment risk.
There are material risks associated with investing in real estate securities including liquidity, tenant vacancies, general market conditions and competition, lack of operating history, interest rate risks, the risk of new supply coming to market and softening rental rates, general risks of owning/operating commercial and multifamily properties, short term leases associated with multi-family properties, financing risks, potential adverse tax consequences, general economic risks, development risks, long hold periods, and potential loss of the entire investment principal.
The rules and regulations of the QOZ Program are complex, and compliance with the QOZ Program comes with significant challenges such as appreciation unpredictability, certain neighborhoods may be less accommodating to development, illiquidity for up to ten or more years, availability and cost of construction and development financing uncertainty, development and redevelopment real estate risks, as well as a number of Jobs Act interpretation uncertainty which may impact future risks, if any.
Registered Representative and securities offered through Concorde Investment Services, Inc. (CIS), member FINRA/SIPC. Legacy Investments & Real Estate, LLC. is independent of CIS.
#nd-jnb-gp-a-605-6-2024