Using a Qualified Opportunity Zone Fund to Defer and Exclude Capital Gains
A Qualified Opportunity Fund is an investment vehicle that is set up as either a partnership or corporation for investing in eligible property that is located in a Qualified Opportunity Zone.
Below are frequently asked questions about Qualified Opportunity Funds:
Q. What is a Qualified Opportunity Zone?
A. The QOZ regime contained in the Tax Cuts and Jobs Act (“TCJA”) allows taxpayers to defer tax on capital gains from the sale of investments if the capital gain is invested within 180 days in a qualified opportunity fund (“QOF”). The deferral of the capital gains invested may last until December 31, 2026 and may also allow the taxpayer to exclude up to 15% of the deferred gain completely.
More importantly, the TCJA allows for a permanent exclusion (through a basis step-up) of capital gains derived from the later sale of the investment in a QOF provided that is held for at least ten years. Proposed regulations permit an investor to hold its investment in a QOF until December 31, 2047 and still receive the benefit of capital gain exclusion.
Q. What is an Opportunity Zone?
A. An Opportunity Zone is an economically-distressed community where new investments, under certain conditions, may be eligible for preferential tax treatment. Localities qualify as Opportunity Zones if they have been nominated for that designation by the state and that nomination has been certified by the Secretary of the U.S. Treasury via his delegation of authority to the Internal Revenue Service.
Q. How were Opportunity Zones created?
A. Opportunity Zones were added to the tax code by the Tax Cuts and Jobs Act on December 22, 2017.
Q. Have Opportunity Zones been around a long time?
A. No, they are new. The first set of Opportunity Zones, covering parts of 18 states, were designated on April 9, 2018. Opportunity Zones have now been designated covering parts of all 50 states, the District of Columbia and five U.S. territories.
Q. What is the purpose of Opportunity Zones?
A. Opportunity Zones are an economic development tool—that is, they are designed to spur economic development and job creation in distressed communities.
Q. How do Opportunity Zones spur economic development?
A. Opportunity Zones are designed to spur economic development by providing tax benefits to investors. First, investors can defer tax on any prior gains invested in a Qualified Opportunity Fund (QOF) until the earlier of the date on which the investment in a QOF is sold or exchanged, or December 31, 2026. If the QOF investment is held for longer than 5 years, there is a 10% exclusion of the deferred gain. If held for more than 7 years, the 10% becomes 15%. Second, if the investor holds the investment in the Opportunity Fund for at least ten years, the investor is eligible for an increase in basis of the QOF investment equal to its fair market value on the date that the QOF investment is sold or exchanged.
Q. What is a Qualified Opportunity Fund?
A. A Qualified Opportunity Fund is an investment vehicle that is set up as either a partnership or corporation for investing in eligible property that is located in a Qualified Opportunity Zone.
Q. I am interested in knowing where the Opportunity Zones are located. Is there a list of Opportunity Zones available?
A. Yes. The list of designated Qualified Opportunity Zones can be found at Opportunity Zones Resources and in the Federal Register at IRB Notice 2018-48. Further a visual map of the census tracts designated as Qualified Opportunity Zones may also be found at Opportunity Zones Resources.
Q. Can a limited liability company (LLC) be an Opportunity Fund?
A. Yes. A LLC that chooses to be treated either as a partnership or corporation for federal tax purposes can organize as a Qualified Opportunity Fund.
Q. I sold some stock for a gain in 2018, and, during the 180-day period beginning on the date of the sale, I invested the amount of the gain in a Qualified Opportunity Fund. Can I defer paying tax on that gain?
A. Yes, you may elect to defer the tax on the amount of the gain invested in a Qualified Opportunity Fund. Therefore, if you only invest part of your gain in a Qualified Opportunity Fund(s), you can elect to defer tax on only the part of the gain which was invested.
Q. How do I elect to defer my gain on the 2018 sale of the stock?
A. You may make an election to defer the gain, in whole or in part, when filing your 2018 Federal Income Tax return. That is, you may make the election on the return on which the tax on that gain would be due if you do not defer it.
Q. I sold some stock on December 15, 2017, and, during the required 180-day period, I invested the amount of the gain in a Qualified Opportunity Fund. Can I elect to defer tax on that gain?
A. Yes. You make the election on your 2017 return. Attach Form 8949, reporting Information about the sale of your stock. Precise instructions on how to use that form to elect deferral of the gain will be forthcoming shortly.
Q. Can I still elect to defer tax on that gain if I have already filed my 2017 tax return?
A. Yes, but you will need to file an amended 2017 return, using Form 1040X and attaching Form 8949.
Q. Can I defer section 1231 capital gain net income for a taxable year under the Opportunity Zone rules?
A. Yes. If a taxpayer’s section 1231 gains for any taxable year exceed the section 1231 losses for that year, the net gain is long-term capital gain. A taxpayer can elect to defer some or all of this capital gain under section 1400Z-2 by making an investment of a corresponding amount in a Qualified Opportunity Fund (QOF) during the 180-day period that begins on the last day of the taxpayer’s taxable year.
Q. Can I transfer property other than cash as an investment to a QOF?
A. Yes. A taxpayer can transfer property other than cash as an investment to a QOF. However, a transfer of non-cash property may result in only part of the investment being eligible for Opportunity Zone tax benefits, so that not all of the taxpayer’s capital gain is able to be deferred. See proposed regulations §1400Z2(a)-1(b)(9) & (10).
Q. When I transfer property to a QOF, does my holding period of the property also transfer to my QOF eligible investment?
A. No. The Opportunity Zones tax incentives provisions determine a taxpayer’s holding period in a qualifying investment in a QOF without regard to the holding period of the cash or other property transferred to the QOF.
Q. I deferred gain based on an investment in a QOF, and now that QOF has dissolved before the end of my deferral period. What happens to my deferred gain?
A. When the QOF dissolved, the deferral period ended, and you must include the deferred gain when you file your return, reporting the gain on Form 8949.
Q. I deferred a gain based on an investment in a QOF, and now I gave the investment to my child before the deferral period had ended. Is there anything that I need to do?
A. Yes. The deferral period ended when you gave away the QOF investment. You must include the deferred gain when you file your return, reporting the gain on Form 8949.
Q. When is tangible property “original use” tangible property?
A. Tangible property is original use on the date first placed in service in the qualified opportunity zone for purposes of depreciation or amortization. Used tangible property satisfies the original use requirement if the property has not been previously placed in service in the qualified opportunity zone.