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Gain Deferral through Qualified Opportunity Zones Funds

By Brett Murphy

PhlQOZ

Map of Philadelphia-area Qualified Opportunity Zones

Last month, the Treasury Department issued proposed regulations clarifying the potential tax benefits to taxpayers who invest in Qualified Opportunity Zones (QOZ) through a Qualified Opportunity Fund (QOF). Introduced by the 2017 Tax Cuts and Jobs Act, QOZ are state-designated census tracts within low-income communities in which a state desires to encourage investment and development.

Investment in qualified opportunity zones provide two major tax benefits for a certain investor-taxpayers:

  • Deferral of capital gain when corresponding amounts are invested properly in a QOF within 180 days of the sale or exchange giving rise to the capital gain.
  • Exclusion of gains on an investment in a QOF held for at least 10 years.

In order for a fund investment to qualify for deferral, a taxpayer must acquire an equity interest in a QOF – defined as a partnership or corporation holding at least 90 percent of its assets in qualified property. Such property includes tangible property that is qualified opportunity zone business property itself and stock or partnership interests of a business in which substantially all of the tangible property of the business is qualified opportunity zone business property.

A deferred gain must be recognized on the date on which the investment is disposed, but in all cases no later than December 31, 2026. If the requirements for deferral are met, the initial capital gain may be reduced by 10% for investments held for at least 5 years and by 15% for investments held for at least 7 years. Practically speaking, taxpayers will only be able to take advantage of the 15% gain reduction for capital gains realized through the end of 2019.

The QOZ rules also provide for an exclusion of the gain on a taxpayer’s eligible investment in a QOF if the taxpayer holds the investment for at least 10 years and the investment was made pursuant to a QOZ capital gain deferral. Investments and portions of investments in a QOF that are not derived from a QOZ capital gain deferral are not eligible for this exclusion.

By way of example, assume a taxpayer realizes $100,000 of gain in 2018 and timely and properly invests all $100,000 in a QOF. Further assume that the taxpayer continues to hold that QOF investment until 2030, when she sells it for $200,000. Under these assumptions, the taxpayer would obtain the following benefits:

  • She will recognize none of the $100,000 gain in 2018.
  • She will recognize only $85,000 of this gain in 2026.
  • She will recognize no gain on the disposition of the QOF interest in 2030.