There has been much discussion regarding the Qualified Opportunity Zone program established via the Tax Cuts and Jobs Act in 2017 because of potential tax advantages. This program aims to incent long-term private sector investment in low-income communities nationwide while allowing investors to potentially defer and partially reduce capital gains tax by investing capital gain amounts (or a portion) in Qualified Opportunity Zone (“QOZ”) through a Qualified Opportunity Zone Fund. When considering a QOZ Fund, as with any investment, it is important to ensure that the investment is sound, prudent and addresses one’s financial objectives.
Types of investments in QOZ Funds
As background, the types of investments that will become QOZ Funds include properties and businesses located in Qualified Opportunity Zones:
Real or personal property, including commercial real estate development and renovations
New businesses established and operating,including manufacturing, wholesale, warehousing and distribution or retail businesses
Expansion of existing businesses or property
QOZ Fund applications and important considerations
This new program has several possible applications aside from the beneficial tax considerations:
Businesses can establish a QOZ Fund in order to raise capital and/or seek co-investment to expand their business, if 90% of their assets are in Opportunity Zone Properties
Investors might consider a QOZ Fund as part of their philanthropic and/or community involvement goals as an impact investment
Investors might consider a QOZ Fund as part of their private real estate and/or private equity strategy
The latter two applications may allow investors the opportunity to defer and partially reduce capital gains tax as noted above.
Although there may be tax benefits to investing capital gains in a QOZ Fund, investors must first address the following questions regarding their fundamental goals and objectives:
How does this investment fit into one’s tax, estate and financial planning objectives?
Taking into account asset allocation, risk tolerance and liquidity needs, how does this investment fit into the one’s big picture investment portfolio?
Is there the possibility of meeting philanthropic and/or community involvement goals?
What is the right QOZ Fund investment
Investment considerations of QOZ Funds
Remember that most QOZ Funds are structured as private investments. Private investments are intended for qualified purchasers and accredited investors who have a fundamental understanding of the inherent risk associated with these types of investments.
A QOZ Fund, like other private investments, is illiquid. To have the opportunity to take full advantage of the tax benefits, the investment of the capital gain amount may not be sold for a 10-year timeframe.Furthermore, interim liquidity may be limited given the requirement that QOZ Funds reinvest sale proceeds from the sale of QOZ property into new QOZ property in order to avoid penalties.
Investors considering a QOZ Fund must carefully assess their risk tolerance and overall asset allocation. Originally, the capital usage requirements set forth in the QOZ program language only allowed for the development of tangible property, therefore the funds initially forming have been predominantly geared toward new ground-up development and/or heavy reposition of expiring real estate assets. Newly issued proposed regulations have made it possible for the development of a trade or business as well, making it possible for operating companies to now consider forming a QOZ Fund. QOZ funds may present investors with risks that are typically not as pronounced in funds acquiring more stabilized, cash-flow oriented assets. This type of investment may have additional risk given the fund rules requiring cash to be deployed more quickly in comparison to other private investments.
Investors must also factor in that QOZ fund managers are currently raising billions to target QOZ investments, and the number is rising each day. All this fresh capital targeting an extremely limited set of attractive QOZ regions creates the potential for fierce competition and, in turn, robust pricing for QOZ assets, especially in the locales with the most favorable market dynamics. It is important for investors to work with fund managers and operators who are familiar with not only the language of the QOZ program, but with the local markets in which they will be investing. Doing so can help investors navigate pitfalls that may arise from elevated competition for assets.
It is imperative not to let the tax benefits overshadow investment-planning essentials in meeting broad
financial goals. As with any investment, sound due diligence is needed in conjunction with consideration of other basic portfolio construction elements when selecting an investment.
This is where a partner like BMO Family Office and our investment management, investment research as well as our tax and financial planning capabilities can help. We are carefully monitoring the QOZ fund landscape as to form and additional guidance becomes available. Our professionals can assist clients with questions regarding QOZ Funds, not only to address questions about which investments may be appropriate, but also to consider whether this type of investment makes sense as part of one’s overall planning objectives.
Important definitions
A Qualified Opportunity Zone is a state designated low income community.
A Qualified Opportunity Zone Fund is a Treasury Department certified entity that holds 90% of the assets in Opportunity Zone Property.
The Tax Incentives Outlined
There are three potential tax incentives to investing in economically distressed communities:
A temporary deferral: An investor can defer capital gains until 2026 by putting and keeping realized gains in an OZ Fund.
A reduction in capital gains: the original amount of capital gains on which an investor has to pay deferred taxes is reduced by 10% if the OZ Fund investment is held for 5 years and another 5% if held for 7 years.
An exemption of capital gains on appreciation: any capital gains on investments made through the OZ Fund accrue tax-free as long as the investor holds them for at least 10 years.
FAQs
If you sold or exchanged your investment in a Qualified Opportunity Fund during the tax year, you must report the amount of gain or loss. To do this, file Form 8949, Sales and Other Dispositions of Capital Assets. You need to know your basis to figure any gain or loss on the sale or other disposition of the property.
How do you qualify for qualified Opportunity Zone Fund? ›
A Qualified Opportunity Zone business must earn at least 50% of its gross income from business activities within a Qualified Opportunity Zone. It must do so for each taxable year.
What are the tax benefits of a qualified Opportunity Zone? ›
The Qualified Opportunity Zone program offers taxpayers a potential federal capital gains tax incentive for investing in economically distressed areas of the US. The potential tax benefits include deferral, discount, and exemption from federal capital gains taxes.
What is a qualifying investment for Opportunity Zone? ›
A QOF is an investment vehicle that files either a partnership or corporate federal income tax return, is organized for the purpose of investing in QOZ property and elects to self-certify as a Qualified Opportunity Fund.
What is an example of a qualified opportunity fund? ›
2 For example, if a property is purchased for $700,000, then the opportunity fund has a 30-month window to make at least $700,000 worth of improvements. Certain types of businesses cannot be included in opportunity funds, even if they reside within opportunity zones. They include: Golf courses.
How do I avoid capital gains tax opportunity zone? ›
Be an entity organized for the purpose of investing in Qualified Opportunity Zone property. Hold at least 90% of its property – such as stock, partnership interests, or real estate – within a QOZ. Self-certify to the IRS using Form 8996 as an Opportunity Fund and verify that they are fulfilling the 90% asset ...
Can I create my own qualified opportunity fund? ›
The fund must hold at least 90% of its assets in qualifying Opportunity Zones property. Q: Who can create an Opportunity Fund? A: Any taxpaying individual or entity can create an Opportunity Fund, through a self-certification process.
Can I invest in a qualified Opportunity Zones without capital gains? ›
Only capital gains can be invested in this program. Investors don't put monies directly into Opportunity Zones. Only QOFs can do so.
What are Opportunity Zone tax benefits for 2023? ›
The new law will allow Qualified Opportunity Zone (QOZ) investors to reduce their capital gains taxes by up to 15% if they re-invest their realized gains in a Qualified Opportunity Fund (QOF) by December 31, 2022, and by 10% if they re-invest by year end 2023.
Can an individual invest in a qualified opportunity zone? ›
A qualified opportunity zone fund can be established by any taxpayer by filing Form 8996 (opens in new tab) and submitting it with their federal income tax return. The purpose of this form is to certify individuals, partnerships or corporations as organizations for investing in qualified opportunity zones.
Investors in qualified opportunity zones benefit primarily from the deferral of capital gains from prior investments. The key benefit of a 1031 exchange is that investors can swap or consolidate investment properties while deferring capital gains taxes at the same time.
What is the difference between 1031 and Opportunity Zone? ›
The QOZ program differs from a 1031 exchange in several ways. A 1031 exchange can now only be used with real estate assets – the investor sells investment real estate and trades into replacement investment real estate. With the QOZ program, gain from the sale of any type of asset – real estate, stocks, bonds, etc.
How risky are opportunity zone investments? ›
Qualified Opportunity Zone (QOZ) investments are among the highest risk opportunities available for real estate investment. It is essentially ground-up development in unproven locations.
Is investing in Opportunity Zones a good idea? ›
Investing in blighted or up-and-coming “opportunity zones” offers some significant tax-deferral opportunities, and if you hold your investment for 10 years, your gains could be 100% tax free.
Can I invest ordinary income into opportunity zone? ›
Qualified opportunity zone tax benefits only apply to capital gains, not to ordinary income. If a transaction produces both ordinary income and capital gains, the entire gain can still be invested in a QOZ if the taxpayer elects to do so, but only the capital gain amount will be eligible for the QOZ benefits.
What are the best qualified opportunity funds? ›
List of Top Opportunity Zone Investors
- 3LB Equities. ...
- GTIS Partners. ...
- Cresset Partners. ...
- Decennial Group. ...
- ODG Fund. ...
- Allagash Partners. ...
- Obsidian Opportunity Fund. ...
- Fund of America.
31, 2026. While some of the tax deferral “goodies” have already expired, the Opportunity Zone 10-year rule can still offer a tax-advantaged strategy for patient investors interested in social improvement.
How do opportunity zone funds make money? ›
Qualified opportunity funds pool money from investors and then use it to purchase properties within an opportunity zone. The fund must then make "substantial improvements" to the property within a 30-month period and which are equal to its value at the time of purchase.
What is a simple trick for avoiding capital gains tax? ›
1. Hold onto taxable assets for the long term. The easiest way to lower capital gains taxes is to simply hold taxable assets for one year or longer to benefit from the long-term capital gains tax rate.
How do billionaires avoid capital gains tax? ›
Portfolio loans
In this option, the concept is the same as was just discussed, except an investment portfolio is used as collateral instead of a home, and no assets need to be sold taxably to access cash. In fact, this is often what billionaires do — take loans against their company stock.
How to Reduce Capital Gains Tax On Stocks
- Control Your Asset Location.
- Consider Donating Appreciated Stock.
- Use Tax-Loss Harvesting.
- Try Qualified Opportunity Funds.
- Know Your Tax Brackets (And Use Them to Your Advantage)
- Add Stock Into Your Estate Plan.
- Realize Capital Gains With A Unified Strategy.
Typical investment minimums can range from $25,000 to $100,000, with some funds requiring a minimum investment of $250,000, or even $1 million.
What is a qualified private fund? ›
(5) Qualifying private fund means any private fund that is not registered under section 8 of the Investment Company Act of 1940 (15 U.S.C. 80a–8) and has not elected to be treated as a business development company pursuant to section 54 of that Act (15 U.S.C. 80a–53).
Can you 1031 into a qualified opportunity fund? ›
Because these programs have different purposes and requirements, the answer to the question, “can I 1031 into an Opportunity Zone?” or rather, “can an investor use the 1031 Section to exchange into a QOZ?” is a resounding NO. The main reason is because the like-kind exchange has a like-kind requirement.
Are qualified opportunity zones going away? ›
2028 — The first year in which some of the earliest Opportunity Zone investments may be sold and qualify for the 10-year gain exclusion. December 31, 2028 — Expiration of the designation of Qualified Opportunity Zones.
Can you still invest in opportunity zones 2023? ›
Don't take your eye off the ball — investing in opportunity zones is well situated to offer meaningful tax benefits to knowledgeable investors. As 2023 is now well under way, it's a good time to take a look at what investing in opportunity zones (opens in new tab) holds for us in the coming year and beyond.
What tax year is needed for 2023 2024? ›
The FAFSA form asks for income and taxes paid according to lines on the IRS tax forms for 2021, the “base year” for 2023-2024. Data from the completed tax year is used as a predictor of the family's financial situation for the current year.
What must the two properties do to qualify for a 1031 tax deferred exchange? ›
Both properties must be held for use in a trade or business or for investment. Property used primarily for personal use, like a primary residence or a second home or vacation home, does not qualify for like-kind exchange treatment. Both properties must be similar enough to qualify as "like-kind."
Can you combine 1031 exchange and Opportunity Zone? ›
Conclusion. Both a 1031 exchange and an Opportunity Zone investment can be used to reinvest gains from the sale of a property to defer taxation and gain tax benefits.
What are exclusions for 1031 exchange? ›
The 1031 exchange can only be used with property that has been held for rental, investment or use in your business. It does not apply to property held for personal use such as your primary residence, second home or vacation property, although certain exceptions may apply as outlined in Revenue Procedure 2008-16.
Deferring Capital Gains Tax
The biggest pro of 1031 exchanges is being able to defer capital gains taxes. When you can defer capital gains taxes, it allows you to grow wealth faster, as the amount of money you started with into the first investment is now even more money than it was before.
Should I do a 1031 exchange or pay capital gains? ›
The main benefit of carrying out a 1031 exchange rather than simply selling one property and buying another is the tax deferral. A 1031 exchange allows you to defer capital gains tax, thus freeing more capital for investment in the replacement property.
What are the benefits of buying a property in an Opportunity Zone? ›
Opportunity Zones offer tax benefits to investors who elect to temporarily defer tax on capital gains if they timely invest those gain amounts in a Qualified Opportunity Fund (QOF).
What is the biggest problem with opportunity zones? ›
Opportunity zone residents have higher poverty rates, lower incomes, and lower educational attainment than the U.S. population as a whole.
What are the three most risky investments? ›
While the product names and descriptions can often change, examples of high-risk investments include:
- Cryptoassets (also known as cryptos)
- Mini-bonds (sometimes called high interest return bonds)
- Land banking.
- Contracts for Difference (CFDs)
Opportunity Zone Investor Cash Flow Example
As you can see above, the two investment options have the exact same annual rate of return (7.5%) but the QOF generates almost $43,000 of additional sales proceeds after ten years due to the preferential tax treatment.
What is the safest investment opportunity? ›
U.S. Treasury bonds are widely considered the safest investments on earth. Because the United States government has never defaulted on its debt, investors see U.S. Treasuries as highly secure investment vehicles.
What is the 20% rule for Opportunity Zone? ›
The QOZ business property must be acquired from an unrelated person. If the QOZ business and selling entity are partnerships for tax reasons, the seller and the buyer will be considered related by the IRS if the same persons directly or indirectly own more than 20% of the capital interests or profit interests.
What are the fees for Opportunity Zone Fund? ›
Essentially, there's a 1.5% asset management fee on net assets per year. Investors then receive: 4% preferred distribution annually on their investment and a full return of their capital; For remaining profits, investors get 85% and the General Partner receives 15%;
What IRS code section is opportunity zone? ›
IRC section 1400Z-2 provides rules for the treatment of capital gains under the Opportunity Zone program created by the Tax Cuts and Jobs Act.
Opportunity Zone FAQs
If you invest in an opportunity zone REIT, the distributions will be taxed as ordinary income. Distributions in a partnership are tax-free.
How do I report foreign investment income to the IRS? ›
Use Form 8938 to report your specified foreign financial assets if the total value of all the specified foreign financial assets in which you have an interest is more than the appropriate reporting threshold.
How do I report an investment property on 1040? ›
Use Schedule D (Form 1040), Capital Gains and Losses and Form 8949, Sales and Other Dispositions of Capital Assets to report sales, exchanges, and other dispositions of capital assets. Property (Basis, Sale of Home, etc.)
What are opportunity zone tax benefits for 2023? ›
The new law will allow Qualified Opportunity Zone (QOZ) investors to reduce their capital gains taxes by up to 15% if they re-invest their realized gains in a Qualified Opportunity Fund (QOF) by December 31, 2022, and by 10% if they re-invest by year end 2023.
Can you invest in Opportunity Zones without capital gains? ›
One question that sometimes pops up is: “Can I invest non-capital gains into an opportunity zone?” The answer is no, for two reasons: Only capital gains can be invested in this program. Investors don't put monies directly into Opportunity Zones.
What is the difference between 1031 and opportunity zone? ›
The QOZ program differs from a 1031 exchange in several ways. A 1031 exchange can now only be used with real estate assets – the investor sells investment real estate and trades into replacement investment real estate. With the QOZ program, gain from the sale of any type of asset – real estate, stocks, bonds, etc.
How does a qualified opportunity fund work? ›
A Qualified Opportunity Fund is any investment vehicle that is organized as a corporation or a partnership for the purpose of investing in Qualified Opportunity Zone property (other than another Qualified Opportunity Fund) that holds at least 90% of its assets in Qualified Opportunity Zone property.
How much of my 401k distribution is taxable? ›
401(k) distribution tax form
When you take a distribution from your 401(k), your retirement plan will send you a Form 1099-R. This tax form shows how much you withdrew overall and the 20% in federal taxes withheld from the distribution.
How does IRS know about foreign income? ›
One of the main catalysts for the IRS to learn about foreign income which was not reported is through FATCA, which is the Foreign Account Tax Compliance Act. In accordance with FATCA, more than 300,000 FFIs (Foreign Financial Institutions) in over 110 countries actively report account holder information to the IRS.
Do US citizens have to pay taxes on foreign investment income? ›
When Americans buy stocks or bonds from a company based overseas, any investment income (interest, dividends) and capital gains are subject to U.S. income tax.
The Foreign Earned Income Exclusion (FEIE, using IRS Form 2555) allows you to exclude a certain amount of your FOREIGN EARNED income from US tax. For tax year 2022 (filing in 2023) the exclusion amount is $112,000.
Do you have to report all investments on taxes? ›
Yes, in that the IRS requires all investment income to be reported when your income tax return is filed.
Is an investment property a good tax deduction? ›
Main tax benefits of owning rental property include deducting operating and owner expenses, depreciation, capital gains tax deferral, and avoiding FICA tax. In most cases, income from a rental property is treated as ordinary income and taxed based on an investor's federal income tax bracket.
What is the $250000 / $500,000 home sale exclusion? ›
You can sell your primary residence and be exempt from capital gains taxes on the first $250,000 if you are single and $500,000 if married filing jointly.
