How to Invest in Qualified Opportunity Zones: Step-By-Step
An expert in QOZ programs walks us through how to benefit from some significant tax-deferral opportunities (and, if you hold your investment long enough, tax-free gains!).
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Qualified opportunity zone (QOZ) programs provide tax incentives that encourage investors to invest in designated census tract areas throughout the U.S., which can provide jobs and increase tax revenue through economic development. The idea is to generate more opportunities for more Americans through economic stimulus.
The primary benefit of investing in these communities under a qualified opportunity zone program is the deferral of capital gains tax liability, as well as the possibility of a 100% tax-free gain on the investment if held to the required term.
This article will show you how to invest in a qualified opportunity zone (opens in new tab) and will provide you with a step-by-step guide and other important information you need to know.
A Brief Overview
To boost economic growth in communities across the country, the Tax Cuts and Jobs Act of 2017 introduced numerous tax incentives that grant significant tax benefits to taxpayers who invest in these designated areas. These incentives include:
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- Capital gains taxes are deferred until December 31, 2026, generally considered payable in 2027. Due to bipartisan support, Congress is now considering an amendment that would extend the qualified opportunity zone program to 2028.
- 10 years of holding the original investment entitle an investor to 100% tax-free gains.
The Steps for Investing in an Opportunity Zone
1. Find out where opportunity zones are available.
Currently, there are 8,741 qualified opportunity zones (opens in new tab) across the U.S., including the District of Columbia, and other U.S. territories. An interactive map (opens in new tab) is available on the Department of Housing and Urban Development’s website that shows all the QOZs.
While qualified opportunity zones (opens in new tab) exist in all 50 states, New York, Arizona and Texas are among the states with the highest percentage of opportunity zones.
Many of the country’s top real estate development firms offer institutional quality real estate investments in ready-made qualified opportunity zone funds (QOFs), available to accredited investors only. These investments include Class A apartment buildings, industrial warehouses, life science facilities, self-storage, student housing and hotels.
An investor may wish to consider the convenience of investing in a ready-made institutional quality QOF that invests in assets that would be out of reach for most individual investors due to the investments’ size and scope. Many of these funds are capitalized with $100 million or more. QOFs of this nature are available in fractional denominations from securities registered investment advisers and/or broker-dealers.
2. Create your own opportunity fund, or find one that is accepting investment capital.
A qualified opportunity fund is an investment vehicle structured as a REIT or partnership with the specific objective of investing in opportunity zone assets. The fund must hold and invest at least 90% of its assets in qualified opportunity zone properties and qualified opportunity zone businesses.
To reap the tax benefits introduced by the Tax Cuts and Jobs Act of 2017, investors cannot invest their capital gains directly into an opportunity zone. Instead, all opportunity zone investments must pass through a qualified opportunity fund to qualify for the associated tax incentives.
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.
A variety of investments can then be made with these funds, including investments in stocks, partnership interests or business property. As for the latter, the fund must significantly improve the qualifying property. QOFs may also invest in multiple QOZs as long as at least 90% of their assets are invested in the QOZs.
3. Invest in qualified opportunity zones and apply investment strategies for leveraging capital gains.
The IRS and the U.S. Treasury Department clearly state that only capital gains can be invested in QOFs, which would be channeled into qualified opportunity zone properties or businesses.
Let’s break that down a little more:
- Ordinary income consists of wages and interests, including your salary and interests you get on savings or certificate of deposit accounts. Dividends on stocks are also regarded as regular income. Ordinary income cannot be invested in a QOF.
- Capital gains are generated when you sell a capital asset for a price that’s higher than its purchase basis. This includes gains from the sale of stocks, closely held businesses, real estate, cryptocurrency, art, cattle or just about any other type of investment that could generate a capital gain.
Make sure you meet the deadline.
Investments in opportunity zones can help you defer taxes and create tax-free investments. In exchange for an equity stake in the QOF (qualifying investment), the eligible gain must be invested in a QOF within 180 days of triggering the capital gain.
How long should you hold your investment in a qualified opportunity zone?
Investors who want to defer taxes on capital gains can receive tax benefits from opportunity zones if they meet specific time requirements for investing the realized gain in a qualified opportunity fund (QOF). As a result, investors can postpone paying taxes on realized capital gains until December 31, 2026 (possibly extended to 2028).
For the gains to be 100% tax-free, the investment in a QOF needs to be held for 10 years. The combination of tax deferral and tax-free investing can provide a significant advantage to QOF investments versus other traditional investments that are taxed on investment gains. A good adviser should be able to provide a side-by-side comparison for an investor of paying taxes on capital gains today versus deferring them and investing in a QOF with tax-free growth.
Investing in qualified opportunity zones (opens in new tab) isn’t that complex, as long as you adhere to the regulations set in place by the IRS, which clearly state that you as an investor, cannot invest in a qualified opportunity zone directly. However, you can create a qualified opportunity fund, or find a ready-made QOF, which can invest the funds for you into designated QOZs on your behalf. This will allow you to defer taxes and grow your investment tax-free if held to the required 10-year timeline.
Many of the QOFs offered by real estate development firms plan to but do not guarantee a return of capital tax-free during the five-year mark of the investment via a cash-out refinance. This can help an investor with the liquidity they may need to pay future taxes, but an investor should have other sources to pay the tax, because the cash-out refinance is not guaranteed.
Daniel C. Goodwin, Provident Wealth Advisors (opens in new tab) and AAG Capital, Inc. (opens in new tab) are not attorneys and do not provide legal advice. Nothing in this article should be construed as legal or tax advice. An investor would always be advised to seek competent legal and tax counsel for his or her own unique situation and state-specific laws. Visit our website at www.provident1031.com (opens in new tab).
This article was written by and presents the views of our contributing adviser, not the Kiplinger editorial staff. You can check adviser records with the SEC (opens in new tab) or with FINRA (opens in new tab).
Daniel Goodwin is a Kiplinger's contributor on various financial planning topics and has also been featured in U.S. News and World Report, FOX 26 News, Business Management Daily and BankRate Inc. He is the author of the book Live Smart - Retire Rich and is the Masterclass Instructor of a 1031 DST Masterclass at www.Provident1031.com (opens in new tab). Daniel regularly gives back to his community by serving as a mentor at the Sam Houston State University College of Business. He is the Chief Investment Strategist at Provident Wealth Advisors, a Registered Investment Advisory firm in The Woodlands, Texas. Daniel's professional licenses include Series 65, 6, 63 and 22. Daniel’s gift is making the complex simple and encouraging families to take actionable steps today to pursue their financial goals of tomorrow.
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