The federal qualified opportunity zone (QOZ) program was enacted in 2017 as part of the Tax Cuts and Jobs Act. It allows individual and institutional investors to tap into substantial tax incentives when rolling over capital gains into investment vehicles, known as qualified opportunity funds (QOFs), that finance projects located in designated underserved communities. With over 8,700 opportunity zones in the U.S. and its territories, the program provides a rich opportunity to channel new investment dollars into these struggling communities while also taking advantage of generational tax break possibilities: a rare opportunity to do well by doing good.
With certain key provisions in the Tax Cuts and Job Act set to begin expiring after 2026, investors face a closing three-year window to maximize the financial advantages baked into the QOZ cake. Yet several compelling factors still make opportunity zones highly favorable for near-term capital deployment — from proposed congressional extensions to specialty sector funds targeting major industries with footprints in qualifying regions.
Let’s examine what continues to make this arena an attractive avenue for tax-free wealth development, even as deadlines loom.
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Core tax incentives driving opportunity zone investments
As many readers are aware, the QOZ program centers on three primary tax incentives for investors rolling existing capital gains from stocks, bonds, business sales, real estate, cryptocurrencies, etc., into qualified opportunity funds within 180 days from the realization of the gain. These funds then deploy those gains into qualifying real estate development or operating businesses located within Census tracts certified as low-income opportunity zones. The primary tax incentives driving investment since 2017 have been:
- Deferral of taxes due on the capital gains invested until December 31, 2026
- Permanent elimination of any taxes owed on appreciation of the opportunity zone investment if held for at least 10 years
A three-year tax deferral on capital gains taxes is certainly valuable but pales in comparison to the possibility of an investment that could potentially be entirely free of any capital gains taxes, provided it’s held for at least 10 years.
With over $10 billion already deployed into job-creating community revitalization projects nationwide, the QOZ incentive has seen tremendous traction since its bipartisan origins. However, with the deferral extension ending after 2026, investors looking to maximize value face a ticking clock that is set to sunset the program at the end of December of that year.
Unless …
Proposed legislation could potentially extend QOZs
On the political front, bipartisan efforts through the Opportunity Zones Improvement, Transparency, and Extension Act in Congress seek to strengthen and lengthen QOZ incentives by:
- Making permanent the tax-free appreciation provision for longer-term investments held over 10 years
- Extending capital gains deferral through 2028 — a two-year extension to drive continued near-term investments
- Empowering states to nominate new opportunity zones, based on updated 2020 Census information
- Allowing for qualified opportunity “funds of funds” by enabling a QOF to invest in other QOFs, a practice not permissible under current law
While an uncertain fate awaits in a bitterly divided Congress, it’s also true that Congress was no less divided in 2017 when the original legislation passed, so hope springs eternal. At any rate, the latest bill language signals a willingness by lawmakers to lengthen the most powerful tax provisions, even as parts of the statute are slated to expire after 2026.
The rise of specialized opportunity zone fund strategies
Irrespective of whether legislation can successfully extend the program’s existence, another recent development in the field should provide further incentive to initiate a QOF investment. In the past few years, more niche fund strategies have emerged, targeting specialized industries with major footprints overlapping counties containing certified QOZs. One in particular provides the rare chance to marry a timely investment opportunity to some of the most powerful tax incentives we’ve seen in a generation or more. We’re speaking, of course, about oil and gas QOFs.
In prolific oil states like Texas, specialized QOFs tailor capital raising and asset allocation specifically to the energy sector. The very best funds feature veteran management teams and focus on financing infrastructure or providing expansion/acquisition growth capital to services contractors that are opening new operations in qualifying counties.
The timing couldn’t be better. Despite (or perhaps because of) the proliferation of interest in electric vehicles, a perceived reduction for the need of fossil fuels has led to a sharp reduction in exploratory activity. And as predictably as the rising of the morning sun, demand is now outstripping supply in the oil and gas sector. Perhaps we’ll all be driving battery-operated, windmill-powered cars in the future, but that future is decades away, and here in 2024, the need for fossil fuels is actually increasing, not falling!
Enter these energy-focused QOFs, which allow accredited individuals and institutions to strategically deploy capital gains into tangible drilling, midstream or production assets, while contractually anchoring those assets and activity back into still-recovering communities vulnerable to recurrent industry volatility cycles. As recovering oil regions expand production rapidly among ongoing global supply deficits, new investments in these niche funds could well enjoy embedded exponential growth potential. And all with the sweetener of QOZ benefits like tax-deferred ... or tax-free ... compounding growth!
Compelling reasons to act through late 2026 … and beyond?
Oil-and-gas-targeted qualified opportunity zone funds exemplify sector-specific channels remaining open for those looking to align financial objectives of maximal growth and minimal taxes with outsized social returns on investment. Of course, gains are never guaranteed in the oil and gas sector or in any other investment, and the need to work with an experienced financial team to identify the proper QOF opportunities just can’t be overstated.
While uncertainty hangs over the exact duration of QOZ advantages, compelling reasons persist for qualified investors to put eligible capital gains to work via this program both in 2024 and over the next few years. The confluence of still generous existing tax benefits through 2026, future upside from potential incentive extensions, intergenerational tax exemption on appreciation and sector-specific fund strategies keep opportunity zones offering outsized exposure to burgeoning markets.
Investors just learning about QOFs might think they’ve missed the boat. In fact, while the ideal time to invest in QOFs may have been in 2017, the next best time is right now.
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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 or with FINRA.
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