Qualified Opportunity Fund Investment: All You Need to Know

A Qualified Opportunity Fund (QOF) is an investment vehicle created as part of the Opportunity Zone program, which was established by the U.S. government in 2017. The qualified opportunity zone program aims to promote economic development and job creation in designated low-income communities, known as Opportunity Zones.

In addition, the Qualified Opportunity Fund Investment is made into eligible businesses and properties located within these Opportunity Zones. It allows investors to receive certain tax benefits by investing capital gains into the fund. The goal of the Qualified Opportunity Fund is to gain tax incentives on long-term investments in economically distressed areas, fostering job creation and spur economic development.

Moreover, it’s worth noting that this program looks similar to 1031 Exchanges. So, read our post on the differences between 1031 Exchanges and the Qualified Opportunity Fund Investment program.

In this blog, we will learn all about Qualified Opportunity Fund Investments. So, let’s keep reading:

What is a Qualified Opportunity Fund?

A Qualified Opportunity Fund refers to any investment vehicle that:

• is arranged as a partnership/corporation for investing in Qualified Opportunity Zone property.
• holds a minimum of 90% of assets in Qualified Opportunity Zone property.

Now, you might ask: what is a qualified opportunity zone?

A Qualified Opportunity Zone refers to a specific geographic area or a low-income community as designated by the Internal Revenue Service (IRS). 

To qualify as an Opportunity Zone, an area should meet certain criteria and be nominated by the state and territory governors. The designation is made at the census tract level, which is a small geographic area typically consisting of around 1,200 to 8,000 residents. Here are the criteria for an area to be designated as a Qualified Opportunity Zone:

• Low-Income Communities: The qualified opportunity zone must be a low-income community, as defined by the U.S. Census Bureau. This generally means that the poverty rate is a minimum of 20% or the median family income is below 80% of the surrounding area.
• State Governor Nomination: The governor of each state and certain U.S. territories can nominate a limited number of census tracts to be designated as Opportunity Zones. The number of designations is based on the total number of eligible census tracts in the state or territory.
• Treasury Certification: After receiving nominations from the governors, the U.S. Department of the Treasury reviews and certifies the designated Opportunity Zones.

Tax Benefits of Qualified Opportunity Fund Investment

Investing in Qualified Opportunity Zones through Qualified Opportunity Funds offers several tax benefits and preferential tax treatment. Here are the main advantages:

Deferral of Capital Gains Taxes

The primary benefit is the deferral of taxes on capital gains. When an investor reinvests their capital gains into a Qualified Opportunity Fund within 180 days, they can defer paying taxes on those gains until the earlier of December 31, 2026, or when they sell their investment in the Qualified Opportunity Fund.

Reduction of Deferred Capital Gains

If the investment in the Qualified Opportunity Fund is held for at least five years, the investor receives a step-up in basis, resulting in a 10% reduction on the deferred capital gains. This reduction applies to the amount of the original capital gains that are subject to taxation.

Additional Reduction of Deferred Capital Gains

If the investment in the Qualified Opportunity Fund is held for at least seven years, the investor receives an additional 5% reduction on the deferred capital gains. This also leads to a total reduction of 15% on the original capital gains subject to taxation.

Exclusion of Capital Gains on Qualified Opportunity Fund Investment

The most significant benefit comes after holding the investment in the Qualified Opportunity Fund for at least ten years. In this case, one can choose to exclude any capital gains from the sale or disposition of theQualified Opportunity Fund investment from taxable income. This means the investor pays no capital gains taxes on the appreciation of the Qualified Opportunity Fund investment.

These tax benefits can provide substantial advantages for investors, especially those with significant capital gains. By investing in Qualified Opportunity Zones, investors can defer and potentially reduce their tax liabilities and have the potential to exclude future capital gains altogether if they hold the investment in the Qualified Opportunity Fund for at least ten years.

Eligible Taxpayers for Qualified Opportunity Fund

Eligible taxpayers for Qualified Opportunity Zone investment should be able to recognize a capital gain, and they typically include:

• Individuals
• Partnerships
• Trusts
• S corporations
• Estates
• C corporations, including regulated investment companies (RICs) and real estate investment trusts (REITs).

When partnerships or S corporations defer eligible gains, the deferred gain is not recognized at the entity level. In addition, it doesn’t affect the income distribution to partners or shareholders, and it also does not impact their respective basis.

When the partnership or S corporation decides not to defer eligible gain, the gain becomes part of the partners’ or shareholders’ distributive income share. This influences the individual basis of partners or shareholders in their respective partnership or S corporation interests. At this point, partners or shareholders have the option to defer the gain under the provisions of IRC Sec. 1400Z-2(a)(1)(A).

FAQs

Q: How to make Qualified Opportunity fund investments?

A: First, you need to identify a fund that meets the requirements of the Opportunity Zone program. Then, contact the fund manager or sponsor to inquire about their investment process.

Q: Do Qualified Opportunity Funds allow limitations on the kind of investments?

A: Qualified Opportunity Funds can invest in various types of properties at a fair market value. These properties include residential, commercial, industrial, and mixed-use properties. However, there are limitations on certain activities, such as businesses like casinos, liquor stores, and golf courses.

Q: What is the timeline for investing realized capital gains in a QOF investment?

A: You must invest capital gains in Qualified Opportunity Funds within 180 days. This is from the date of the sale or realization of the gains in order to be eligible for the tax benefits of Qualified Opportunity Funds.

Q: Are there any risks in Qualified Opportunity Zone Funds?

A: As with any investment, it also involves risks. It’s important to carefully review the fund’s offering documents. In addition, assess the potential risks associated with the specific investment, and consult with our financial and tax advisors to make an informed decision.