Understanding Qualified Opportunity Fund Investments

A Qualified Opportunity Fund (QOF) is an investment vehicle established by Congress in 2017’s Investing in Opportunity Act. The Investing in Opportunity Act revised the U.S. tax code to provide incentives for investments made in designated geographic locations in need of job creation and economic stimulus.

By investing in these specifically designated zones, known as Qualified Opportunity Zones (QOZs), investors can defer, reduce or even eliminate capital gains tax liability, depending on how long the investment is held. As investors enjoy the significant tax benefits of QOFs, their money enables local communities to experience the same economic growth as more affluent areas of the state and country.  Tax incentives can also attract investor capital to spur economic development in rural parts of a state.

Like any investment, it is important to understand the details — as well as potential risks and rewards — that a QOF can offer before deciding to proceed.

Adopted as part of the Tax Cuts and Jobs Act 2017, this legislation was intended to fuel economic growth in those parts of the U.S. that have yet to fully recover from the recessionary conditions that peaked in 2008.

Government intervention alone is insufficient to bring economic stability back to these regions. So, to encourage private sector capital investments in disadvantaged areas, Congress instituted legislation in the form of the Investing in Opportunity Act.

A QOF investment is similar in some ways to a 1031 tax-deferred exchange. What 1031 exchanges provide for the real estate investor, Opportunity Zone investing provides for owners of businesses and investors in stocks and bonds. 1031 exchangors can defer the payment of capital gains tax on the sale of real estate, while business owners and investors are able to defer and partially eliminate capital gains tax on the sale of a business, stock, bonds, mutual funds, and almost all other types of assets, which normally trigger capital gains on sale. 1031 exchanges still make sense when selling appreciated real estate, but QOFs cover most all of the other asset classes. 1031 exchanges allow real estate investors to defer the payment of capital gains tax indefinitely and eliminate the tax altogether for heirs upon death. Investors in QOFs defer the payment of tax, but only for a specified time period. There are situations where QOFs make sense even for the sale of real property. While 1031 exchanges eliminate capital gains tax altogether for heirs upon death, the gains realized by the eventual sale of a QOF are eliminated for the living.

Upon the sale of a qualifying, appreciated business ownership, stocks, bonds, or real estate, investors have 180 days to invest the capital gains portion of the sale proceeds in one or more Opportunity Funds. There is no limit on the dollar amount of capital gain proceeds that may be invested into Opportunity Funds.

Opportunity Funds are organized as corporations, partnerships, or LLCs. Qualified Opportunity Funds may invest contributed monies into real estate development projects located in a Qualified Opportunity Zone (QOZ) and/or ownership interest (partnership or stock) in businesses based or primarily operating in QOZs.

If the investment is held through 2026, capital gains can be deferred until the tax reporting deadline in 2027. Holding the investment for five years allows you to take a 10% reduction in capital gains liability. Hold it for seven years and your reduction increases to 15%. If you hold a QOF investment for 10 years, you can permanently exclude any appreciation from capital gains liability.

Before moving forward with a QOF investment, it’s important to research potential funds carefully. Since the offering of QOFs to the public are considered securities, disclosure documents are requisite for sponsors to provide to potential investors. Take your time to evaluate, along with professional advisors. not only the merits of the proposed investments by the fund, but the management team, and the compensation structure for the sponsor and affiliated entities.

Qualified Opportunity Funds are available, which invest in the construction of multi-family housing, hotels, retail, office, senior-living, industrial facilities, mobile home parks, and most every other real estate property type. Some funds offer a diversified portfolio of properties, while others have one property per fund. Some funds concentrate in one geographical area, while others invest anywhere the sponsor determines the opportunity for appreciation is the greatest. More and more funds are becoming available that are equivalent to “venture capital” funds, providing capital to startups or expanding companies.