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What is a QOZ?

What is a QOZ?

March 07, 2024

A Qualified Opportunity Zone (“QOZ”) is a designated area, often identified as economically distressed, in which certain investments may provide favorable tax treatment such as tax deferral and capital gains elimination. QOZ is nominated by the governors of each U.S. state and territory and certified by the U.S. Treasury Department. As of now, there are more than 8,700 communities designated as QOZs throughout the United States.

What are the potential perks of QOZ investment?

The QOZ program is created by the Tax Cuts and Jobs Act of 2017. Investors capitalize on the benefits of QOZs through investment vehicles called Qualified Opportunity Fund (“QOF”). A QOF is a fund that is organized as a corporation or a partnership which holds at least 90% of its assets in QOZ property.

The two major advantages brought by QOZs are tax deferral on capital gains and potential tax savings on investment appreciation.

  • A taxpayer may elect to defer the tax on his or her capital gain if they invest in a QOF within 180 days starting on the date of the sale/exchange that generates the capital gain. They will be able to defer the capital gain tax until the earlier of the day their interest in QOF is sold or Dec.31st, 2026 (shown on the 2026 tax return filed in 2027); It's important to note that when capital gains are derived from a flow-through entity, such as a partnership, taxpayers are afforded extra flexibility in commencing their 180-day investment window. They have the option to initiate the 180-day period on either the final day of the flow-through entity's tax year or on the tax return due date for the entity.
  • If an investor can hold his or her investment in QOF beyond 10 years, he or she is eligible to avoid income tax on the appreciation portion of the investment. For example, a taxpayer rolls over his $1 million capital gain into a QOF fund in 2024. In 2035, he sells the investment for $2 million. The increase of $1 million in value is non-taxable.

Additionally, it's important to note that while QOZ investments might initially appear risky due to their focus on low-income areas, the designation criteria stem from the 2010 Census. Consequently, many regions classified as “economically distressed” at that time have since experienced significant recovery.

Who are the suitable investors?

QOZ presents opportunities for taxpayers who have a significant amount of capital gain and who have the mindset of a long-term investor. Since QOZ investment allows taxpayers to defer and potentially reduce their capital gain tax liability, entrepreneurs and company founders who sell their businesses after years of value growth can benefit tremendously from QOZ. Moreover, not only tech-savvy entrepreneurs but also regular individuals like you and me, who have seen capital gains from stocks or real estate, can leverage QOZ investments to their benefit as well.

More factors to consider

Although there are many advantages to having a QOZ, there can be certain disadvantages if not set up properly or if the fund simply isn’t a fit for you. It is critical to look at the big picture, encompassing an individual’s tax scenarios, liquidity needs, financial goals and risk tolerance, before making an investment decision. To take full advantage of QOZ tax benefits, the investment must be held for 10 or more years. It’s difficult to forecast what an investment will look like 10 years down the road, which makes comparing QOZ investments to other long-term investments a complicated task, to say the least. Therefore, it would be advisable to discuss this opportunity with an expert who understands both your tax affairs and personal financial landscape prior to committing to an investment.

Reach out to us today to discover how we can help you plan for your tax future with QOZ opportunities.