Opportunity Zones
Reinvesting realized capital gains into a qualified opportunity zone fund within 180 days has multiple tax benefits.
Strategy Overview
An opportunity zone is a designated economically-distressed community where new investments, under certain conditions, may be eligible for preferential tax treatment. If you have realized capital gains (e.g. from the sale of stock), you can re-invest those gains into a Qualified Opportunity Zone Fund (QOZ) within 180 days of realizing the gain. Doing so can provide multiple tax benefits, including deferring the payment of capital gains tax to a future year, potentially reducing the amount of capital gains tax you will owe, and tax-free gains on any appreciation of the QOZ investment.
Tax Details
Opportunity zones were created as part of the Tax Cuts and Jobs Act in 2017. They have a number of unique and specific tax benefits, as well as investment requirements, associated with them. The program is currently set to expire within a few years, but is also under review by congress (e.g. it could be modified or extended).
Investment Requirements
Reinvest capital gains. Investments in QOZs can only be made with realized capital gains (short-term or long-term), and must be made within 180 days. Unlikely some other tax programs (e.g. 1031 exchange), funds do not need to be held in escrow prior to making a QOZ investment
Investments within the QOZ must be in specified areas. QOZ funds must make new investments (typically in real estate or businesses) geographically located in a census tract designated as an opportunity zone
Tax Benefits
Deferred capital gains recognition. If an investment in a QOZ is made, the capital gain is deferred to 2026 (and thus payment is due April 2027). Notably, the capital gain is what is deferred, and as such, tax-loss-harvesting can also be utilized in 2026 to help offset/manage the tax bill
No capital gains tax On QOZ fund appreciation. If the investment in the QOZ fund is held for at least 10 years, the investment receives a 100% step up in basis. Functionally, this means that any appreciation in the value of the investment will not be subject to capital gains tax upon sale or exchange.
Tax basis step-up (not currently applicable) . The program originally included a basis step-up of 10% to 15%, reducing the capital gains tax bill that would be due in April 2027. However, the QOZ investment needed to be made on/prior to December 31, 2021 to achieve the 10% benefit (and December 31, 2019 to achieve the 15% benefit).
Key Benefits
Potential for tax-free gains on the QOZ investment. If you hold the investment in the QOZ fund for at least 10 years, you may be eligible to eliminate capital gains tax on the appreciation of that investment.
Defer capital gains taxes. This deferral applies to the original gains you reinvested in the QOZ fund, allowing you to put off paying taxes on those gains for several years.
Extra time to tax loss harvest. The deferral of capital gains taxes until 2026 gives you time to potentially use tax-loss-harvesting strategies to offset the deferred gains.
Key Considerations/Flags
High fees. QOZ funds often have high fees; frequently exceeding normal private real estate fund fees. These can eat into your return on investment and should be factored into your investment decision.
Primarily real estate investments. Most QOZ investments are in real estate. If you're not comfortable or familiar with real estate investing, this may not be the best strategy for you.
Potential changes to the program. The opportunity zones program is relatively new, and the rules governing it may change as it's reassessed and refined. Changes could impact the tax benefits of these investments (positively or negatively).
State taxation can differ. A handful of states have opted to not conform with federal tax guidance as it relates to QOZs (most notably California). Before investing in a QOZ, we recommend you research your states taxation relating to QOZ investments and plan accordingly.
Strategy: When to Consider This and When to Avoid It
🟢 When to Consider This Strategy:
You have realized capital gains and know the size of the investment you desire to make.
You desire to invest in real estate, and are willing and able to commit to a long-term horizon (e.g. 10+ years for maximum tax benefits).
You're comfortable with the risks associated with investing in economically distressed areas.
🔴 When to Not Use This Strategy:
You need the cash from the sale of the investment.
You're unable or unwilling to invest for a long-term horizon with no access to liquidity.
You're not comfortable with the risks associated with these investments.
🟡 Consider on a Case by Case Basis:
You anticipate you will be in a higher tax bracket in future years
You're concerned that the currently applicable long-term capital gain tax rates will increase in the future
Example
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