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Is Your Investment Eligible for the Qualified Opportunity Zones Update?

What are Qualified Opportunity Zones (QOZ)?

If you're not familiar with Qualified Opportunity Zones (QOZ), you're not alone.

A QOZ is a community or region that has been nominated by the state, then certified by the U.S. Treasury Department that it qualifies for the program. These zones are typically areas that have limited economic opportunities, so opening or expanding businesses into these areas can result in significant tax savings for your business. There are about 8,700 Qualified Opportunity Zones located in all the 50 U.S. states, Washington, D.C., and in U.S. territories.

But how does the program work and how can your business benefit? In this article, we'll get into details about how your business can qualify for the program and what the benefits can be, as well as information on the recent update from the IRS.

How Does the Program Work?

When you sell or exchange appreciated property, you can defer your capital gains if you reinvest the realized capital gains in a Qualified Opportunity Fund within 180 days from the sale date. The fund can then invest in QOZ properties, helping to expand the economic opportunities in these distressed areas. Though the return of principal can also be invested, only the capital gains portion is exempted from tax if it appreciates further when used for the QOZ investment. However, the capital gains do not need to be invested in similar types of property to receive the deferral.

If the reported capital gain is received from flow-through entities (including partnerships, trusts, estates, or S corporations), you have 180 days from the calendar year's end to make the investment in a Qualified Opportunity Fund, no matter how early the entity realized the gain in the calendar year. Now that you understand the basic rules of the process, what exactly is a Qualified Opportunity Fund?

It is an investment vehicle, organized as a partnership or corporation, that has been created for the purpose of investing in QOZ properties which requires that the company holds a minimum of 90% of the company's assets in the QOZ property. As with similar investments, Qualified Opportunity Funds can either rise or fall in value over the investment period and income can be paid on these investments, depending on the specific terms. Because the program's purpose is to improve economically disadvantaged areas, the expectation is that the fund will continue investing in improving the properties it has invested in, with cash flow occurring once improvements are done and the property has been sold or leased to a third party.

The property would have to have been acquired after the end of the 2017 calendar year. Launched through the 2017 Tax Cuts and Jobs Act, this program is still fairly new and, as with many new tools, there is some risk involved in the investment process. This can include issues such as liquidity risk, business risk, and market loss, among others. This is among the reasons why it's important to carefully consider whether QOZ property investment is a good one for your needs.

By concept, Qualified Opportunity Funds bring property new to the entity that can be used in the QOZ. Funds that only acquire properties that are already in use within the QOZ don't qualify unless they have substantial improvement, which requires the improvements to exceed the initial investment or the cost of the property, in an existing property over the scale of a 2.5-year period of time. Recreational facilities including racetracks, golf courses, massage parlors, country clubs, hot tub facilities, liquor stores, and gambling facilities are not allowed to be used for Qualified Opportunity Fund investment options.

In December 2019, the final regulations for QOZs were released, published in January 2020's Federal Register, but questions about several key elements have remained. April 2020 saw correcting amendments, as with August of 2021, which has provided much-needed clarity to the issue. These issues include:

  • The 70% tangible property test (also known as the substantially all tangible property standard) is automatically satisfied in the working capital safe harbor period or periods.
  • Any tangible property that is expected to be acquired through the written plan is to automatically be treated as QOZ business property in the safe harbor period or periods.
  • Working capital assets that are otherwise covered by safe harbor, however, are not considered QOZ business property, nor are working capital assets treated as tangible property after the safe harbor period or periods end.
  • Self-decertification processes for Qualified Opportunity Funds have been simplified but can be affected in forms and manners as prescribed by the IRS, with expectations for modifications to Form 8996.

By understanding what the options, limitations, and changes have been to QOZ investment opportunities, you can make a smarter decision for your needs.

If you have any questions about QOZ investment opportunities, please contact one of our professionals.

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Biz Tip Topic Expert: Chris Fearn, CPA

Chris Fearn, CPA

Chris is a Principal with SVA Certified Public Accountants with expertise in the real estate and nonprofit industries. In his role, he manages and performs audits for owners of affordable multifamily housing projects receiving Section 42 Low-Income Housing Tax Credits.

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