Qualified Opportunity Fund Tax Rules
A Qualified Opportunity Fund (QOF) offers investors the attractive benefit of being able to defer and potentially reduce their taxes on the fund’s recognized capital gains. Established as part of the 2017 Tax Cuts and Jobs Act, the Qualified Opportunity Zone (QOZ) program provides such tax incentives to private capital investors (US taxpayers) who make long-term investments in businesses located in economically distressed communities.
But as with any tax incentive, certain rules must be met for a QOF to meet opportunity zone eligibility. In this post, you will learn more about the QOF rules and requirements.
Opportunity Zone Requirements
Before a distressed community can be classified as an Opportunity Zone, it first needs to be nominated for that designation by the state, the District of Columbia, or the U.S. territory it is located in. Once nominated, the locality can only be classified as an Opportunity Zone after it has been certified by the Secretary of the U.S. Treasury via his or her delegation of authority to the Internal Revenue Service (IRS).
A Qualified Opportunity Fund is an investment product that is organized as a corporation or a partnership for the sole purpose of investing at least 90% of its assets in Qualified Opportunity Zone Properties.
Opportunity Zone Fund Rules for Deferring Capital Gain Tax
An investor can defer the income tax recognition of realized short-term and long-term capital gains that are invested in a Qualified Opportunity Fund until he/she has an inclusion event or by December 31, 2026, whichever comes first. An inclusion event is any event that reduces or terminates the investor’s investment in a Qualified Opportunity Fund, such as:
an event that reduces the taxpayer’s equity interest in the QOF;
the taxpayer receives property with respect to the investment that is treated as a distribution;
the taxpayer claims a loss or deduction for the worthlessness of the investment; or
the QOF loses its status as a QOF.
The term “eligible gains” pertains to both short-term and long-term capital gains and qualified IRC Section 1231 gains. These capital gains are only considered eligible if they are:
Recognized for federal income tax purposes on or before December 31, 2026;
Not realized via a transaction with a related person; or
Reported on IRS Form 4797, Sales of Business Property (for qualified IRC Section 1231 gains)
To defer tax on an eligible gain, the QOF investment must be made in exchange for QOF equity interest (i.e. new issue QOF equity securities) within 180 days of recognizing the capital gain. If the investor does not defer the capital gain, then the capital gain would be recognized for federal income tax purposes in the occurrence tax year.
Investors are also permitted to transfer property other than cash as an investment in a Qualified Opportunity Fund. When doing so, however, it is important to understand that the transfer of tangible property may result in only a portion of the investment qualifying as eligible for Opportunity Zone tax benefits. As a general rule, the amount of capital gain that is eligible for deferral is limited to the basis of the contributed property, even if the property being transferred is of greater value.
Qualified Opportunity Zone Rules for Businesses
To be considered a Qualified Opportunity Zone Business, the business must earn at least 50% of its gross income associated with its business operations located within a Qualified Opportunity Zone. Opportunity Zone regulations provide three safe harbors that a business may use to meet this requirement, including:
At least half of the aggregate hours of services performed by employees and independent contractors were performed in a QOZ;
At least half of the aggregate amounts that the compensation paid employees and independent contractors were for services performed in a qualified Opportunity Zone; or
Its necessary tangible property and necessary business functions were located in a QOZ
Discuss Opportunity Zone Tax Rules With the Pros at The Pearl Fund
Opportunity Zone Funds are relatively new investment vehicles that offer socially minded investors with outstanding opportunities to further diversify their portfolios while at the same time helping economically distressed communities grow.
The Pearl Fund is the industry leader in Opportunity Zone business investing. We were the first OZ VC investment fund in the nation, so we have the experience you’re looking for if you want to take advantage of the many benefits that come from investing in Qualified Opportunity Zones Businesses. Contact us today and let us help you reach your investment goals.
