A Qualified Opportunity Zone (QOZ), is an economically distressed community where new investments, under certain conditions, may be eligible for preferential tax treatment. Opportunity Zones were conceived as an innovative approach to spurring long-term private sector investments in low-income communities nationwide. QOZs were added to the tax code by the Tax Cuts and Jobs Act on December 22, 2017. The first set of QOZ designations, covering certain parts of 18 states, were designated on April 9, 2018. Today, QOZs have been designated to cover parts of all 50 states, the District of Columbia, and 5 U.S. territories.
WHAT IS AN OPPORTUNITY ZONE?
The Opportunity Zones provision, based on a bipartisan Investing in Opportunity Act, and was championed by Senators Tim Scott (R-SC) and Cory Booker (D-NJ) and Representatives Pat Tiberi (R-OH) and Ron Kind (D-WI), who led a regionally and politically diverse coalition of nearly 100 congressional cosponsors.
QOZs are an economic development tool—that is, they are designed to spur economic development and job creation in distressed communities. Opportunity Zones are low income census tracts nominated by governors and certified by the U.S. Department of the Treasury into which investors can now put capital to work financing new projects and enterprises in exchange for certain federal capital gains tax advantages. The country now has over 8,700 Opportunity Zones in every state and territory.
HOW DO QOZ's SPUR ECONOMIC DEVELOPMENT?
QOZs are designed to spur economic development by providing tax incentives for investors who invest new capital in businesses operating in one or more QOZs:
First, an investor can defer tax on any prior eligible gain to the extent that a corresponding amount is timely invested in a Qualified Opportunity Fund (QOF). The deferral lasts until the earlier of the date on which the investment in the QOF is sold or exchanged, or December 31, 2026. If the QOF investment is held for at least 5 years, there is a 10% exclusion of the deferred gain. If held for at least 7 years, the 10% exclusion becomes 15%. Additionally, the amount of eligible gain to include is decreased to the extent that the amount of eligible gain you deferred exceeds the fair market value of the investment in the QOF.
Second, if the investor holds the investment in the QOF for at least 10 years, they are eligible for an adjustment in the basis of the QOF investment to its fair market value on the date the QOF investment is sold or exchanged. As a result of this basis adjustment, the appreciation in the QOF investment is never taxed. A similar rule applies to exclude the QOF investor’s share of gain and loss from sales of QOF assets.
WHAT ARE THE INCENTIVES THAT ENCOURAGE LONG-TERM INVESTMENT IN LOW INCOME COMMUNITIES?
Opportunity Zones offer investors the following incentives for putting their capital to work in low-income communities:
A temporary tax deferral for capital gains reinvested in an Opportunity Fund. The deferred gain must be recognized on the earlier of the date on which the opportunity zone investment is sold or December 31, 2026.
A step-up in basis for capital gains reinvested in an Opportunity Fund. The basis of the original investment is increased by 10% if the investment in the qualified opportunity zone fund is held by the taxpayer for at least 5 years, and by an additional 5% if held for at least 7 years, excluding up to 15% of the original gain from taxation.
A permanent exclusion from taxable income of capital gains from the sale or exchange of an investment in a qualified opportunity zone fund, if the investment is held for at least 10 years. (Note: this exclusion applies to the gains accrued from an investment in an Opportunity Fund, not the original gains).