What is a Qualified Opportunity Zone?
A Qualified Opportunity Zone (QOZ) is an economically distressed community where new investments
may be eligible for preferential tax treatment. A state, the District of Columbia, or a U.S. territory
nominates the census tracts, and the U.S. Treasury certifies them.
The Opportunity Zone program is now a permanent part of the tax code. Zones are redesignated every
ten years. The next set of zones takes effect on January 1, 2027 and runs through December 31, 2036.
Most zones designated under the original program remain in effect through December 31, 2028.
What is a Qualified Opportunity Fund?
A Qualified Opportunity Fund (QOF) is an investment vehicle organized to invest in QOZ property. It files a partnership or corporate federal income tax return and must hold at least 90% of its assets in QOZ property.
A fund that holds at least 90% of its assets in rural zones is a Qualified Rural Opportunity Fund. Investors in these funds are eligible for a larger reduction of their deferred gain.
How Can I Invest in a Qualified Opportunity Fund?
Investing in a QOF starts with an eligible capital gain. There are three steps:
- Invest within 180 days. The investor places some or all of an eligible gain in a QOF within 180 days. The period generally begins on the date the gain would be recognized for federal income tax purposes. Investors who receive gains through a partnership, S corporation, or trust may have additional options for when the period begins.
- Elect deferral. The investor elects to defer the gain on the federal income tax return for the year of the gain, using Form 8949. Form 8997 is then filed for each year the investment is held.
- Hold the investment. Tax on the invested gain is deferred for five years from the date of the investment, or until the investment is sold if that comes first.
How Do I Qualify for a Qualified Opportunity Fund? Who Should Consider Opportunity Zone Investments?
Some QOFs are available only to Accredited Investors, depending on how the fund is offered. An individual generally qualifies as an Accredited Investor by meeting one of these tests:
- Income over $200,000 individually, or $300,000 jointly with a spouse or partner, in each of the prior two years, with a reasonable expectation of the same in the current year
- Net worth over $1 million, individually or with a spouse or partner, excluding a primary residence
- A Series 7, Series 65, or Series 82 license in good standing
Opportunity Zone investments tend to suit investors who have a recent capital gain, can commit capital for ten years or more, and are comfortable holding an illiquid private investment.
What are some Benefits of Opportunity Zone Investing?
The program offers four federal tax benefits to investors who place eligible gains in a QOF:
- Deferral. Tax on the invested gain is postponed for five years from the date of the investment, or until the investment is sold if that comes first.
- A reduction of the deferred gain. After five years, the taxable amount of the deferred gain is reduced by 10%. The reduction is 30% for investments in a Qualified Rural Opportunity Fund.
- Tax-free growth. If the investment is held for at least ten years, its appreciation is not subject to federal capital gains tax when the investment is sold. For investments held longer than 30 years, the benefit covers appreciation through year 30.
- No depreciation recapture. Depreciation taken during the hold is generally not recaptured on a sale after ten years.
The tax on the deferred gain comes due at year five. The investment is usually still illiquid at that point, so investors should plan for the payment. The taxable amount is based on the lesser of the deferred gain or the fair market value of the investment at that time.
These are federal benefits. State tax treatment varies. Note all benefits may be contingent on the QOF maintaining QOF status with the IRS, and assuming no inclusion events have taken place for the investor.
What Types of Capital Gains Qualify for Opportunity Zones?
Eligible gains include capital gains and qualified Section 1231 gains. Both short-term and long-term capital gains can qualify.
Common sources include the sale of:
- Stock and other securities
- Real estate
- A business
- Cryptocurrency
- Art and collectibles
- Partnership interests
Two limits apply. The gain cannot come from a sale to a related party, and ordinary income does not qualify. The gain must also be invested in exchange for an equity interest in the QOF.
Can You Invest in Opportunity Zones without Capital Gains?
Yes. Although an individual who invests in a Qualified Opportunity Fund (QOF) without eligible gains will not enjoy the tax benefits of the Opportunity Zone program.
Can You Invest in Opportunity Zones without Capital Gains?
Yes. A QOF can accept money that is not an eligible gain. That portion of the investment does not receive the program’s tax benefits. An investor who contributes both eligible gains and other money holds two separate interests for tax purposes, and only the eligible-gain portion qualifies for tax benefits.
Is it Possible for an Opportunity Fund to Invest in Multiple Opportunity Zones?
Yes. A QOF can invest in a single property or in several properties across different Opportunity Zones. A Qualified Rural Opportunity Fund must keep at least 90% of its assets in rural zones.
When Do the Updated Rules Apply?
The updated Opportunity Zone rules apply to investments made in a QOF on or after January 1, 2027. A gain realized in late 2026 may still be within its 180-day window in early 2027. Under current IRS guidance, an investment of that gain made in 2027 follows the updated rules.
Investments made on or before December 31, 2026 follow the earlier rules. Under those rules, the deferred gain is recognized on December 31, 2026. The ten-year benefit remains available for those investments.
The IRS guidance is interim, and proposed regulations are expected. Investors should confirm timing with a tax advisor.
What are the Differences Between 1031 Exchanges and Opportunity Zone Investments?
Both tools let an investor postpone tax on a capital gain; however, they differ in what they protect.
A 1031 exchange applies only to real estate held for investment or business use. To defer the full gain, the investor reinvests all of the sale proceeds in replacement property. The deferral has no set end date and can continue through later exchanges.
An Opportunity Zone investment accepts gains from most assets, and only the gain needs to be invested. The deferral lasts five years. The main benefit applies to the growth of the new investment, which is free of federal capital gains tax after a ten-year hold.
A 1031 exchange tends to suit real estate owners who want open-ended deferral and plan to stay in real estate. An Opportunity Zone investment tends to suit investors with a gain from any asset who can hold for ten years or more.
