The US is a first-world country bursting with various resources and workforce for sustaining its economy. However, not all states in the country are economically empowered. Consequently, the federal government introduced an initiative called Qualified Opportunity Zone (QOZ) to help marginalized communities. Whether or not this initiative will be viable is still a subject of many debates.
What Is a Qualified Opportunity Zone?
According to Forbes, a Qualified Opportunity Zone is a federal government initiative under the Tax Cuts and Jobs Act (TCJA) to encourage empowerment to low-income and distressed communities in the country through investments. It was enacted by The Tax Cuts and Jobs Act (TCJA) on December 22, 2017, for all 50 states, The District of Columbia, and five other US territories. The first set of QOZ designations was in 18 parts of the US on April 9, 2018. Some critics argue that it’s unclear if QOZ will help or rob communities of values. Distressed or low-income communities in urban and rural areas should get preferential tax treatment. The initiative aims to give investors some federal income tax advantages, provided they inject capital gains into the QOZ fund during a specific period. According to Akerman, the federal income tax benefits funders of QOZ investors include:
- 10% or 15% pardon of the capital gains if investors meet their end of the bargain for at least five to seven years
- Deferral of income tax on the capital gain for QOZ funds
- Exemption from income tax after the investment appreciates in value. This applies when an investor holds on to their investment for at least ten years before selling it.
The terms and conditions of QOZ
Most people might not understand how QOZ works, so here is a layperson’s explanation. For starters, you have up to 180 days from when the sale of the appreciated property you invested in gets capital gains into the Quality Opportunity Fund (QOF) before deferring net gains. If you qualify, then your property is open for QOZ fund investment. As a taxpayer interested in receiving QOZ benefits, ensure you invest what you earned as principal and capital gain. You should forward the portion of the investment related to the capital gain to become eligible for tax exemption. It applies to any Opportunity Zone investment that appreciates like stocks, according to WellsFargo. The initiative expects the stocks’ gains can be reinvested into the QOF. You don’t have to invest in property with like-kind features to defer the gain. Another thing to note is that taxpayers who get capital gain via flow-through firms like partnerships or real estate also have 180 days from the date they requested to defer to qualify for investment in QOF. Whether you applied in January, June, or any other month, the firm got revenue doesn’t matter.
Here’s an example:
If your partnership firm got a capital gain in February, you and your partners have 180 days to trigger it. That means your triggering date will be December the same year. The best solution is to apply in June the following year to qualify for the QOZ investment.
What is a QOZ property?
QOZ properties are anything under QOZ stock, QOZ business property, or QOZ partnership interest. This applied when you got the property after December 31, 2017, for conducting trade or business in a QOZ. Ownership interest in stock and partnership interests having a tangible asset such as property might also feature under this category. Ideally, the Opportunity Zone uses Qualified Opportunity Funds to bring an unfamiliar property to the entity. Properties using these funds should show improvement and qualify. The improvements should surpass the QOF’s initial investment into the existing property within 30 months.
Here’s an example:
Suppose QOF gets an existing property in a QOZ for $2 million. In that case, it will take 30 months for the fund to be pumped into a significant amount, not more than the $2 million it spent on improving the property to make them eligible for the program. Qualified Opportunity Zone properties apply to real existing buildings conducting non-luxurious businesses. Therefore, businesses like spas, bars, casinos, country clubs, suntan facilities, etc., aren’t eligible for QOF investments.
Here’s another example:
Thomas bought a small building for selling medications in her hometown seven years ago. He bought it for $300,000 and, over the years, attracted good cash flow. One day, he woke up to realize that his property’s price had doubled, meaning it was worth $600,000. An idea struck in Thomas’ mind; why not sell it because the market had rewarded him for it? It sounds like a good idea, but there’s one hitch; he will have to pay capital gains tax. Fortunately, the idea of a 1031 exchange to defer capital gains seems practical. He already knew the benefits of using the exchange program when buying the property, as it will also play a role if he decides to sell it. Part of his worries is the multifamily cap rates. Thomas already knows that finding such like replacement might be daunting. Because he wants to retain the property without the previous owners meddling in his affairs, investing in the Qualified Opportunity Zone program seems like a viable plan. The more he researches it, the more he’s pleased with what he’s learned.
Why invest in QOZs?
- You have the opportunity to reinvest the capital gains only, not the 100% of what you acquired from the previous asset sale.
- Attracts opportunities from diverse investments like cryptocurrencies, precious metals, and stocks
- You can defer sales outside QOZs, not restricted to within
- QOF can be used by investors in many sectors, including residential rental properties
QOZs may have invoked mixed reactions regarding who benefits the most, but it’s a stepping stone to encouraging more investments and business opportunities. Also, it applies to everyone as long as you meet its terms and conditions. Getting QOZ benefits starts by involving experienced legal counsel with experience in navigating complex projects that revolutionize communities. To get extensive knowledge about the program, involve an attorney with vast knowledge of funds, investors, developers, landowners, and grassroots communities.