Eliminate your capital gains – Set up a Qualified Opportunity Fund

Qualified Opportunity Funds (QOFs) have proven to be a strong catalyst for economic revitalization in underserved communities across the United States designated as Qualified Opportunity Zones (QOZs). Since their inception under the Tax Cuts and Jobs Act of 2017, QOZs have attracted substantial investment from QOFs, driving growth in housing, infrastructure, and local businesses. Just last year (2024), it was reported by Cantor Asset Management that QOZ capital raised over $40 billion in equity in 2024.

 What is driving the investment into QOZ? It is the tax benefits!

Investment in pursuit of a QOZ is held for at least five years, the basis in the investment increases by 10% of the deferred gain. Holding the investment for seven years increases the basis by an additional 5%. That is a 10% and 15% respective savings on capital gains subject to tax. Investment held for at least ten years can benefit from a permanent exclusion of any additional gains and appreciation from taxation. The most beneficial factor is that investment is with pre-tax dollars so the investment grows at a faster rate than if one was to pay the tax first and invest the post-capital gains tax dollars in a regular real estate fund or property.

You can defer taxes on eligible capital gains (from any asset or security) by investing that gain in QOF until the earlier of an inclusion event or December 31, 2026. (An inclusion event, in general, is an event that reduces or terminates your qualifying investment in a QOF.) Although a QOZ investor may have paid the tax on the inclusion event or December 31, 2026, an QOZ investor still receives the respective exclusion after one of the 5-, 7-, or 10-year benchmark periods are met.

To set this up, a QOZ investor will need to:

1.     Organize the QOF fund into a corporation or partnership entity and fund the entity with the capital gains within 180 days from the date of sale of the asset or security driving the capital gain.

2.     The entity will need to self-certify with an IRS form 8996,

3.     The investor in the fund will need to prepare an IRS form 8997 to reflect investment in the QOF,

4.     The investor will need to ensure maintenance of the fund – at two measurement dates per year:

Ensure that at least 90% of the fund’s assets are invested in QOZ property or the pursuit of investing in QOZ property,

Ensure that at least 70% of a Qualified Opportunity Zone Business (QOZB) tangible property must meet the requirements for qualified opportunity zone business property (QOZBP),

5.     Continue compliance on IRS forms 8996 and 8997 in future years,

6.     Address requirements to improve the QOZ property after purchase - not discussed here,

It is extremely important to engage an experienced advisor. The best time to contact the advisor would be before you sell the asset or security that will be driving the capital gain. There are timing and structuring considerations to consider putting a potential QOZ investor in the best tax position and avoid failing the entire setup up front. Additionally, the maintenance of the fund during the year and proper documentation required to support the pursuit of QOZ investment is vital to ensure the IRS does not assess penalties should QOZ investment be halted due to unfavorable or outside factors.

We at Hagger Tax & Advisory stay up to date with various tax strategies including the Qualified Opportunity Zone strategy. Please reach out to us at +1 305-762-9587 or chad.hagger@hagger-tax.com if you would like to discuss the Qualified Opportunity Zone and how it can benefit you.

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