LUTZ BUSINESS INSIGHTS
What is a Qualified Opportunity Fund?
JOE DONOVAN, TAX MANAGER
A Qualified Opportunity Fund (QOF) is an entity formed to invest in qualified opportunity zone property. These “Opportunity Zones” are designated by the state with the purpose of incentivizing investments through QOFs to enhance the economic development of a distressed community via job creation and property investment. It’s important to understand what an opportunity zone is and how it can benefit your business and the community. Here’s what you need to know:
Quality Opportunity Fund (QOF) Defined
When an entity is created with the goal of investing in opportunity zone properties that are qualified, it is known as a qualified opportunity fund or QOF. In order to qualify for preferred treatment, 90 percent of the assets held by a QOF must be in qualified opportunity zone property. Assets can include equipment, commercial real estate, business property, QOZ stock and partnership interests.
Benefits of Qualified Opportunity Funds
QOFs have a whole host of benefits that you can take advantage of for tax purposes including:
- Capital gains deferment. With a QOF, you can delay the taxes owed on realized capital gains that would normally be recognized on your tax return. Capital gains are allowed to be deferred until December 31, 2026.
- Receive a step up in basis. On top of the ability to defer the recognition of your capital gain until December 31, 2026, you also have the ability to reduce the total gain recognized on these capital gains. If the investor holds the QOF for 5 years they are able to reduce their realized gain by 10%. If the QOF is held for 7 years they are allowed to reduce their gain by 15%. In short, you could possibly only pay tax on 85% of the original gain a full 7 years after it was realized (or in December 31, 2026, whichever is first).
- Avoid tax on the appreciation in your QOF Investment. When you stay in the QOF investment for at least 10 years, you may avoid tax on the appreciation of the QOF Investment by making an election with your return. This benefit is in addition to the step up in basis on the original gain. An example would be a shareholder who sells $200,000 which they had $100,000 in basis in. Normally this would result in a $100,000 capital gain being taxed in the current year. If the gain is properly invested in a QOF the taxpayer will not pay tax on the $100,000 gain realized in the current year. If they hold the QOF for 7 years they will only pay tax on $85,000 of the gain (85% of the$100,000 gain) in 2026. Furthermore, if the QOF investment increases to $500,000 in ten years, the owner will not have to pay tax on the $400,000 of appreciation in the QOF from $100,000 to $500,000.
- You’re enhancing the local economy. QOFs do more than offer tax savings. These funds help boost the local economy of distressed communities by creating jobs and helping businesses and the community thrive.
QOF Disclaimer to Consider
Taxpayers can not only defer their taxable capital gains when they invest in a QOF, but also can reduce future tax on appreciation in their QOF Investment. However, it’s important to note that there are many issues to consider with qualified opportunity zone investing. Consult with a tax professional who has expertise and experience in handling QOF and capital gains, since Qualified Opportunity Zones have specific rules that can make quantifying opportunities challenging. A tax professional can help you consider the opportunity costs and benefits for investing in these types of funds.
If you’re looking for a way to invest in a distressed community, enhance the growth of a local community and even defer your capital gains taxes, then QOFs may be an ideal option to achieve these goals. However, it’s critical to consider the costs and benefits associated with investing in QOFs. By understanding the basics and consulting with a tax professional, you can better determine if an investment in a QOF is right for you and your business.
ABOUT THE AUTHOR
JOE DONOVAN + TAX DIRECTOR
Joe Donovan is a Tax Director at Lutz with over six years of experience in taxation. He primarily focuses his time on tax compliance, research, and consulting assistance to privately held companies in a variety of industries including real estate development and construction.
AREAS OF FOCUS
AFFILIATIONS AND CREDENTIALS
- American Institute of Certified Public Accountants, Member
- Nebraska Society of Certified Public Accountants, Member
- Certified Public Accountant
- BSBA in Accounting, University of Notre Dame, Notre Dame, IN
- Masters in Science of Accountancy, University of Notre Dame, Notre Dame, IN
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