Timing is everything with Qualified Opportunity Zone (QOZ) investments. The U.S. Internal Revenue Service sets rules not only on how long to hold these tax-advantaged assets, but also how quickly capital must be invested in the nation’s and territories’ approximate 8,700 targeted communities.
However, Congress does not want these limitations to impede the success of Qualified Opportunity Zones, an economic stimulant in the 2017 Tax Cuts and Jobs Act. To ensure this, in January 2019 senators from both political parties gave Treasury Secretary Steven T. Mnuchin additional guidance on congressional intent. Specifically, the tax incentive’s lead sponsors asked for solid assurances that QOZ investors will get enough time to make eligible investments. “Timing flexibility is particularly needed around initial investment and reinvestment periods,” the senators wrote.
To help clear confusion over timing, we talked to Adam J. Tejeda, a New York-based tax partner with the international law firm K&L Gates. An authority on Qualified Opportunity Zones, Tejeda advised Origin on its first QOZ fund, which raised $105 million in capital commitments within 17 hours of its initial announcement to investors.
Making QOZ Investments: The 180-Day Rule
To qualify for tax benefits, investors must invest capital gains in a Qualified Opportunity Fund (QOF). A QOF is a corporation or partnership organized to invest in qualified opportunity zone property, and structured to give individuals and partnerships the opportunity for deferrals, exclusions and exemptions from federal income taxes on capital gains. At least 90 percent of its assets must be held in qualified opportunity zone business property, qualified opportunity zone partnership interests or qualified opportunity zone stock, each of which relate to operating a business in, and owning property in, an opportunity zone.
To receive the benefits of the program, investors must invest capital gains in a QOF within 180 days of realizing that capital gain beginning on the date the capital gain event occurs. This 180-day rule requires that capital must actually be invested in a QOF within the prescribed time frame, not just committed to the QOF.
That means investors must line up their assets to harvest capital gains as their commitment is drawn down, especially for capital calls that stretch out for many months or even years. “If I sold Facebook stock today, and made $1,000 on the sale of Facebook stock, my 180-day period would generally start today,” Tejeda explains.
However, at times the capital call structure may leave some investors without enough capital gains to invest in a Qualified Opportunity Fund. In those cases, committing ordinary income or other cash on hand will not bring investors the significant tax benefits but is allowable.
Two Options on the 180-Day Rule for Partnerships
Capital gains realized by entities such as S Corporations, partnerships or LLCs with more than one owner are eligible for Qualified Opportunity Fund investment as well, but different rules apply to the 180-day requirement. One way is for the partnership to invest capital gains directly into a QOF within 180 days from the sale.
Alternately, partners can choose to invest their proceeds individually. In that case, the 180-day clock starts on the last day of the entity’s tax year (unless the partner or beneficial owner elects the gain date); the capital gains will be reported on the partnership’s K-1 form. Each investor then must choose the deferral election in their personal tax filings.
However, proposed regulations on the Qualified Opportunity Zone tax incentive create some uncertainties for partnerships, Tejeda says. Individual partners may find it difficult to determine how much of a distribution is a capital gain eligible for QOZ tax treatment. And partners may not get their K-1s until the March 15 due date—or later given extensions, narrowing their six-month window to elect the tax benefit. “It would be helpful if there were clearer regulations that address partnership distributions and other special circumstances, Tejeda says.
Good Things Come to Those Who Wait, and Wait Some More
The Opportunity Zone Program generally provides investors with three potential tax benefits: the deferral of the taxation of capital gains invested in a QOF; partial elimination of tax on such deferred capital gains provided that the investment is held for at least five or seven years; and a federal income tax exemption on capital gains realized on the disposition of an investment in a QOF.
Investors set the tax deferment process in motion when they report capital gains on Schedule D and QOF investments on Form 8949. “The deferred capital gains will be included in the investor’s taxable income either when the QOF is disposed of or the taxable year that includes 12/31/2026, whichever is earlier. Some people think that means you actually have to pay the taxes on 12/31/2026. That’s not accurate,” he adds.