In the world of Qualified Opportunity Zone investing, December 31, 2021, was a big day. It was the last chance under the current QOZ program law for investors to reap one of the big benefits of a QOZ fund investment—a 10% reduction in the amount taxed on capital gains invested for a minimum of five years prior to Dec. 31, 2026. As of Jan. 1, 2022, that benefit disappeared.
However, bipartisan legislation could give investors a second chance to increase the amount of their deferred taxes through a QOZ fund. The Opportunity Zones Transparency, Extension and Improvement Act, introduced in early April, makes some revisions to the original 2017 law. It aims to increase reporting requirements, extend the capital-gains benefits for investors and improve support for public and private investment, among other changes. As of this writing, the bill has not yet been scheduled for debate.
QOZ Program Investments Continue to Rise
The QOZ program was created as part of the 2017 Tax Cuts and Jobs Act to promote investment in more than 8,700 designated low-income and economically distressed communities. Investment in a select number of QOZ funds tracked by national accounting and consulting firm Novogradac surpassed $30 billion as of June 30, a 25% increase since December 2021, although other estimates put the total amount invested at more than $90 billion.
Under the QOZ program, investors who reinvested capital gains into a QOZ fund could defer tax on capital gains until the end of 2026. Investments held a minimum of seven years prior to December 31, 2026, receive a 15% reduction in the taxes owed; investments held a minimum of five years receive a 10% reduction. As well, any gain from the QOZ investment itself is not subject to taxes if the investment is held for a minimum of 10 years.
Read on for a breakdown of the main parts of the bill.
1. Extend Tax Incentives for Two Years
The Treasury Department released final regulations governing QOZs nearly two years after the law was passed, “during which time many investors and stakeholders stayed on the sidelines awaiting clear rules for the policy,” according to a statement by the sponsor lawmakers upon announcing the bill. So extending the policy would encourage continued investment and make up for time lost to those delays and to the COVID-19 pandemic, which also impacted development.
That change means that investors would once again be eligible for a 15% tax reduction if they invest before the end of 2022 and hold the investment until 2028, and 10% if they invest before the end of 2023 and hold their investment for at least five years. Current investors who missed the original investment deadlines would benefit from this as well. Those investors could invest additional capital gains into a QOZ fund and defer the taxes for up to an additional two years.
2. Reinstate and Expand Reporting Requirements
The original version of the Opportunity Zone legislation contained reporting requirements that were omitted from the 2017 Tax Cuts and Jobs Act due to procedural rules. However, the new legislation would require QOZ funds to submit details on individual investments, including type of business, number of residential units of property, and the average number of full-time employees. Noncompliance would trigger fines. The U.S. Treasury would compile the information into an annual report on job creation, poverty reduction and new businesses formed. All that data would track how big an impact QOZs are having.
3. Remove Some Higher-Income Opportunity Zones
In the first version of QOZ law, according to FactRight, a U.S. Census tract qualifying for a QOZ was required to have median family income less than 80% of the state or metropolitan area median family income. However, states were allowed to nominate 5% of their QOZs from Census tracts next to qualifying tracts. In the new version, Opportunity Zones in Census tracts with a median family income at or above 130% of the national median would lose their status as a QOZ. That’s a small percentage of the total number of zones, according to bill sponsors. For each zone that is removed, states could designate a new tract in high-need communities.
4. Allow for ‘Funds of Funds’ for Smaller Investments
The new legislation would create a pathway for smaller investments by allowing QOZ funds to be organized as a “fund of funds.” That is, funds can invest in other funds to provide needed financing. An individual investor could spread their finances further by investing this way and further diversify their investment portfolio. Also, this approach could allow a private real estate fund manager to invest in deals outside their own funds.