Qualified Opportunity Zone Funds – A Tax Efficient Investment Vehicle for Those Selling Appreciated Assets

By Steve Haskell, Vice President – Kay Properties and Investments, LLC

What is a Qualified Opportunity Zone (QOZ)?

A QOZs as described under the 2017 Tax Cuts and Jobs Act is a social program with the intent of redeveloping impoverished districts throughout the country by driving private capital to over 8,700 underserved communities and 35M Americans throughout by offering tax incentives to investors¹.

What is a Qualified Opportunity Zone Fund (QOF)?

A QOF is a legal entity (partnership or corporation) used to invest capital gains into QOZs. A QOZ Fund must hold 90% of its assets in equity investments within business or property within a QOZ. A QOZ Fund must double its basis within a 30 month period in order to qualify for the tax benefits and provide a “substantial improvement” to its assets.² This means that the fund must double its value rapidly which requires a loan.

What are the Benefits of Opportunity Zones?³

QOZ Fund offers a unique opportunity for investors planning to sell stock, REITs, cryptocurrency, bond, jewelry, art, closely held businesses and other assets and potentially defer their capital gains by reinvesting the gain into QOF. Below are the potential tax incentives to consider before investing.

  • When gain from an investment is reinvested in a QOZ Fund held for 5 years, it will receive a 10% step up in basis. However, the investment must be before December 31, 2021.
  • When gain from a previous investment is reinvested in the QOZ Fund and held for 7 years, it will receive a 15% step up in basis. However, the investment must also be made prior to December 31, 2019.
  • All appreciation that takes place within the QOZ Fund will receive a full step up in if held within the fund for 10 years.
  • The investor is NOT required to identify a replacement property in 45 days nor use an accommodator, like they do in a 1031 exchange. Investors must reinvest the assets within 180 days.
  • Investors only need to reinvest the gains from their original investment to achieve the tax advantages offered by a QOF. Investors can pocket their original investment.

I am Selling a Piece of Appreciated Real Estate…. 1031 or QOZ Fund…which option is best for me?

Though QOZ Funds offer multiple potential benefits for investors looking to defer their taxes, for investors selling real estate, a 1031 exchange may be a potentially better option. To help make the determination on which strategy is best for investors, we ask the following questions.

    1. If you are debt free, do you really want to take on more debt? QOZ Funds must finance development within the fund in order to double the basis of the fund within 30 months and qualify for the tax deferral status. This exposes the investor to the risk of lender foreclosure and the potential of losing her entire investment due to foreclosure. If the property does not have a mortgage, there is no risk of lender foreclosure and therefore mitigates a significant amount of risk.
    2. Will you have enough liquidity to pay taxes in 2026? Taxes accrued on the proceeds of the relinquished property and subsequently invested in the QOZ Funds must be paid on December 31, 2026. Therefore, the investor should have enough discretionary income to support a potentially large tax consequence in 2026. If the investor decided to 1031, they have the option to perpetually defer their taxes.
    3. Is a step up in basis important to your legacy planning? If the investor passes away, the investment in the QOZ Funds will not receive a step up in basis to market value. Therefore, the heirs will be forced to pay the tax consequence upon selling ownership in the QOZ Fund.
    4. Did you depreciate your basis? Unlike Real Estate, QOZ Funds do NOT allow you to defer the recapture of deprecation of the underlying asset upon sale. The 1031 exchange allows the investor to perpetually defer recapture of depreciation. At this time, QOZ Funds do not.4
    5. Are you prepared to potentially take on additional risk? The development risk of new construction within a QOZ Fund may not be suitable for investors in their later years who do not have time to overcome the loss. High interest loans are often taken in order to meet the legal requirements of the QOZ Funds and double the basis of the fund. This exposes the investor to significantly more risk than simply purchasing a stabilized asset with minimal moving parts. Finally, QOZ Funds are inherently targeting low income areas. Heavily leveraged development ventures in lower income communities may propose more risk than warranted by the tax incentives.

If you are interested discussing whether a QOZ Fund or 1031 exchange is right for you, contact your registered representative at Kay Properties & Investments at www.kpi1031.com. Please visit www.kpi1031.com for more details, call us at 1.855.899.4597 or email info@kpi1031.com[/cs_text]

Sources:

  1. https://eig.org/news/opportunity-zones-map-comes-focus
  2.  Section 1400z-2(d)(1)
  3. https://www.taxpolicycenter.org/briefing-book/what-are-opportunity-zones-and-how-do-they-work
  4. https://www.natlawreview.com/article/second-set-proposed-opportunity-zone-regulations

About Kay Properties and www.kpi1031.com

Kay Properties is a national Delaware Statutory Trust (DST) investment firm. The www.kpi1031.com platform provides access to the marketplace of typically 20-40 DSTs from over 25 different DST sponsor companies, custom DSTs only available to Kay clients and a DST secondary market. Kay Properties team members collectively have over 400 years of real estate experience, are licensed in all 50 states, and have participated in over 30 Billion of DST 1031 investments.

Diversification does not guarantee profits or protect against losses. All real estate investments provide no guarantees for cash flow, distributions or appreciation as well as could result in a full loss of invested principal. Please read the entire Private Placement Memorandum (PPM) prior to making an investment. This case study may not be representative of the outcome of past or future offerings. Please speak with your attorney and CPA before considering an investment.

There is a risk of loss of the entire investment principal. Past performance is not a guarantee of future results. Potential distributions, potential returns and potential appreciation are not guaranteed. For an investor to qualify for any type of investment, there are both financial requirements and suitability requirements that must match specific objectives, goals, and risk tolerances. Securities offered through FNEX Capital, member FINRASIPC.