Selling a highly appreciated investment property can bring a significant financial windfall, but long-term capital gains taxes can erode a hefty portion of your profits.
Investors who face a substantial capital gains tax liability after selling an investment property can defer their tax burden by investing in a Qualified Opportunity Fund (QOF). There are some key timelines and stipulations that must be met, most notably the 180-day and 30-month rule.
Here’s a look at how both work.
What is a Qualified Opportunity Fund?
Qualified Opportunity Funds are investment vehicles that are created specifically to make investments in businesses and properties located in Qualified Opportunity Zones (QOZs).
These zones are in hundreds of predetermined areas throughout the United States which have been deemed economically distressed and require additional incentives to stimulate fresh investment capital. A QOF must invest at least 90 percent of its assets into Qualified Opportunity Zone properties of businesses in order for investors to realize tax-advantaged treatment. Benefits increase with longer investment horizons:
- 10 percent step-up on the basis of deferred capital gains for holding periods of at least five years.
- 15 percent step-up on the basis of deferred capital gains for holding periods of at least seven years.
- Full deferral of any capital gains realized through asset appreciation on holding periods of at least 10 years. The QOZ property or business can be sold at fair market value and investors will receive a step-up in basis that eliminates any realized gains from the asset.
These investments carry many of the same risks as other types of real property investments, which can include liquidity, market, and business risk.
QOF Timelines and Stipulations: The 180-Day and 30-Month Rule
In addition to the timelines mentioned above, there are some key stipulations for investing in a Qualified Opportunity Fund.
- 180-day rule. Investors have 180 days from the close of sale on their investment properties to make investments into Qualified Opportunity Funds.
- 30-month rule. The primary goal of the QOZ program is to stimulate economic development in distressed areas. Qualified Opportunity Funds have 30 months to make substantial improvements to properties. These improvements must be equal to the purchase price of the asset or business. For example, if a QOF purchases a property in a designated Qualified Opportunity Zone for $1 million, it must make substantial improvements totaling $1 million or more to the property within 30 month’s time in order for investors to realize the tax advantages that come with QOF investments.
Putting it all Together
Investors can realize several tax advantages by investing in Qualified Opportunity Funds. You have 180 days from the close of sale on an investment property to invest in a QOF, and the fund has a 30-month window to make substantial improvements on properties of businesses in Qualified Opportunity Zones. These improvements must be equal to or greater than the purchase price of the asset.
Qualified Opportunity Fund investments may not work for all investors. Consulting with a certified financial planner or registered investment adviser can help determine if QOF investments align with your personal investment strategy and tolerance for risk.
This material is for general information and educational purposes only. Information is based on data gathered from what we believe are reliable sources. It is not guaranteed as to accuracy, does not purport to be complete and is not intended to be used as a primary basis for investment decisions. It should also not be construed as advice meeting the particular investment needs of any investor.
Realized does not provide tax or legal advice. This material is not a substitute for seeking the advice of a qualified professional for your individual situation.
Investors in QOFs will need to hold their investments for certain time periods to receive the full QOZ Program tax benefits. A failure to do so may result in the potential tax benefits to the investor being reduced or eliminated.
If a fund fails to meet any of the qualification requirements to be considered a QOF, the anticipated QOZ Program tax benefits may be reduced or eliminated. Furthermore, a fund may fail to qualify as a QOF for non-tax reasons beyond its control, such as financing issues, zoning issues, disputes with co-investors, etc.
Distributions to investors in a QOF may result in a taxable gain to such investors.
The tax treatment of distributions to holders of interests in a QOF are uncertain, including whether distributions impact the aforementioned QOZ Program tax benefits.
A QOF must make investments in Qualified Opportunity Zones, which carries the inherent risk associated with investing in economically depressed areas.
