The Tax Cuts and Jobs Act of 2017 included a new Federal income tax incentive for investing in a qualified opportunity fund (a “QO Fund”) codified at Internal Revenue Code section 1400Z. This new incentive allows a taxpayer to defer capital gain that is invested by the taxpayer in a QO Fund within the 180-day period beginning on the date the taxpayer realizes the gain. A QO Fund is any investment vehicle organized as a corporation or partnership for the purpose of investing in and that holds at least ninety percent (90%) of its assets in qualified opportunity zone property (stock in a corporation or a partnership interest in a partnership that is a qualified opportunity zone business or qualified opportunity zone business property).
The capital gain will be deferred until the earlier of the date the investment in a QO Fund is sold or December 31, 2026. In addition to the deferral of the gain:
- Ten percent (10%) of the deferred gain will be eliminated in the event that the QO Fund investment is held by the taxpayer for at least five (5) years (as of the date the investment in a QO Fund is sold or December 31, 2026);
- An additional five percent (5%) of the deferred gain will be eliminated in the event that the QO Fund investment is held by the taxpayer for at least seven (7) years (as of the date the investment in a QO Fund is sold or December 31, 2026); and
- Any gain from the sale of the QO Fund investment will be free from tax in the event that the QO Fund investment is held by the taxpayer for at least ten (10) years.
For example, taxpayer sells stock on December 17, 2018 for $3,000,000. Taxpayer’s basis in the stock is $1,000,000 (resulting in the realization of a $2,000,000 gain). Taxpayer invests the $2,000,000 gain in a QO Fund on February 1, 2019. Taxpayer holds the QO Fund investment until February 1, 2030, at which time, taxpayer sells the QO Fund investment for $5,000,000. Since taxpayer held the QO Fund investment for at least seven (7) years, fifteen percent (15%) of the deferred gain is eliminated for Federal income tax purposes. On taxpayer’s 2026 U.S. income tax return, taxpayer reports a $1,700,000 capital gain (the original $2,000,000 gain reduced by $300,000, which is the deferred gain that was eliminated). Since taxpayer held the QO Fund investment for at least ten (10) years, taxpayer does not pay any Federal income tax on the sale of the QO Fund in 2030.
This article is intended to only provide a brief overview of the tax benefits in investing in a QO Fund. For more information on the qualifications of a QO Fund or the elections that are required to be made by a taxpayer in order to realize the tax benefits in investing in a QO Fund, contact Theodore F. Claypoole or another member of the taxation group at Unruh, Turner, Burke & Frees.