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While qualified opportunity funds (QOFs) can offer very real benefits to suitable clients, be aware of some important caveats before advising your clients to add them to their holdings.
The Tax Cuts and Jobs Act of 2017 created QOFs as a new way for affluent investors to do well by doing good. These funds, which invest in identified “opportunity zones” – distressed or underprivileged communities that have been targeted for economic development – offer some major tax advantages for suitable investors. And yet, according to an October 2019 article in the Wall Street Journal, investors have been slower than anticipated to embrace QOFs.
QOFs are categorized as impact investing, a type of activity in which investors seek to confer positive social benefits while also benefitting financially. Typically, QOFs are formed as partnerships or corporations; they can also be structured as real estate investment trusts (REITs). QOFs can own a broad range of property types including residential units, commercial property, and certain types of businesses, but the property must be located in an identified Qualified Opportunity Zone. A state-by-state list of Designated Qualified Opportunity Zones can be downloaded from the Community Development Financial Institutions Fund website, operated by the U.S. Treasury.
IRS rules provide generous tax incentives for investing in QOFs, to provide a much-needed economic boost for identified communities. If your client has a large capital gain from the sale of appreciated assets, they can reinvest that gain in a QOF within 180 days and defer the associated capital gains taxes from the sale until December 31, 2026 (when the law sunsets), or until the Opportunity Zone investment is sold (whichever comes first). They can also reduce their capital gains tax by up to 15% because of an increase in the basis of the appreciated assets used to buy the fund interest. The basis increases by 10% if the client holds their interest in the QOF for a minimum of five years. Hold it for seven or more years, and the basis rises to 15%. As a bonus, they can eliminate the capital gains due on the appreciation in the QOF if they hold the fund for 10 years or longer.
