There is misinformation out there and some of the headlines can be misleading. OZ incentive is a totally different program than 1031. You cannot 1031 into OZ!!
More below ⬇️
The Opportunity Zone program offers investors that pay US taxes (individuals, partnerships, corporations, foreign investors) certain tax benefits for rolling over their realized capital gains into a Qualified Opportunity Fund (QOF)
A QOF is an investment vehicle that files either a partnership or corporate federal income tax return and is organized for the purpose of investing in QOZ property.
Most commonly these are LLC's and can have 1 member or hundreds
Policymakers intentionally made it easy to establish a QOF. There is no application process. Instead, entities simply elect QOF status with the IRS when filing their tax returns (Form 8996) and self-certify that they hold at least 90% of their assets in qualified investments.
Once a QOF is setup you need to get money into it.
Generally, you have 180 days to invest an eligible gain in a QOF. The first day of the 180-day period is the date the gain would be recognized for income tax purposes if you did not elect to defer the recognition of the gain.
Gains that may be deferred are called “eligible gains.” They include both capital gains and qualified 1231 gains, but only gains that would be recognized for federal income tax purposes before January 1, 2027, and that are not from a transaction with a related person
Now you have a QOF setup and you put $$ in which was the result of a capital gain which occurred within the past 180 days.
IF you continue playing by the rules, instead of owing that tax next April you don’t owe it until April of 2027.
What’s next?
You cannot just sit on cash in your QOF!!! Remember that the OZ incentives are intended to spur new economic development.
You must invest it into QOZ property. I am going to focus on real estate although there are many other options.
The OZ tax benefits are good but not good enough to save a crummy deal. You need to find a good RE deal and execute. The deals that work well are going to be new development or heavy value-add.
All asset classes except: golf courses, country clubs, massage parlors, hot tub facilities, suntan facilities, racetracks, gambling, and liquor stores
Step 1 is to find either raw land or land/building in an Opportunity Zone. They were Low-income & Low-income adjacent census tracts in 2010. A lot has changed since 2010!
Step 2 is you have 30 months to complete the new development (for ground up) or the “substantial improvement” (for value add). You can get an extension to 60 months if needed
Basic example of "substantial improvement" for OZ purposes:
PP: $1,000,000
Land Value: $300k
Bldg: $700k
Need to spend $700k on improvements. This can include interest carry, legal/CPA cost, and all other CapEx
If you’ve done this correctly, then in addition to keeping the deferral on your original “eligible gain” you’re also well on your way to earning a full tax exemption for your QOF.
If you continue to stay in compliance and hold the QOF for 10 years then once everything is unwound you will get to step-up all of the assets to “market value”.
On the QOF assets, you will not owe capital gains and will not have to recapture depreciation.
A few notes here. Some may be future threads:
***You can do cashout refinances and use the proceeds to buy/renovate more properties
***You can and probably should do cost segregation to maximize depreciation losses because you never have to recapture them.
***There is no UBIT like in some retirement accounts. You can use debt without any penalty
***After 24 months of forming your QOF you can make distributions out of the QOF without penalty
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