Client Portals

Deferring Capital Gains With Qualified Opportunity Zones (QOZs)3 min read

The Challenges and Opportunities of QOZ Investing

Sep 9, 2020 - John Osbon ( 4 mins to read)

John Osbon

The U.S. Department of the Treasury Opportunity Zones, created by the Tax Cuts and Jobs Act in 2017, offers unique and creative tax opportunities for high net worth investors with capital gains. In exchange for investing in economically distressed areas, the IRS provides investors with substantial benefits that reduce, delay and avoid taxation. The right partner, the right location and the right strategy are critical success factors. Here are some considerations:

What is a QOZ?

QOZ investments are real estate developments. The law aims to move capital into low-income neighborhoods that may have been previously less attractive to investors. It will take at least ten years to see if this program produces the intended result and lifts economically disadvantaged or depressed regions. The program requires that investors add meaningful improvements to the community. In other words, investors must significantly update and improve the real estate holding to benefit the community. 

What are the benefits to the investor?

There are seven main benefits to investing in a QOZ:

  • Defer current capital gains taxes until 2026
  • Reduce current capital gains due by 10%
  • Given that it’s a real estate investment, you will likely earn cash flow from rental income. Many of the QOZ strategies include a plan to refinance within three years, which can help pay the tax bill due in 2026
  • When the QOZ investment term ends in ten years, the investor pays no taxes on the property’s capital gains.
  • The traditional real estate tax benefit applies. You can deduct depreciation from annual cash flows.
  • (Bonus) There is no depreciation recapture at the end of the investment term. Regular real estate investments result in a high tax bill on the exit related to depreciation. With a QOZ there is none.
  • Contribute to the revitalization of a previously distressed neighborhood

A QOZ has many Roth IRA-like features, mainly in the form of never paying taxes on appreciation and the ability to withdraw money without paying taxes. 

Check if a QOZ is right for you:

  • Capital gains: If you have a current capital gain of one million dollars or more, it’s worth considering a QOZ as a tax optimization technique.
  • Well capitalized: Since QOZs are illiquid for ten years, investing in a QOZ is attractive if you have at least five million dollars of liquid capital. This will allow you to get diversification without investing too much of your money in one asset class. Five million dollars of liquid net worth also means you are a qualified purchaser, a requirement for most private institutional investments. 
  • Location: Not all QOZ real estate opportunities are attractive. The tax benefit is only half of the equation. Second and third-tier cities are often far more appealing than first-tier cities like New York, Los Angeles or Chicago.
  • The right partner: It’s essential to have the right real estate partners who understand the QOZ rules intimately, who have reasonable fees, use conservative levels of debt, are selective buyers with a focused strategy, and have direct real estate experience in the local market where the property will ultimately be located. 

Next Steps

There are many factors to consider before investing in a QOZ. If you would like to have a conversation with us about implementing this strategy, we are here to help.

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