An Opportunity Zone is a community nominated by the state and certified by the Treasury Department as qualifying for this program. The Treasury Department has certified zones in all 50 states; Washington, D.C.; and U.S. territories. A list can be found at the U.S. Department of Housing and Urban Development.
The Opportunity Zone program allows for the sale of any appreciated assets, such as real estate or stocks, with a reinvestment of the gain into a Qualified Opportunity Fund. Unlike a 1031 Exchange, there is no requirement to invest in a like-kind property to defer the gain.
To defer a capital gain (including net §1231 gains), a taxpayer has 180 days from the date of the sale of the appreciated asset, to invest the realized capital gain dollars into a Qualified Opportunity Fund, an investment vehicle that files either a partnership or corporate federal income tax return and is organized for the purpose of investing in Qualified Opportunity. The fund then invests in Qualified Opportunity Zone property.
The taxpayer may invest the return of principal as well as the recognized capital gain, but only the portion of the investment attributable to the capital gain will be eligible for the exemption from tax on further appreciation of the Opportunity Zone investment, as explained below.
Note that a taxpayer who receives a reported capital gain from a flow-through entity, such as a partnership, an S-corporation, or a trust/estate, has the option to start the 180 day investment period on any of the following dates:
A Qualified Opportunity Fund is any investment vehicle that is organized as a corporation or a partnership for the purpose of investing in Qualified Opportunity Zone property (other than another Qualified Opportunity Fund) that holds at least 90% of its assets in Qualified Opportunity Zone property.
Similar to other investments, an investment in a Qualified Opportunity Fund may increase or decrease in value over the holding period. In addition, income may be paid on this investment. Given that the purpose of the program is to improve particular areas, it is expected that the fund will continue to invest in the improvement of the property in which it is invested. Cash flow may occur once the property improvements are complete and the property is leased or sold to third parties.
Because Qualified Opportunity Funds are income tax planning tools and are investment options for taxpayers, these investments may involve risk. Like many other types of investments, the risks may potentially include market loss, liquidity risk, and business risk, to name just a few. Because this investment may not be appropriate for all investors, consult with your investment advisor before pursuing such an investment to determine if this fits with your risk profile and diversification of your investments.
Qualified Opportunity Zone property is used to refer to property that is a Qualified Opportunity Zone stock, a Qualified Opportunity Zone partnership interest, or a Qualified Opportunity Zone business property acquired after December 31, 2017, used in a trade or business conducted in a Qualified Opportunity Zone or ownership interest in an entity (stock and partnership interests) operating with such tangible property.
Conceptually, the Qualified Opportunity Fund must bring property new to the entity to be used in the Opportunity Zone. A fund that simply acquires property already being used in the zone will not qualify without substantial improvement. Substantial improvement requires improvements to exceed the Qualified Opportunity Fund’s initial investment into the existing property over a 30-month period. (Note: investment only applies to the amount paid for the building.)
For instance, if a Qualified Opportunity Fund acquires existing real property in an Opportunity Zone and $1 million, of the purchase price is allocated to the value of the building, the fund has 30 months to invest an amount greater than the $1 million building value for improvements to the property in order to qualify for this program. Certain businesses, such as golf courses, country clubs, massage parlors, hot tub facilities, suntan facilities, race tracks or other facilities used for gambling, and liquor stores, are prohibited for Qualified Opportunity Fund investments.
A Qualified Opportunity Fund investment provides potential tax savings in three ways:
Tax deferral through 2026 -A taxpayer may elect to defer the tax on some or all of a capital gain if, during the 180-day period beginning at the date of sale/exchange, they invest in a Qualified Opportunity Fund. Any taxable gain invested in a Qualified Opportunity Fund is not recognized until December 31, 2026 (due with the filing of the 2026 return in 2027), or until the interest in the fund is sold or exchanged, whichever occurs first. In addition, the deferred gain has the potential to be reduced as described below.
Step-up in tax basis of 10% or up to 15% of deferred gains - A taxpayer who defers gains through a Qualified Opportunity Fund investment receives a 10% step-up in tax basis after five years and an additional 5% step-up after seven years. Thus, to be eligible for the 10% step-up in tax basis, the taxpayer needed to invest by December 31, 2021 and invest by December 31, 2019 for the additional 5% step-up in tax basis. If the taxpayer will have held the investment in the fund for seven years at the end of 2026, the taxpayer would qualify for the 15% increase in tax basis. Due to the rule regarding recognition of gain no later than December 31, 2026, the step-up in tax basis benefit was no longer available for new investors beginning with the 2022 tax year.
No tax on appreciation - Perhaps the most significant tax benefit of the program, remaining in the Qualified Opportunity Fund for at least 10 years results in the cost basis of the property being equal to the fair market value on the date of sale/exchange.
What if there is a loss in value in the Qualified Opportunity Fund?
The taxpayer is still eligible for the increase in basis for holding the investment for five or seven years, so long as they met the previously described investment deadlines. The taxpayer’s recognized gain for 2026 (or the year of divesting from the fund) will be the lesser of the original deferred gain or the fair market value of the fund interest reduced by the taxpayer’s adjusted basis in the fund, if any. Because of the complicated nature of these investments and the complicated rules that are associated with it, please consult your tax advisor before committing any funds. The example below is simplified for illustration purposes only.
For each example: This information is hypothetical and is provided for illustrative purposes only. It is not intended to represent any specific strategy, nor is it indicative of future results.
Qualified Opportunity Funds remain an option for deferral of capital gains as long as you are able to retain the investment for the noted time frames. Keep in mind that depending on any future tax legislation, capital gains rates at the time of sale in 2026 could be at a higher rate than in 2024. Taxpayers should seek the advice of their professional legal and tax counselors when considering a Qualified Opportunity Zone investment.
Source: Internal Revenue Service. (28 April 2022). Opportunity Zones. https://www.irs.gov/newsroom/opportunity-zones
According to the Internal Revenue Service, an Opportunity Zone is an economically-distressed community where new investments, under certain conditions, may be eligible for preferential tax treatment. Localities qualify as Opportunity Zones if they have been nominated for that designation by the state and that nomination has been certified by the Secretary of the U.S. Treasury via his/her delegation authority to the Internal Revenue Service.
The Private Bank is an experience level for qualifying clients of Wells Fargo Wealth and Investment Management (WIM). WIM offers financial products and services through affiliates of Wells Fargo & Company. Bank products and services are available through Wells Fargo Bank, N.A., Member FDIC.
Wells Fargo Bank, N.A. ("the Bank") offers various banking, advisory, fiduciary and custody products and services, including discretionary portfolio management. Wells Fargo affiliates, including Financial Advisors of Wells Fargo Advisors, may be paid an ongoing or one-time referral fee in relation to clients referred to the Bank. In these instances, the Bank is responsible for the day-to-day management of any referred accounts.
Wells Fargo & Company and its affiliates do not provide legal advice. Please consult your legal and tax advisors to determine how this information may apply to your own situation. Whether any planned tax result is realized by you depends on the specific facts of your situation at the time your taxes are prepared.
