Planning for Deferred Tax Liabilities on Opportunity Zone Investments
The qualified opportunity zones incentive, created as part of the Tax Cuts and Jobs Act of 2017, provided three distinct benefits to taxpayers who contributed eligible capital gains into an investment vehicle organized as a Qualified Opportunity Fund (“QOF”). These benefits are:
- Temporary deferral of capital gains invested in a QOF through December 31, 2026 (or earlier if the QOF investment is sold);
- Possible 10% or 15% permanent reduction in the deferred gains if the taxpayer held the QOF investment for at least 5 or 7 years, respectively, before December 31, 2026; and
- Total permanent exclusion of future gains from the disposition of the QOF investment if the taxpayer held such investment for at least 10 years.
Legislation was recently introduced in Congress to extend the Opportunity Zone program by two years, including a provision to extend the deferral period through December 31, 2028, which would be a two-year additional deferral period beyond the current scheduled end date. While this legislation is still in proposal form, many stakeholders are hopeful that it will be enacted into law.
Under current law, the deferral period is set to end on December 31, 2026. On this date, taxpayers who have invested into QOFs will need to recognize deferred capital gains as taxable income. For many calendar year taxpayers, this means the tax liabilities would be due on April 15, 2027.
Planning for a liquidity solution to manage deferred tax liabilities will become a critical strategy for QOF investors. Many QOF sponsors may have originally planned to make distributions to investors prior to or near the end of 2026, either from operating cash flow or from debt refinancing proceeds. With high interest rates and depressed property values, refinancing a property may prove challenging.
QOF investors are encouraged to initiate communication with QOF sponsors about expected distributions. Further, QOF investors and their tax advisors should be proactive in their own planning efforts to identify strategies which may soften the impact of recognizing deferred capital gains. Because each investor’s individual tax situation is unique, personal tax planning strategies may be equally valuable to the strategies employed by QOF sponsors.
CLA’s Opportunity Zone working group, consisting of Brian Duren, Ben Darwin, Sharla Simpson, Matthew Dunscombe, Adam Lembcke, and Chris Short (just to name a few), are ready and willing to help you prepare. Reach out to us today!
Brian is a Signing Director in CLA's Real Estate industry group and has more than 15 years of experience working with real estate operators, land developers, commercial real estate companies, private equity funds, and general contractors. Brian is also part of CLA's Opportunity Zone working group, and leads a team providing compliance, consulting, and advisory services to opportunity zone investors, qualified opportunity funds, and qualified opportunity zone businesses.
Great blog Brian! It will be interesting to see what the new legislation looks like once enacted.