Call it what it is – a revolutionary tax break
As investors, we’re always poised for that next eye-opening opportunity: a chance to defer tax and reduce gains, grow our portfolios, and do some good for the world. Well, it’s here.
The recent introduction of opportunity zones (QOZs) and qualified opportunity funds (QOFs) offers an unprecedented chance to do all three with a simple investment. All it took was making note of one of the most significant tax code changes in recent history – and grasping the breadth of its consequences.
If you consider yourself a serious investor looking to defer capital gains, then you should be taking a thorough dive. We sure have. And the takeaway is nothing short of stunning:
It’s the first time in history where investors can defer, reduce, and eventually eliminate capital gains from any venture into a new kind of investment vehicle with a specified time period.
Let us break it down. Beyond the basics about QOZs and QOFs, we’ll help you understand how they work and the benefits they promote beyond your portfolio. Earnings come from insights. Insights from understanding.
And understanding starts right here.
“Qualified Opportunity Funds offer tremendous potential for investors who are seeking to realize the tax benefits of reinvesting their capital gains from the sale of other investments, while contributing to positive economic development in local communities that have been left behind.”
- Taylor Lembi, Founder & CEO, M31 Capital
Literally “zones,” QOZs are special Census tracts
Qualified Opportunity Zones (QOZs) and Qualified Opportunity Funds (QOFs) are a great fit for many investors, investment styles, and portfolio needs. Despite this, few investors have heard of them, and those who have may have received conflicting or overly simplistic information.
The simple fact is, QOZs are special census tracts that state and federal governments have targeted for economic development. Census tracts are areas established by the U.S. Census Bureau, originally for understanding population demographics of the U.S. They’re about the size of a neighborhood with populations ranging from 2,500 to 8,000 people.1 Neighborhoods with a very special point of differentiation.
These neighborhoods, or QOZs, unlock a new kind of investment vehicle called Qualified Opportunity Zone Funds (QOFs). QOFs are the investment vehicles that allow people to invest in real estate located in QOZs, businesses, and stock. And these funds offer investors significant growth opportunities paired with never before offered capital gains tax advantages.
“We need a new formula for the public and private sectors to work together to generate new investments, new businesses, and new good paying jobs in places that have fallen behind.”
- The Honorable Andrew Young (2017) 2
Self-determination means targeted revitalization
What makes QOFs so significant is that they’re more than an attractive investment opportunity. They’re also a targeted response to a pressing national issue: widespread, geographic economic disparity.
That key word in QOZ, “opportunity”, isn’t just about investment; it’s also about creating new paths forward in places that “have long been disconnected from the broader economy”, says Jared Bernstein, Senior Fellow at the Center for Budget and Policy Priorities and former Chief Economist to Vice President Joseph Biden3.
As an added benefit, this solution also provides local self-determination. QOZs are not determined by legislators sitting in the Capitol who don’t understand a given area’s specific socio-economic issues. Instead, local governors work with their communities to nominate appropriate areas and submit them for federal government approval.
During the zone selection process, local governments employed various strategies of community and expert engagement, including town hall meetings, public comment periods, national expert consultations, and working with local non-profits to ensure the right areas were selected for revitalization4. And, so far, the process is working well.
3 key tax benefits available to QOF investors
Just imagine – Investors in QOFs can defer, reduce and even eliminate capital gains taxes. In fact, holding the fund for ten years means paying zero capital gains taxes on the exit from the fund.
The only requirement is having capital gains and investing in the fund within 180 days of either realizing those gains by selling the assets or getting an allocation from a K-1, or capital gain dividend from a REIT. And as the IRS has increasingly limited the applications for 1031 exchanges5, investors have looked elsewhere for tax-advantaged investment opportunities.
1. Defer Gains Tax
Temporarily defer taxes on initial capital gains6. Capital gains from property, stocks, and other assets can be reinvested into a QOF within 180 days of sale to an unrelated entity. Unlike a 1031 Exchange, you can pull out the basis from any rollover into a Qualified Opportunity Fund and invest the gains only.
And capital gains taxes are deferred until 12/31/26 on those gains that are rolled into Morpheus 1 fund.
2. Reduce Gains Tax
Reduce capital gains taxes up to 15%. QOF tax advantages increase at the five, seven, and ten-year marks of holding an interest in the fund. At five years, Opportunity Fund investors get a 10% basis increase for tax deferral. At seven years, if the investment is made by December 31, 2019, they get a 15% basis increase.
3. Eliminate Tax on Future Gains
Pay zero taxes on fund profits by holding the fund for ten years or more. One of the most exciting investor benefits of QOFs is paying zero taxes on future appreciation. Investors who hold their QOF investments for ten years or more pay zero capital gains taxes on capital gains from their fund holdings.
The revolution is happening. Investment strategies and opportunities continue to evolve every day. We at M31 Capital believe that if you’re serious about preserving capital gains, the QOF opportunity deserves a thorough study to see how it fits with your long-term investment plans.
 Some states don't qualify.