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Qualified Opportunity Zones: Formation and Investment Opportunities


As part of the 2017 tax law changes, a new tax benefit was created allowing for the deferral of capital gains invested in designated low-income communities known as Qualified Opportunity Zones (QOZs). Over the past few months, we have received numerous inquiries from clients and others on how to take advantage of this new tax benefit and asking Quarles & Brady LLP for assistance in thinking about the various legal issues relating to the formation of Qualified Opportunity Funds (QOFs) and investment by the funds into qualified opportunity zone business properties.

Overview of the Opportunity Zone Tax Benefit

Under the new program, taxpayers can defer tax on capital gains invested into a qualified opportunity fund if the capital gains are invested into the QOF within 180 days of the date on which they were realized. If certain conditions are met, the capital gains that are deferred through the re-investment of proceeds into a QOF. The deferral ends on the earlier of the date the investment is liquidated or December 31, 2026.

In addition to deferral, investment in a QOF offers an opportunity to obtain a level of permanent tax reduction through certain basis step-up rules. Specifically, on the date the taxpayer sells or exchanges its investment in the QOF or December 31, 2026, whichever is earlier (a recognition date), the amount of gain recognized by the taxpayer will be equal to (A) the lesser of the capital gains invested in the QOF or the fair market value of the investment on the recognition date, over (B) the taxpayer's basis in the investment on the recognition date. For purposes of this gain calculation, the taxpayer's basis in the investment gets a step-up of 10% after five years and a step-up of 5% after seven years (for a total step-up of 15%). For investments that are held for at least ten years, basis is stepped-up to the fair market value of the investment on the date of disposition. Thus, under these new tax rules, the use of a QOF can, in proper circumstances, allow taxpayers to pay deferred tax on just 85% of their original capital gains and no tax on any new gains earned in the QOZ.

Overview of the Opportunity Zone Requirements

To qualify for this special tax treatment, the QOF must invest at least 90% of its assets either in qualified opportunity zone business property or in qualified opportunity zone businesses that invest in qualified opportunity zone business property, determined by averaging the percentage of qualified opportunity zone business property held by the QOF, as measured (A) on the last day of the first 6-month period of the taxable year of the QOF, and (B) on the last day of the taxable year of the fund.

Qualified opportunity zone business property is property used in a trade or business of the QOF if the property was acquired by the QOF by purchase from an unrelated party after December 31, 2017, the original use of the property in the QOZ commences with the QOF or the QOF substantially improves the property, and during substantially all of the QOF’s holding period for the property, substantially all of the use of the property was in a QOZ.

For purposes of these rules, property will be treated as substantially improved only if, during any 30-month period beginning after the date of acquisition, additions to the basis of the property in the hands of the QOF exceed the adjusted basis of the property at the beginning of the 30-month period.

Open Issues That Should Be Addressed Prior to Moving Forward with an Opportunity Zone Fund

Although the opportunity for tax deferral created by the new law has the potential to attract traditional investors to new markets, the new law also leaves many practical questions unanswered, with the result that most taxpayers are reluctant to move forward with this form of investing at the present time. Examples of just some of the issues as to which various groups have requested IRS guidance include the following:

  • Although the new law seems to allow any taxpayer to qualify for the tax benefits described above by timely investing capital gains into a QOF, it is unclear, in the case of a partnership with capital gains, whether the individual partners or the partnership must do the investing, or, in the case of consolidated groups, whether a group investment must be made by each member in accordance with its particular gain, or may be allocated differently among members of the group.
  • How the requirement that the QOF invest at least 90% of its assets in corporations, partnerships and property located in designated opportunity zones, will be applied, including:
    • How the first measurement date will be defined and whether an initial grace period will be allowed from the time the QOF is formed before the first measurement date applies;
    • On what basis will the average of the qualified opportunity zone business property held by the QOF be calculated? Fair market value? Current basis? Original cost basis? As the average of the two percentages determined on the two measurement dates?
    • Whether an allowance will be made for "reasonable working capital" being used to pay for the costs of a project that otherwise meets requirements of a qualified opportunity zone business property.
  • Whether and how property that is at the beginning or in the middle of the process of being substantially improved will count as qualified opportunity zone business property.
  • Whether the QOF's investment in qualified opportunity zone business property or in a qualified opportunity zone business that has invested in such property can be used to repay predevelopment financing with respect to the property.
  • Whether leased property can qualify as qualified opportunity zone business property.
  • Confirmation that an investment in a QOF may also qualify for other tax incentives, such as the New Markets Tax Credit, the Low-Income Housing Tax Credit, and the Rehabilitation Tax Credit.

Adopting a "Wait and See" Approach

Although we are aware of a few funds that have been created based on a "best guess" as to how these and other open issues will be resolved, most fund sponsors appear to be questioning how they can go out to investors, and investors are wondering how they can invest in QOFs, without specific guidance from the IRS on how the opportunity zone tax rules will actually work. As a result, and in light of the securities laws that will apply to the offering of interests in a QOF, we have been advising clients to take a "wait and see" approach and delay circulating offering memoranda or solicitations of interest, and for investors to delay investing in QOFs, until the open issues are sorted out.

At least some guidance from the IRS is expected soon. The Office of Information and Regulatory Affairs, a division of the White House Office Management of the Budget (OMB) on received from the IRS proposed rules for review earlier this week. The proposed rules will return to the Treasury Department and IRS after the OMB review, and are anticipated to be published later this month. If adequate guidance is issued in September, the fourth quarter will likely be occupied by fund formation matters for our clients.

Next Steps

If you would like additional information on the tax and securities law issues that will need to be addressed in connection with the formation and operation of a Qualified Opportunity Fund, or on the mechanics of investing in a QOF, please call your local Quarles & Brady attorney or contact


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