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Pain Points Persist for Qualified Opportunity Zone Investors, Developers by Arthur J. Lieberman

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Posted on January 09, 2024 by Art Lieberman

Opportunity Funds are entering their seventh year since being introduced under the Tax Cuts and Jobs Act of 2017. While initial hiccups from slow guidance and COVID are now behind us, new issues, challenges and pain points continue to emerge for investors and sponsors.

Tax Benefits of Qualified Opportunity Funds

 As a refresher, qualifying investments into qualified opportunity funds (QOFs) receive the following tax benefits:

The last point is really the main tax benefit of opportunity zone investing because it permanently eliminates the gain rather than deferring it.

For Investors

The looming Dec. 31, 2026, deadline for taxpayers to recognize deferred gains previously invested in QOFs is an area that may require significant tax planning. After all, many QOF investments were structured assuming that a liquidity event in late 2026/early 2027 would cover this tax.

Notwithstanding the challenges in today’s capital markets, cash-out refinances for QOF investments with low internal leverage appear to be on track. A cash-out refinance may not be an option for investments with higher internal leverage due to non-tax financing and capital markets issues. For QOF investments that may not be able to complete a refinance in time to cover the deferred tax, investors should begin investigating other ways to shelter this upcoming tax liability.

One way to potentially shelter the 2026 liability is the zero-basis rule for investments in QOFs. Qualified investments in QOFs have a zero basis to the investor, meaning losses in excess of an investor’s share of qualified liabilities are suspended until the basis is restored when the deferred gains become taxable in 2026. These suspended losses may become deductible when the gain becomes taxable and, therefore, provide shelter against the 2026 liability.

For passive investors, any suspended passive losses from the QOF or any other passive investment will also be available to shelter the tax. If the original deferred gain was passive, the gain in 2026 will likewise be passive.

Other tax attributes that can shelter the tax on a deferred gain, include NOL carryforwards and capital loss carryforwards. Delayed cost-segregation studies for assets placed in service in prior years can also help.

For Developers and Sponsors

For developers and sponsors, we are seeing early sales of investments that did not work out or that receive attractive offers for purchase. Regardless of the reason, not all QOZ investments will make it to the 10-year holding requirement. Fortunately, the regulations allow a sponsor up to 12 months from the date of sale to reinvest the net proceeds from the early sale of an investment into other Qualified Opportunity Zone (QOZ) property. Cash held for this purpose will not be treated as nonqualified financial property as long as the cash is reinvested within 12 months. All requirements and planning opportunities for QOZ property will apply to the newly acquired property, including the following:

Opportunity Zones can offer investors and developers significant tax savings along with some unique challenges they can minimize and overcome with the guidance of experienced tax advisors.

About the Author: Arthur J. Lieberman is a director with the Tax Services practice of Berkowitz Pollack Brant Advisors + CPAs, where he works with real estate companies and closely held businesses on deal structuring, tax planning, tax research, tax controversies and compliance issues. He can be reached at the CPA firm’s Miami office at (305) 379-7000 or info@bpbcpa.com.