Opportunity Zone Investments: Investing Before Year End Can Maximize Tax Benefits

07.19.2019 - Jeffrey S. MacDonald, CFA


As part of the tax reform package introduced in 2018, Congress created a program to encourage development in certain low-income areas of the country referred to as Qualified Opportunity Zones (QOZ).

After gathering information from all 50 states, Congress designated roughly 8,700 census tracts as Qualified Opportunity Zones—offering a number of tax incentives to attract businesses and investors to these communities. In general, we believe this program could attract capital to some of the targeted areas. But we would also caution that QOZ investments carry specific risks and restrictions that are worth careful consideration.

In this Q&A, we offer a brief summary of the pros and cons of investing in QOZs, based on the information available so far and the questions we are hearing from investors.

What Tax Incentives Do QOZ Investments Offer?

Investing in QOZs can offer tax advantages during your lifetime and as part of your estate plan:

1. Defer Capital Gains Taxes
Normally, investors are required to pay federal capital gains taxes in the year they are realized. But if capital gains are reinvested in a QOZ project within 180 days, that tax obligation can be deferred until December 31, 2026.

2. Step-Up Your Tax Basis
In addition to postponing tax payments, reinvesting capital gains in a QOZ can also reduce your tax bill. Investors can "step-up" the tax basis on 10% of their QOZ investment after holding it for five years, and step-up an additional 5% to fair market value after holding the QOZ investment for seven years—reducing the total original tax obligation by 15%, payable at the end of 2026.

3. Permanent Tax Exclusion 
The tax basis of the entire QOZ investment automatically steps up to fair market value after an investor has held it for ten years. So, if you sell your QOZ investment after ten years or the QOZ partnership is dissolved and proceeds are distributed after ten years, you will not pay capital gains taxes on the appreciated investment(s).

4. No Cap Gains Tax When Transferred Upon Death
QOZ investments are not subject to capital gains taxes when they are transferred to a surviving spouse, estate or a trust upon your death. However, deferred gains may become taxable if the QOZ investment is gifted during your lifetime.

What Am I Actually Investing In?

When you invest in a QOZ, you are essentially investing in commercial real estate and/or real estate development. Importantly, real estate development does not have the same characteristics as other real estate investments. Income, a component of core real estate investments, is not expected to be a primary characteristic of QOZ assets. While we expect attractive relative returns from this category, it is not without commensurate implementation risk.

How Does Someone Invest in a QOZ?

You can invest directly by purchasing property in a Qualified Opportunity Zone. But we expect many investors will focus on funds and other vehicles created by institutions with real estate development expertise, mainly because they provide the benefits of diversification and professional management. 

How Do I Determine if Investing in a QOZ Is Right for Me?

There are several important factors to consider when evaluating the suitability of QOZ investments.

  • First, investors need to have accumulated capital gains, be willing to realize those gains relatively soon, and be able to assess the pros and cons of a QOZ investment versus other tax strategies that might also minimize or defer capital gains taxes.
  • This assessment also needs to be made fairly quickly (assuming the program is not modified). Since the QOZ investment must be held for seven years to qualify for the 15% step-up in tax basis, and tax payments are due in December of 2026, gains would need to be harvested in 2019 and reinvested within 180 days to qualify for the 15% tax break.
  • In addition, investors should carefully consider QOZ lock-up commitments. In our view, QOZs are not suitable for investors who believe they might need access to funds invested in a QOZ within the next 10 years. In addition, we would strongly recommend against planning to sell a portion of your QOZ investment to meet your tax obligation. Instead, we encourage all QOZ investors to set aside capital specifically for satisfying the original tax obligation (2026 timeframe).
  • Also reducing some of the potential appeal for investors is that any fund or vehicle created for QOZ purposes will likely have logistical constraints such as liquidity, minimum investment criteria, infrequent valuations and structure considerations (i.e. Limited Partnership vehicle or Private REIT structure). They are likely to include large minimum investment requirements, limited transparency, and delayed tax reporting (Schedule K-1).
Does Franklin Templeton or Fiduciary Trust Offer QOZ Investments?

QOZs represent a new and evolving addition to the investment universe. Therefore, we continue to look for an approach that will allow our clients to take full advantage of the opportunities they present.

Since these investments do not have an established track record, we are evaluating the potential risks and rewards carefully before making any recommendations. At the same time, we recognize the importance of acting quickly. So, we are working diligently to identify the most qualified investment managers and compelling QOZ investment vehicles available. 



Important Information All investments involve risks, including possible loss of principal.

This communication is intended solely to provide general information. The information and opinions stated are as of May 10, 2019 and may change without notice. The information and opinions do not represent a complete analysis of every material fact. Statements of fact have been obtained from sources deemed reliable, but no representation is made as to their completeness or accuracy. The opinions expressed are not intended as individual investment, tax or estate planning advice or as a recommendation of any particular security, strategy or investment product. Please consult your personal advisor to determine whether this information may be appropriate for you. The information presented is not intended to be making value judgments on the preferred outcome of any government decision. This information is provided solely for insight into our general management philosophy and process. Historical performance does not guarantee future results and results may differ over future time periods.

IRS Circular 230 Notice: Pursuant to relevant U.S. Treasury regulations, we inform you that any tax advice contained in this communication is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein. You should seek advice based on your particular circumstances from your tax advisor. CFA® and Chartered Financial Analyst® are trademarks owned by CFA institute.


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