Qualified Opportunity Zones: Guidelines for Developers

Congress designated Qualified Opportunity Funds in 2017 with a win-win goal: To spur growth in 8,700 distressed communities, known as Qualified Opportunity Zones, via investment vehicles offering attractive tax incentives for private capital investors. 

Public interest hit a fever pitch.  Beyond the opportunity to align with social change, the program – created as part of the larger Tax Cuts and Jobs Act – presents a unique opportunity for individuals, businesses, and developers to earn generous tax incentives within a relatively short investment window. 

In the two years since the program’s inception, though, Quality Opportunity Funds’ labyrinth-like complexities have begun to share the stage with its promise. Investors and would-be investors alike are realizing that a small misstep could cost them the whole game. The result is a burgeoning realization that this federal program, calls for due diligence.  

“Compliance is critical to any program, but particularly labor intensive with Qualified Opportunity Funds,” explains David Gill, Jr. Partner at Haefele Flanagan. “This program is ripe with strict eligibility standards and checkpoints that warrant the involvement of expert guidance. Developers in particular, for whom a specific set of regulations apply, need to understand the fine print before leveraging capital.” 

Stringency starts right out of the gate: In best-case outcomes, investors will defer (and sometimes even forego) taxation on the capital gains invested in Qualified Opportunity Zones – and subsequent profits. A key phrase here is eligible capital gains: Unlike traditional investment opportunities that welcome almost any liquid asset, Qualified Opportunity Funds only accept investments incurred as capital gains by the investor within the past six months. 

 “In other words, investors interested in Qualified Opportunity Zones need to move quickly once they’ve acquired capital gains – not only because of this six-month window, but due to other timing-related mandates, as well.” 

 Tax benefits are determined in large part by the duration of the investment. The program only extends through the end of 2026, and favors investors who play the long game by maintaining their holdings for several years. 

“Tax benefits improve incrementally once an individual investor reaches the five- and seven-year marks. Given the program’s finite reality, investors who wait too long won’t reach those critical milestones.”

Other key components of Qualified Opportunity Zones are similarly prone to oversight.

“One of the program’s trademarks is that fact that developers need double their initial investment to qualify as an eligible investment option ,” Gill clarifies. “Buy a building for $250,000, and you need to invest another $250,000 into improving the property”

Even more, developers need to have these improvements in place within 30 months of the initial investment, meaning capital needs to be in place relatively soon after the purchase of  properties. 

There are similarly stringent standards in relation to purchase dates. Properties have to have been purchased after January 1st, 2018; however, even this rule is prone to exceptions. Properties owned prior to January 1st, 2018 can sometimes qualify for the program – per a second sent of regulations released recently by the IRS – but said eligibility is tied to the specific way property owners structure related party leases. Complexities also apply to vacant properties, which can be categorized differently if they’ve been empty for more than five years. 

“The point remains: This is a promising program, but not one to embark on hastily,” Gill says.