How to Invest in Opportunity Zone Funds

By Brian O'Connell · September 30, 2023 · 5 minute read

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How to Invest in Opportunity Zone Funds

The Qualified Opportunity Zone program is an initiative aimed at incentivizing investors to allocate cash to economically distressed communities who could benefit from the capital.

The Qualified Opportunity Zone program, highlighted by the Community Development Financial Institutions Fund, was rolled out as part of the 2017 Tax Cuts and Jobs Act. The program allows some U.S. investors to offset capital gains taxes under certain conditions by investing in some communities.

What Is an Opportunity Zone Fund?

Opportunity Zone (OZ) Investment Funds are a type of alternative investment fund that offers capital gains tax relief for some investments aimed at revitalizing communities. Opportunity Zones represent what the Internal Revenue Service calls an “economic development tool,” designed to accelerate economic development and job creation in economically struggling U.S. communities.

The Treasury Department determines eligible Opportunity Zones, of which there are thousands spread across the United States. Corporations or partners establish an Opportunity Zone Fund and use it to invest in properties located in a recognized opportunity zone.

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How to Invest in a Qualified Opportunity Zone Fund

To take advantage of the tax-efficient investment benefits of OZ investing, interested partners must first register as a corporation or partnership, complete IRS form 8996, and file the form along with their federal tax returns. After gaining approval by the IRS, the fund must commit at least 90% of its assets to a specific Opportunity Zone. Once that threshold is cleared, the QOF is eligible for capital gains tax relief.

Qualified Opportunity Fund Investment Requirements

The money that Qualified Funds invest in distressed communities must also fit the Treasury Department’s criteria of an Opportunity Zone investor.

•  The Fund must make significant upgrades to the community properties they invest in with fund dollars.

•  The investment must be made within 30 months of becoming eligible as a Qualified Opportunity Fund.

•  The investment must meet specific Treasury Department financial investment standards. In other words, the investments made in community properties must be equal or superior to the original value paid by the Opportunity Zone investment fund. For instance, if an Opportunity Zone Fund purchased a distressed property for $500,000, that investor has the 30-month window to steer at least $500,000 into the Opportunity Zone property improvements.

•  Some Opportunity Zone properties qualify for opportunity funds (private and multi-family homes, business settings and non-profit properties) and some don’t. For example, golf and country clubs, liquor stores, massage parlors, and gambling facilities do not qualify as Opportunity Zone investments.

•  The investor must commit to a timely investment in Qualified Opportunity Funds – the longer the time, the bigger the capital gain deferral. The IRS says the tax deferral may last until the exact date on which the Qualified Opportunity Fund is sold or exchanged, or by December 31, 2026. By law, the investor has 180 days from a capital gains sales event to turn those gains into an Opportunity Zone investment.

•  The funding program is tiered, with a 10% tax exclusion offered to investors who hold a Qualified Investment Fund investment for at least five years. If the investor holds the investment for seven years, the tax exclusion rises to 15%. If the investor stays in for 10 years or more, the IRS allows for an adjustment based on the amount of the QOF investment based on its fair market value on the exact date the investment is sold or exchanged. Any appreciation in the fund investment isn’t taxed at all, according to the IRS.

•  Opportunity Zone investors don’t have to physically reside in the communities they financially support, nor do they have to hold a place of business in that community. The only criteria for eligibility is making a qualified financial investment in an eligible, economically distressed community and the ability to defer the tax on investment gains.

Opportunity Zone Investment Considerations

Investors looking to defer capital gains taxes may view Qualified Opportunity Funds as an attractive proposition. Before signing off on any Opportunity Zone commitments, however, investors may want to review some key facts and investment risks worth keeping in mind when investing in OZs.

Real Estate as an Investment

Since Opportunity Zone funding focuses on distressed communities, most investments are real estate oriented, making it an alternative investment that may be part of a balanced portfolio. Typical Opportunity Zone investments include multi-family housing, apartment buildings, parking garages, small business dwellings/strip malls, and storage sheds, among other structures.

Recognize the Up-Front Cost Realities

Opportunity Zones are a high priority for public policy administrators, which is one reason QOFs require high minimum investments. Up front minimums of $1 million aren’t uncommon with Opportunity Zone Funds, and investors should know that going into any funding situation. In most cases, that means that accredited investors are more likely than other individuals investors to take advantage of OZ investing.

Your Cash May Be Tied up for a Long Time

To optimize the capital gains tax break, Opportunity Zone investors should count on their money being tied up for 10 years. Funds need that time to collect and disseminate cash, choose the appropriate potential properties for investment, and conduct the actual remodeling or upgrades needed to turn those properties into profitable enterprises. Thus, lock-up timetables can go on for a decade or longer.

Management Fees Can Eat into Portfolio Profits

Like any professionally managed financial vehicle, Qualified Opportunity Funds come with investment fees and expenses that can cut into profits. While many investors opt for Opportunity Zone investments for the tax breaks, those investors may also expect their investment to generate healthy returns. To get those returns, they can expect to pay the fees and expenses associated with any professional managed investment fund.

The Takeaway

Investing in Opportunity Zone funds allows some U.S. investors to offset capital gains taxes under certain conditions by investing in some communities. These funds are a type of alternative investment that may be an attractive addition to a portfolio.

Above all else, Opportunity Zone funds come with a healthy measure of risk, including investment risk, liquidity risk, market risk, and business risk. While the promise of a tax break and the opportunity to boost worn-down U.S. communities are appealing, any decision to invest in Opportunity Zones should be made with the consultation of a trusted financial advisor –- ideally one well-versed in tax shelters and real estate investing.

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