Qualified Opportunity Funds: The Risks of a Tax-Saving Opportunity


One of the more interesting, and least-discussed, investment opportunities on the financial landscape is also somewhat new: Qualified Opportunity Funds (QOFs).

What Are Qualified Opportunity Funds?

Created by the Tax Cuts and Jobs Act of 2017, QOFs invest in projects at newly created Qualified Opportunity Zones. This federal program provides tax incentives for people to invest in projects that drive economic growth in economically distressed areas in the U.S.

How Do They Work?

Here’s an example:

Let’s say you own real estate or stocks that you purchased at a low price, and now they’re worth a lot more. In accountant-speak, you have a low basis, and when you sell the real estate or stocks, you’ll have a relatively high capital gains tax bill.

Under the new tax law, you could sell your appreciated asset, and then reinvest the gains (not necessarily the entire proceeds) in a QOF within 180 days.

If you do that, you can defer paying the capital gains tax on your sold investment, and if you hold the QOF as an investment for 10 years, then the capital gains taxes are completely eliminated on the QOF investment.

But the Actual Tax Situation Is More Complicated Than This…

There are two step-ups in basis — at five- and seven-year holding periods — and since the law sunsets in 2026, there’s some complication about the deferral lapsing at that point.

But the larger issue is that already a number of companies are actively marketing projects in over 8,700 zones established by the IRS (see link for a downloadable spreadsheet on zone locations from the Department of the Treasury website). The Opportunity Zone Fund Directory mostly seems to focus on affordable workforce housing projects. Sizes range from a few million dollars to $10 billion, and of course every promoter and developer touts their marvelous track records.

Investment concepts that are primarily driven by tax opportunities can be a dangerous proposition. The attractive tax benefits tend to distract from the much more important economic potential of the investment, including the nature of the properties being developed, their potential gains, the costs associated with building, acquiring, and operating the properties, and most basically whether the promoter of the investment can be trusted or not with your hard-earned dollars. There is a good possibility that, despite the tax benefits, unscrupulous promoters will help you generate tax losses rather than gains, meanwhile lining their own pockets. In retrospect, the whole QOF marketplace might turn out to be a great example of “buyer beware.”

If you’re interested in finding socially responsible and conscientious ways of investing back into your community, please don’t hesitate to reach out to me.

Stay Diversified, Stay YOUR Course!

Empyrion Wealth Management (“Empyrion”) is an investment advisor registered with the U.S. Securities and Exchange Commission under the Investment Advisers Act of 1940. Information pertaining to Empyrion’s advisory operations, services and fees is set forth in Empyrion’s current Form ADV Part 2A brochure, copies of which are available upon request at no cost or at www.adviserinfo.sec.gov. The views expressed by the author are the author’s alone and do not necessarily represent the views of Empyrion. The information contained in any third-party resource cited herein is not owned or controlled by Empyrion, and Empyrion does not guarantee the accuracy or reliability of any information that may be found in such resources. Links to any third-party resource are provided as a courtesy for reference only and are not intended to be, and do not act as, an endorsement by Empyrion of the third party or any of its content. The standard information provided in this blog is for general purposes only and should not be construed as, or used as a substitute for, financial, investment or other professional advice. If you have questions regarding your financial situation, you should consult your financial planner or investment advisor.

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