7817 / How are amounts invested in opportunity zones taxed?

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Planning Point: Clients must make the deferral election by filing Form 8997 with the IRS along with their federal income tax for the year following the year in which the investment was made.  For example, clients who invested in QOFs during 2024 filed the form along with their 2025 federal income tax return.

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The basis in the investment begins at zero and is increased as gain is recognized. If the investment is held for at least five years, the basis is increased by 10 percent of the gain deferred. If the investment is held for at least seven years, the basis is increased by an additional 5 percent of the gain deferred (15 percent total). If the taxpayer so elects and the investment is held for at least 10 years, the basis is equal to the fair market value of the investment on the date the investment is sold or exchanged.⁷

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Planning Point: Under the original program, December 31, 2019 was the final day that investors could elect to roll their gains into opportunity zone funds in order to obtain the full 15 percent reduction in the amount of the deferred gain (so that the funds were invested for a full seven years). In turn, the qualified opportunity fund had 180 days to acquire qualified property once the taxpayer invested the gain. Because gain on the sale of Section 1231 property is not determined until year-end, taxpayers who wished to roll over Section 1231 gain should have tracked Section 1231 sales carefully to determine whether such sales resulted in gain (treated as long-term capital gain) or loss (treated as ordinary loss).

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A “qualified opportunity fund” means an investment vehicle organized as a corporation or partnership for the purpose of investing in qualified opportunity zone property where at least 90 percent of its assets are qualified opportunity zone property (the “90 percent asset test”).⁸

Qualified opportunity zone property means property that is:

(1)  qualified opportunity zone stock (generally, stock in a qualified opportunity zone acquired for cash after December 31, 2017);

(2)  qualified opportunity zone partnership interests (generally, interests in a qualified opportunity zone partnership acquired for cash after December 31, 2017); and

(3)  qualified opportunity zone business property (tangible property used in a trade or business of the qualified opportunity fund where substantially all of the property’s use (see Q ) is in a qualified opportunity zone, the property was acquired by purchase after December 31, 2017 and the original use begins with the qualified opportunity fund or the fund substantially improves the property (see below)).

Qualified opportunity zone business means a trade or business that meets the following requirements: (1) substantially all of the property owned by the business is qualified opportunity zone business property, (2) at least 50 percent of the gross income of the entity is derived from the active conduct of business, (3) a substantial portion of the intangible property of the entity is used in the active conduct of any such business, (4) less than 5 percent of the average of the aggregate unadjusted bases of the property of the entity is attributable to nonqualified financial property, and (5) the business is not used to provide facilities such as a golf course, country club, massage parlor, sun tanning salon, racetrack or other gambling facility, or store that primarily sells alcohol.⁹

What constitutes “substantial improvement” for purposes of the opportunity zone rules is tested on an asset-by-asset basis. However, under the final regulations, multiple assets may be aggregated into a single property for testing purposes.

In general, buildings located on a single parcel of property can be aggregated. Buildings located on different parcels may be aggregated if (1) the buildings share facilities or centralized business aspects, such as accounting, legal, personnel and similar business elements, (2) the buildings are operated in coordination with (or reliance on) one or more trades or business and (3) the buildings are operated exclusively by the qualified opportunity zone fund or business. The regulations provide a 30-month period during which tangible property purchased by the entity can be treated as qualified opportunity zone property while undergoing substantial improvement—as long as it is reasonably expected that the property will be substantially improved and then used by the QOZF by the end of the 30-month period.

If tangible property ceases to be qualified opportunity zone business property, it will continue to be treated as such for the lesser of (1) five years after the date it ceases to be qualified or (2) the date when the property is no longer held by a qualified opportunity zone business.¹⁰

Covid-Era Relief

In response to the COVID-19 pandemic, the IRS twice extended several key deadlines that apply to opportunity zone investments. The extensions were automatic and generally provide:

For taxpayers whose last day of the 180-day investment period within which to make a QOF investment was on or after April 1, 2020 and before March 31, 2021, the last day of the 180-day period was extended to March 31, 2021.

QOFs that failed to satisfy the 90 percent investment rule for a period ending on or after April 1, 2020 and on or before June 30, 2021 were not subject to a penalty (i.e., the failure is disregarded).

The 30-month substantial improvement period for tangible property that is used prior to being acquired was suspended between April 1, 2020 and March 31, 2021.

QOZ businesses using the 31-month working capital safe harbor prior to June 30, 2021 had an automatic 24-month extension of time in which to spend the capital on qualified property.

If a taxpayer’s original 12-month reinvestment period includes June 30, 2020, the QOF had an additional 12 months’ time to reinvest in QOZ property when the proceeds were received by the QOF from the return of capital or disposition of the QOF property.¹¹