A Guide to Understanding Proposed Changes to the QOZ Program

by Russell Putnam

In 2017, Congress created the qualified opportunity zone (QOZ) program to encourage long-term investment in economically distressed communities by providing investors with three tax incentives to help drive private capital to lower-income areas throughout the country. Since then, the FactRight team of analysts has reviewed several qualified opportunity funds (QOFs) that focus on real estate development located in QOZs. Over the last year, we’ve received a number of questions from broker-dealers and RIAs regarding whether any changes to the QOZ program are on the horizon, and it looks like the answer might be yes.

On April 7, 2022, U.S. Senators Cory Booker and Tim Scott and U.S. Representatives Ron Kind and Mike Kelly introduced a bipartisan bill in the Senate and the House proposing changes to the QOZ program, the Opportunity Zones Transparency, Extension, and Improvement Act (the QOZ Extension Act), which would improve the current QOZ tax benefits and re-emphasize the focus on low-income areas. This post examines the proposed changes in the QOZ Extension Act and how they would impact QOF investors and product sponsors.

Extension of the Deferred Tax Payment Date

One of the primary tax benefits of the QOZ program is the temporary deferral of capital gains, which allows investors to defer capital gains that are reinvested into a QOF until December 31, 2026 (the 2026 Cut-Off Date). Capital gains tax on the invested amount is then due with the first filing following the 2026 Cut-Off date in April 2027. If passed, the QOZ Extension Act would extend the deferral period two years from December 2026 to December 2028 (the 2028 Cut-Off Date), with deferred taxes being due in April 2029.

In addition to promoting further investment in QOFs, the extension would provide QOFs with additional flexibility. For example, most of the QOFs we’ve reviewed intend to use refinancing proceeds, once properties are completed and stabilized, to make tax-free distributions to investors, so they have the liquidity to pay the deferred tax liability prior to the 2026 Cut-Off Date. However, recently we’ve covered a number of QOFs that are developing projects with longer timelines that have targeted completion and stabilization dates in 2026. In these instances, if the QOF experiences any delays in completing, stabilizing, and/or refinancing the property, it is unlikely that the QOF will be able to provide investor distributions before the deferred tax is due in April 2027. The proposed extension would provide QOFs with longer development timelines and future QOFs with more flexibility to complete, stabilize, and refinance their projects allowing them to provide distributions to investors before the deferred taxes would be due in April 2029 as opposed to April 2027.

Reinstatement of the 10% and 15% Step-Up in Basis

The Internal Revenue Code provides QOF investors with a 10% increase in the cost basis of their deferred capital gains if they maintain their QOF investment for at least five years prior to the 2026 Cut-Off Date, or a 15% increase if they maintain their investment for at least seven years prior to the 2026 Cut-Off Date. This means that an investor who invested $1 million in a QOF prior to the end of 2019 would only pay capital gains tax on $850,000 in 2026 and an investor who invested $1 million in a QOF prior to 2021 would only pay capital gains tax on $900,000 in 2026. However, under the current QOZ rules, the partial step-ups are no longer available to new QOF investors because they will not be able to meet the five-year or seven-year holding period prior to the 2026 Cut-Off Date.

In further effort to promote additional investment in QOFs, the QOZ Extension Act would reinstate and modify the step-ups. Under the proposed legislation, investors would be eligible for the 15% step-up if they invest in a QOF before the end of 2022 and hold their investment for at least six years prior to the proposed 2028 Cut-Off Date. Additionally, investors would be eligible for the 10% step-up if they invest before the end of 2023 and hold their investment for at least five years prior to the 2028 Cut-Off Date. Additionally, these changes would benefit current QOF investors who were not eligible for the full 15% or even the 10% step-up when they invested.

Addition of QOF Feeder Funds

Current QOZ rules require a QOF to invest at least 90% of its assets in QOZ property or a subsidiary/joint venture that qualifies as a QOZ business investing in QOZ property, however, QOZ rules do not permit QOFs to invest in other QOFs. The QOZ Extension Act would allow QOFs to invest in other QOFs. The bill’s author believes the fund of funds structure could help raise capital for smaller projects. In addition, the fund of funds structure would allow QOF investors to spread their investment across a broader number of projects, asset classes, geographic locations, managers, and development partners.

While feeder funds could provide QOF investors with broader investment opportunities, broker-dealers and RIAs would need to consider a number of risks when evaluating a QOF feeder fund, including duplicative fees, joint venture and capital stack complexity, and investing in private companies that are illiquid and less transparent than public companies. In addition, QOZ compliance would be more complicated. For example, under the QOZ Extension Act, a feeder fund QOF would need to invest at least 95% of its assets in other qualifying QOFs. Based on the current QOZ regulations finalized in 2020, the underlying QOFs would still be required to invest at least 90% of its assets in underlying QOZ businesses that hold at least 70% of its assets in the QOZ property. If one underlying QOZ business failed to qualify under QOZ rules, it could cause the underlying QOF to fail the 90% test, and in turn cause the Feeder Fund to fail the 95% test, which could potentially result in penalties.

Modification of QOZ Designations to Eliminate Higher-Income Zones

In 2018, the Treasury designated approximately 8,800 census tracts as QOZs, approximately 12% of the census tracts in the country. In order to qualify as a QOZ, a census tract was required to have a poverty rate of at least 20% or a median family income that does not exceed 80% of the statewide or metropolitan area median family income (based on the 2011-2015 American Communities Survey data). In addition, QOZ rules allowed states to nominate 5% of their QOZs from census tracts adjacent to other qualifying census tracts.

The Extension Act would terminate the QOZ status for census tracts with a median family income exceeding 130% of the national median family income, based on the most current census data. States would then be able to nominate additional qualifying census tracts to replace the census tracts that lost their QOZ designation.

So how would the disqualification of certain census tracts affect existing programs? According to the proposed bill, certain investments in terminated QOZs would still constitute qualifying investments provided the QOF met one of the following conditions.

  1. The QOF has prepared a PPM disclosing an intent to invest in a disqualified tract before the Extension Act has been signed into law,
  2. The QOF has entered into a contract to invest at least $250,000 in a project that is located in a disqualified tract before the date when the Treasury publishes the list of disqualified zones, or
  3. The IRS determines that the QOF relied on the designation of the disqualified tract as a QOZ, and that the termination caused the QOF to experience a loss.

We’ve seen a number of projects located in QOZs that would be slated to be phased out if the QOZ Extension Act goes forward. It should be interesting to see how QOF sponsors proceed if they are considering targeting projects in higher-income QOZs that could be slated for termination.

QOFs Going Forward Under the Proposed Extension Act

Novogradac recently reported that reporting QOFs had raised a total of approximately $28.4 billion as of March 31, 2022. The proposed QOZ Extension Act provides a number of improvements that would incentivize investors to continue making investments in QOZs and could also refocus QOFs on lower-income communities. Hopefully, Congress will be able to pass the proposed legislation in less than the two-year period it took the IRS to finalize the original regulations!

If you’re a broker-dealer or RIA looking for more research on QOFs, check out the FactRight Report Center, which provides free access to all of FactRight’s due diligence reports, including QOFs.


Contact Information:

Russell Putnam



(612) 284-1776

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