United States: The Wonderful Land Of OZ: An Overview Of Opportunity Zones

Opportunity Zones (or OZs) may be the most talked-about provision of the Tax Cuts and Jobs Act of 2017. There are many twists and turns on the yellow brick road to completing an OZ project. This article sets forth the underlying rationale of the OZ program, its principal tax benefits, an overview of the basic requirements for making an eligible investment, and certain common problems encountered by taxpayers seeking to take advantage of OZs. In particular, we emphasize the continued availability of the program even if you aren’t prepared to set off for the Emerald City right away.

Purpose of the Program

In the years following the Great Recession, certain segments of the economy have enjoyed sizable increases in asset valuations, while certain regions of the country are still trying to recover from the 2008 financial twister. The OZ program is intended to encourage taxpayers to sell appreciated assets and reinvest the resulting gains into economically distressed areas. While prior tax incentives meant to spur investment in distressed areas seem to have been swept away to some magical land to never be heard from again, the Opportunity Zone program continues to drive considerable investment due to (i) nearly unprecedented tax benefits and (ii) the diverse and expansive set of investible qualifying zones.

Principal Tax Benefits

The Opportunity Zone program provides three Federal income tax1 benefits to taxpayers who have realized capital gains:

  • If you reinvest your capital gains in a Qualified Opportunity Fund (see below), your Federal capital gains taxes on the reinvested capital will be deferred through 2026.
  • If you invest in 2019 and hold the Qualified Opportunity Fund investment through 2026, 15% of your capital gains tax will be eliminated; if you invest in 2020 or 2021 and hold the investment through 2026, your capital gains tax will be reduced by 10%.2
  • If you hold your Qualified Opportunity Fund investment for ten years, you can later sell it without paying any Federal tax.3

Principal Tax Requirements

To receive the aforementioned tax benefits, you must first realize a capital gain from the sale of an asset to an unrelated third party. Next, typically within 180 days following the sale, the capital gains must be invested in a Qualified Opportunity Fund (or a "QOF").4 In most circumstances, a QOF is an LLC that elects to be treated as a QOF for tax purposes and that is formed for the purpose of making an investment in an opportunity zone.

The QOF must invest in "QOZ Property;" in fact, 90% of the QOF's assets must be QOZ Property. The QOF must test its assets semi-annually and use the average of the two testing periods to determine whether it satisfies the 90% QOZ Property threshold for the year in question. QOZ Property can either be (i) tangible business property located in an opportunity zone that is either "Original Use" property or "Substantially Improved" property acquired after December 31, 2017; or (ii) a QOZ Business Entity (see below). In order to satisfy the Original Use test, the tangible property must (i) be new construction, (ii) have been vacant for the past five years or (iii) never previously used in the Opportunity Zone.

Tangible property satisfies the Substantial Improvement test if the QOF spends an amount equal to the adjusted basis of such property upon improvements to the property within a 30-month period. In the case of real estate, only the basis of the buildings and other structures is relevant for purposes of determining whether the property has been Substantially Improved. For example, assume that a QOF acquires an existing Kansas farm for $10M, the underlying land is worth $6M and the farmhouse is worth $4M; the QOF would need to spend $4M on improvements to the farmhouse in order to satisfy the Substantial Improvement test. The value of the land can be disregarded for purposes of the Substantial Improvement test. So long as the land is used in a trade or business, it should qualify as tangible QOZ Property.

In lieu of, or in addition to, investing in tangible property, the QOF may invest in a QOZ Business Entity. A QOZ Business Entity is a corporation or tax partnership if, amongst other requirements, (i) at least 50% of its total gross income is derived from the active conduct of a trade or business in an Opportunity Zone, (ii) at least 70% of its property is tangible QOZ Property5, (iii) it doesn't operate a casino, massage parlor, golf course, country club, hot tub facility, suntan facility, racetrack or other gambling facility, or any store the principal business of which is the sale of alcoholic beverages for off-site consumption, and (iv) no more than 5% of its property is non-qualified financial property.

Common Characters Found on the Yellow Brick Road to OZ

The Lion: Cash is Not King (or QOZ Property)

Cash held by a QOF is not QOZ Property and could cause the QOF to fail to meet the 90% QOZ Property requirement. Treasury regulations permit a QOF to disregard any cash contributed to the QOF within the six month period preceding a particular testing date. However, if the Opportunity Zone project has a longer investment period (e.g., a real estate project that will be developed over a multi-year span), the six month exemption period may be insufficient.

Fortunately, QOZ Business Entities can take advantage of the "reasonable working capital" exception which permits them to count cash as QOZ Property. In order to qualify for this exception, a QOZ Business Entity must have a written plan pursuant to which it will spend the funds over a period of up to 31 months. Accordingly, if you have the courage to take on a long-term project, operating the project through a QOZ Business Entity may be advisable.

The Tin Man: Lacking the Heart Needed for the Substantial Improvement Threshold

Issues with satisfying the Substantial Improvement threshold most commonly arise in the context of real estate projects. As noted above, in order for existing real estate structures to count as QOZ Property, you must spend an amount equal to your adjusted basis in the structures upon improvements to them within a 30-month period. If this is a problem for your project, have heart, as there may be a solution.

You are permitted to choose when the 30-month period begins. Additionally, the Internal Revenue Code provides generous expensing provisions that taxpayers may use to reduce the adjusted basis of real estate structures. You can use the timing flexibility and the expensing provisions to reduce the amount of expenditures necessary to satisfy the Substantial Improvement threshold. This strategy is best illustrated through the following example. In 2019, you acquire real property through a multi-member LLC. This acquisition is likely outside of a QOF structure. The LLC uses the tax code's expensing and bonus depreciation provisions to reduce the basis of the real property improvements on its 2019 tax return. On January 1, 2020, the LLC's basis in the improvements is significantly lower than it was on the acquisition date. The QOF now invests in the acquirer LLC and begins the 30-month Substantial Improvement window.

Alternatively, if deferring renovations does not solve the problem (or is not feasible from a business perspective), you can acquire real property outside of a QOF and then lease the property into the QOF structure. Unlike property owned outright, property which is leased need not be Substantially Improved.6 To many taxpayers, the most significant tax benefit of an Opportunity Zone investment is enjoying the Federal capital gain exclusion upon the sale of an investment held for ten or more years. To maximize this benefit, one must consider how to structure the lease in order to ensure that the QOF-lessee controls the property and has an asset with marketable value (without going afoul of the leased property rules).

The Scarecrow: If I Only Had a Brain Trust

The regulatory framework behind the OZ program is complex and can feel overwhelming to those who unexpectedly find themselves in this strange new land. However, in toto, OZs represent a rare opportunity to reposition capital in a tax-efficient manner that cannot be ignored. Given the regulatory complexity, it is imperative that you assemble a team of advisors including tax and real estate attorneys, accountants, and possibly brokers and valuation experts. Most importantly and contrary to many rumors, OZs are not going away at the end of 2019 and their advantages continue. Fortunately, we can help you build a strong team that will help you spot any flying monkeys as you follow the yellow brick road to OZ.


1 State income tax benefits are also available to investors in certain states; California does not currently provide any state income tax benefits. However, investments made in California or by California investors are eligible for Federal income tax benefits.

2 Legislation is under discussion that would extend the 15% reduction in deferred gains for investments made in 2020. Additional amounts of deferred gain may ultimately be excluded upon the conclusion of the deferral period.

3 A common point of confusion is the 10-15% reduction in deferred capital gains taxes versus the total elimination of future capital gains taxes if a QOF investment is held for 10 years. Please keep in mind that the 10-15% reduction applies to capital gains realized and deferred through 2026; while the total elimination of future capital gains applies to tax on future appreciation of the QOF investment. For example, if you realize a $4M capital gain and invest that amount into a QOF in 2019, the capital gains tax on the $4M gain is deferred through 2026 and reduced by 15%. If you hold your investment in the QOF for 10 years, you can sell it and pay no tax on that future sale.

4 You need only invest the portion of the sales proceeds that constitute capital gain. Any portion of the sales proceeds representing basis can be retained, invested or spent elsewhere. For example, if you sell an asset with an adjusted basis of $3M for $5M, you can invest the $2M gain into the QOF and qualify for the full benefits of the program. You are free to do whatever you would like with the remaining $3M.

5 A QOF funding and operating the project directly would be required to invest 90% of its assets in tangible property that satisfies the Original Use or Substantial Improvement requirements. However, if the QOF were to invest in a QOZ Business Entity, the QOZ Business entity would only need to be 70% invested in such tangible property.

6 There is another group of flying monkeys that is ready to attack your lease structure, but that's a topic for another day.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Similar Articles
Relevancy Powered by MondaqAI
Ostrow Reisin Berk & Abrams
In association with
Related Topics
Similar Articles
Relevancy Powered by MondaqAI
Ostrow Reisin Berk & Abrams
Related Articles
Related Video
Up-coming Events Search
Font Size:
Mondaq on Twitter
Mondaq Free Registration
Gain access to Mondaq global archive of over 375,000 articles covering 200 countries with a personalised News Alert and automatic login on this device.
Mondaq News Alert (some suggested topics and region)
Select Topics
Registration (please scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.


The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.


Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions