Opportunity Zones and QSBS

opportunity zone QSBS

In addition to the associated tax cuts, another benefit to American taxpayers from the TCJA of 2017 was the enactment of federal opportunity zones.

According to opportunityzones.hud.gov, “Opportunity Zones are economically distressed communities, defined by individual census tract, nominated by America’s governors, and certified by the U.S. Secretary of the Treasury via his delegation of that authority to the Internal Revenue Service. Under certain conditions, new investments in Opportunity Zones may be eligible for preferential tax treatment. There are 8,764 Opportunity Zones in the United States, many of which have experienced a lack of investment for decades. The Opportunity Zones initiative is not a top-down government program from Washington but an incentive to spur private and public investment in America’s underserved communities.”

The preferential tax treatment mentioned in this definition is two-fold.

First, investors can defer tax on their previous eligible gain if an equivalent amount is reinvested in a Qualified Opportunity Fund in a timely manner. They can defer until December 31, 2026 or on the date the investment in the QOF is sold or exchanged. If the investment in this qualified opportunity fund is held for at least 5 years, the taxpayer can exclude 10% of the gain. This percentage increases (or “steps up”)  to 15% after 7 years.

After holding the investment in a qualified opportunity fund for at least 10 years, the taxpayer becomes eligible for the second benefit of this code. The basis of the QOF can be adjusted to its fair market value on the date of sale of said QOF. In the end, the appreciation of investment made in the qualified opportunity fund can be tax-free. 

Can Opportunity Zone Funds and QSBS work together?

While the opportunity zone provides investors with attractive tax incentives, the holding period of 10 years can amount to a high hurdle. When looking for a company in which to invest one’s deferred capital, it can be beneficial to also consider the benefits outlined in section 1202, which details QSBS.

Qualified Small Business Stocks offer the opportunity to hold stock for only 5 years and still qualify for an exclusion on capital gains up to the greater of $10 million or 10X the adjusted basis. 

If an investor can place their money in a company that qualifies under section 1202 and lies within an opportunity zone, the options and flexibility for selling at the most beneficial time work in conjunction to become much more powerful.

You can see a map of all Opportunity Zones in the US here.

This article does not constitute legal or tax advice. Please consult with your legal or tax advisor with respect to your particular circumstance.

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