The Permanent Exclusion
This is the most powerful of the tax benefits, and also takes the most commitment since it's targeted at long-term capital gains. Hold on to that QOF investment for at least 10 years, and any gains it makes in value after your investment in it are permanently excluded from the capital gains tax.
Your tax basis for that investment will be the fair market value on the date it's sold or exchanged, and you have to make what IRS calls an "affirmative election" to leverage this tax break. That means you have to choose it, like when you choose to enroll in a 401(k) or similar plan. It's not done for you by the IRS.
So, for example, if that $1 million you invested at the end of 2020 becomes worth $1.5 million in 2030, that $500,000 in appreciation is yours tax-free.
There are a lot of other rules involved in the opportunity zones program and opportunity zone fund investment.
The 180-Day Investment Period
The IRS gives you 180 days to invest an eligible gain in a QOF. The first day of the 180-day period is the date the gain would be recognized for federal income tax purposes (unless you elected to defer recognizing that gain).
Because of the difficulties created in executing real estate transactions, the IRS granted relief on that investment period. Now, if that 180th day to invest in a QOF is on or after April 1, 2020, and before Dec. 31, 2020, you have until Dec. 31, 2020, to invest that gain. Similar relief was extended for the substantial improvements requirement.
Improving properties, and thus their communities, is a core idea of the opportunity zone program in the first place. The IRS requires that the QOF must "substantially improve" that real estate.
The agency considers a threshold to be doubling the adjusted basis in the property after purchase and during any 30-month period that they hold their qualified opportunity zone property.
"The additions to basis must exceed the adjusted basis in the property at the beginning of such 30-month period. Land is excluded from the adjusted basis calculations," says a blog from the Withum advisory and accounting firm.
The firm's post includes this example: "QOF A purchased a vacant office building located in a qualified opportunity zone. The QOF purchased the building for $1 million. Of that, 60% is allocated to the building value ($600,000) and 40% is allocated to the land value ($400,000). Therefore, during any 30-month period, QOF A must substantially improve the property by increasing the adjusted basis in the building by whatever the adjusted basis is at the beginning of the 30-month period.
"So, for the first 30-month period after the purchase, an additional $600,000 (the amount allocated to the building at the time of purchase) of substantial improvements are necessary. A year after purchasing the building, QOF A spends $750,000 and 15 months to redevelop the building and build out spaces for incoming tenants, thereby satisfying the substantial improvement clause."
Note: there are other rules around property improvements as OZ investments, including FHA rehab limits, for starters. Opportunity zones in some eligible census tracts also may offer their own incentives, such as a separate tax credit for affordable housing.
Do your due diligence
IRS rules can be expected to change over time, regardless of the pandemic, as the opportunity zone tax breaks mature, and regulators and lawmakers respond to the impact.
This June 5, 2020, article in the Journal of Accountancy explains in detail the relaxation of OZ rules in response to the pandemic. It's a good place to start your research about the tax benefits.
Bottom line: Investing in OZs is an emerging discipline and the business and tax implications are already complex and getting more so. Be sure to discuss the ramifications and possibilities with a qualified tax attorney and investment advisor.