A Qualified Opportunity Fund (QOF) is an investment vehicle that puts capital into businesses or real estate located in designated Qualified Opportunity Zones, which are low-income census tracts. Investors who roll an eligible capital gain into a QOF can defer the tax on that gain and may avoid tax on the investment’s own appreciation after a long hold.
How a QOF Works
- Asset test: A QOF must hold at least 90% of its assets in qualifying Opportunity Zone property.
- Two-tier structure: Many QOFs do not own property directly. They invest through a Qualified Opportunity Zone Business (QOZB), which must have at least 70% of its tangible property in a zone and earn at least half of its gross income from business conducted there. A QOZB can also hold cash for up to 31 months under a written plan to build or improve property.
- Ownership: QOFs are typically organized as partnerships or LLCs taxed as partnerships. Investors are usually admitted as limited partners, while the sponsor or an affiliate serves as the general partner and controls the investment.
- Tax treatment: For QOF investments made on or after January 1, 2027, the tax on the original gain is deferred for five years from the date of the investment, or until the investment is sold, if that comes first. Investors who hold for the full five years receive a 10% basis step-up, and appreciation on the investment can become tax-free after a hold of at least 10 years.
- Rural funds: A Qualified Rural Opportunity Fund (QROF) is a QOF that holds at least 90% of its assets in Opportunity Zones located in rural areas, generally places outside cities or towns of more than 50,000 residents and their surrounding urbanized areas. A QROF investment held five years receives a 30% basis step-up instead of the standard 10%.
How a QOF Differs From a 1031 Exchange
A QOF investment accepts gains from almost any asset, and only the gain itself needs to be reinvested, generally within 180 days. A 1031 exchange can defer tax indefinitely through successive exchanges, while QOF deferral is temporary but adds the 10-year tax-free treatment on new appreciation. Which fits depends on the asset sold, the amount of gain, and the investor’s time horizon.
Considerations
Opportunity Zone investments are alternative investments. They can be complex and illiquid and carry real risk, including the potential loss of principal. Nothing here is personalized investment, tax, or legal advice; please talk with your own qualified tax and legal advisors before deciding.
To learn more, read our full guide to the 2.0 rules, or see how SREI Group approaches these investments.
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