Key Considerations for a Second Tranche of Opportunity Zones
In recognition of Tax Day, we are providing an overview of one of the only ways to defer tax on already realized gain—the opportunity zone incentive (OZ Incentive) and what “Trump 2.0” may mean for the incentive’s future.
The incentive, codified as the “Investing in Opportunity Act” in the Internal Revenue Code as Sections 1400Z-1 and 1400Z-2, was a novel feature of the Tax Cuts and Jobs Act of 2017 (TCJA) enacted during the first Trump Administration. The incentive offers powerful tax benefits. First, taxpayers can defer taxes on capital gains until Dec. 31, 2026, by investing such gains into “qualified opportunity funds” (QOFs) organized to invest in certain target census tracts, which are generally low-income or impoverished areas. Second, taxpayers who hold their QOF investment for at least 10 years can exclude the gains earned on the QOF investment itself. One source estimates that, of the QOFs it tracks, and as of the end of September 2024, a cumulative $39.54 billion has been invested under the OZ Incentive.
If the incentive is extended, it is likely to retain its key elements and the same general structure. We don’t expect any resolution on an extension nor its exact features until late 2025 when the successor to the TCJA would be enacted. That said, it is worth considering how investors can strategically position themselves for success by anticipating potential changes and integrating the same into existing tax planning.
With that context, here are five key considerations:
1. The (malleable) 180-Day clock is likely to remain a critical feature
To utilize the OZ Incentive, a taxpayer typically needs to place capital gains into a QOF within 180 days of realizing such gains. For example, if a taxpayer realizes capital gain on June 30, 2025, they have until Dec. 27, 2025, to invest such gains into a QOF. QOFs can be as simple as an LLC taxed as a partnership that adequately declares its intent to be a QOF on its tax return and with the Secretary of State of its registration. The Treasury, helpfully, clarified that in the case of a pass-through entity (i.e., an entity taxed as a partnership or S corporation), the 180-day clock does not start for the equity holders of the entity for gain realized by the entity until the last day such entity can timely file a tax return for its equity holders. So, a partnership that realizes capital gain in 2025 has until 180 days after Sept. 15, 2026, to place such gains in a QOF. Investors and tax advisors should be cognizant of these rules and timelines so they will realize gains at the right time. With any successor TJCA bill not expected until the eve of 2025, investors may want to delay realizing gain until mid-July to avail themselves of the ability to respond to what happens at the end of 2025. Alternatively, investors may want to consider realizing gain inside a pass-through entity to create a longer runway to invest.
2. Expect new “OZ” geography
The existing opportunity zone census tracts were determined through a unique decentralized process whereby the governors of each state selected the tracts based on certain criteria. While the process seemed to work well, it was not ideal. Motivated to attract as much investment into the state as possible, many governors selected tracts that were already prime investment candidates and that had already been receiving massive investment. As a result, in some cases, the positive social impact of the incentive was negligible and the investments even exacerbated some economic issues, such as by increasing rents and the cost of living. We expect a second tranche of zone selection that will disqualify some current census tracts and replace them with tracts that generally have greater economic need. Despite the prospect that new tracts will be less economically appealing to investors, the announcement and selection of new opportunity zones has a gold rush feel to it. We expect to see investor excitement similar to the original initiative launch.
3. Will 2026 still be the deadline to pay?
As mentioned above, under the current OZ Incentive, the deadline to invest in QOFs and obtain the tax deferral is Dec. 31, 2026. As of that date, unless the incentive is extended, no matter when taxpayers have invested their capital gains into a QOF, they will be required to pay the corresponding taxes they owe on such gains. The Dec. 31, 2026, deadline was a function of the congressional budget horizon and reduced the cost of the incentive. Any extension will have a huge price tag (at least $25 billion), so adopting an additional deferral period may not be feasible. Rather than extending the current deadline, it seems more likely that Congress may elect to collect the taxes due and owed as of Dec. 31, 2026, and enact a new, independent deferral date, which could be as late as Dec. 31, 2034. This way, the federal government could receive an influx of tax revenue in 2026 or 2027 and provide investors another window to invest newly realized gains. Regardless, taxpayers currently invested in QOFs should prepare to respond by ensuring their assets are sufficiently liquid to pay their deferred gains.
4. Expect the programs to dovetail
The most rewarding aspect of the OZ Incentive is the ability to exclude all appreciation on invested capital gains after holding the investment in a QOF for 10 years. Since a QOF can invest in selected census tracts in several ways, investors are able to retain their investments in a QOF while changing the form of their investments in the underlying census tracts. As long as 90% of the QOF’s funds are invested in “qualified opportunity zone property” as of June 30 and Dec. 31 of each calendar year (assuming the taxpayer’s taxable year follows the calendar year), taxpayers are deemed to be in compliance with the incentive and to have retained their investment. Many investors have strategically taken advantage of this flexibility, which is likely to continue as the new tracts are added. As such, investors should consider organizing funds in late 2025 or early 2026 to be strategically positioned to participate in the new opportunity zone rush once the list of new tracts is released.
5. OZ success requires competent advisors
The IRS issued about 200 Private Letter Rulings (PLRs) granting relief around the OZ Incentive. PLRs can be thought of as permission slips from the IRS for failing to comply with tax laws. Due to the complexity of the OZ Incentive, many QOF organizers and tax advisors representing QOFs filed erroneous tax returns that resulted, or otherwise would have resulted, in losing the incentive’s powerful benefits. Many if not most of the PLRs were issued because a tax advisor failed to check a single box on the partnership tax return—a task that is simple but requires a surprising amount of expertise and familiarity with the incentive. If taxpayers intend to take advantage of the OZ Incentive, they should vet their current or prospective tax and legal counsel to ensure they will reap the rewards of investing in opportunity.
Parsons Behle & Latimer’s attorneys deliver in-depth specialization in the OZ Incentive and all aspects of corporate and tax law, regularly counseling clients to help maximize their investments. To contact Ross Keogh, regarding this or related matters, send an email to rkeogh@parsonsbehle.com or call 406.317.7220. To contact Travis Corbin send an email to tcorbin@parsonsbehle.com or call 801.532.1234.
