How Qualified Opportunity Funds Work for Investors

A Qualified Opportunity Fund (QOF) is an investment vehicle created as part of a federal tax incentive program established by the Tax Cuts and Jobs Act of 2017. This program is designed to encourage long-term private investments in specific economically distressed communities designated as Qualified Opportunity Zones (OZs). There are over 8,700 such zones across the United States and its territories, and the program offers tax advantages to investors to stimulate economic development and job creation.

A QOF is a U.S. partnership or corporation organized for the express purpose of investing in OZ property. To maintain its status, the fund must hold at least 90% of its assets in qualified property located within one or more of these designated zones.

Core Tax Incentives

The tax incentives for investing in a QOF are designed to reward long-term commitment. The first of these is a temporary deferral of tax on existing capital gains. An investor who realizes a capital gain from selling an asset, such as stock or real estate, can postpone paying federal taxes on that gain by reinvesting it into a QOF. This deferral is not indefinite; the tax on the original gain must be recognized on December 31, 2026, or when the QOF investment is sold, whichever comes first.

For example, if an investor sells stock in March 2025 for a $200,000 capital gain and reinvests that amount into a QOF within the required timeframe, they do not have to pay capital gains tax for their 2025 tax return. Instead, the tax payment is pushed to the 2026 tax year, which is filed in 2027. This allows the investor to put the full pre-tax gain to work.

A primary benefit is the potential for tax-free growth on the QOF investment itself. If the investment is held for at least 10 years, the investor can elect to have their basis in the QOF investment stepped up to its fair market value on the date it is sold. This means any appreciation in the value of the QOF investment over the 10-year holding period is exempt from federal capital gains tax. For instance, if a $200,000 QOF investment grows to $500,000 after 11 years, the $300,000 in appreciation would be tax-free.

Investor and Investment Eligibility

Participation in the QOF program is open to a wide range of taxpayers. Eligible investors include individuals, C corporations (including regulated investment companies and real estate investment trusts), S corporations, partnerships, and certain trusts and estates. This allows various types of taxpayers who have realized capital gains to take advantage of the tax incentives offered by the program. The key is not the type of entity, but whether it has an eligible gain to invest.

The program requires the investment of an “eligible gain,” which includes both short-term and long-term capital gains. These gains can come from the sale or exchange of nearly any type of property, such as stocks, bonds, or real estate, as long as the sale is to an unrelated party. Gains that are recognized for federal income tax purposes before January 1, 2027, qualify for this treatment.

A requirement for eligibility is the 180-day investment rule. To defer a capital gain, an investor must reinvest the gain into a QOF within a 180-day period. For an individual investor selling stock, this 180-day window begins on the date of the sale that generated the gain. Missing this deadline renders the gain ineligible for the tax deferral.

The starting point for the 180-day clock can differ for gains passed through from other entities. For capital gains realized by a partnership or an S corporation, an individual partner or shareholder has more flexibility. They can choose to start their 180-day investment period on the date the entity sold the asset, the last day of the entity’s taxable year, or the due date of the entity’s tax return for the year of the gain (without extensions).

Making the QOF Investment

Once an investor confirms they have an eligible gain and are within the 180-day window, they must decide how to make the investment. One path is to invest in an established QOF managed by a third-party asset manager. This involves researching funds found through financial advisors, wealth management firms, and specialized online platforms. Investors should vet the fund’s management team, investment strategy, and fee structure before committing capital.

A second path is to create a self-certified QOF. This option is more complex and suited for those with specific projects in mind. The process begins by forming a legal entity, usually a partnership or a corporation. This entity then self-certifies as a QOF by filing IRS Form 8996, Certification of Qualified Opportunity Fund, with its annual federal income tax return.

To complete Form 8996, the entity must provide its Employer Identification Number (EIN), the date it was organized, and certify that its purpose is to invest in QOZ property. The form is also used to calculate the fund’s 90% asset test. The fund must test its assets on two dates each year—once at the midpoint and once at the end of its taxable year—and report the results on this form.

A procedural step is making the deferral election on the investor’s personal tax return. This is accomplished by filing Form 8949, Sales and Other Dispositions of Capital Assets. The investor reports the original capital gain on this form, but on a separate line, reports a negative adjustment with the code “Z” in column (f) to indicate the amount of the gain being deferred into a QOF.

Maintaining Compliance and Realizing Benefits

After the initial investment is made, ongoing compliance is necessary to secure the long-term tax benefits. Investors who hold an interest in a QOF must file Form 8997, Initial and Annual Statement of Qualified Opportunity Fund Investments, with their tax return each year. This form tracks the status of the QOF investment, including the amount of the deferred gain, any capital contributions or distributions, and the dates of acquisition and disposition.

A key date is December 31, 2026. On this date, the original capital gain that was deferred becomes taxable, regardless of whether the QOF investment has been sold. The investor will report this gain on their 2026 tax return, filed in 2027.

The final milestone is the 10-year holding period. If an investor holds their QOF investment for at least ten years, they become eligible to elect to step up the basis of the investment to its fair market value upon its sale. This election eliminates any capital gains tax on the appreciation of the QOF investment itself. This benefit is available for investments sold on or before December 31, 2047. An investor’s tax benefits can be jeopardized if the fund fails to comply with the 90% asset test.