What Is a Qualified Opportunity Fund (QOF)?

A Qualified Opportunity Fund (QOF) serves as an investment tool designed to foster economic growth within designated low-income communities across the United States. These funds offer distinct tax advantages to investors, encouraging the flow of capital into areas identified for revitalization. The program aims to stimulate long-term investments in areas needing economic uplift, aligning private capital with public policy goals.

What is a Qualified Opportunity Fund?

A Qualified Opportunity Fund (QOF) is an investment vehicle established to direct capital into specific geographic areas known as Opportunity Zones. These zones are economically distressed communities identified by states and certified by the U.S. Treasury Department. The Opportunity Zones program was created as part of the Tax Cuts and Jobs Act of 2017 to incentivize private investment in these areas. QOFs are typically structured as corporations or partnerships, and their primary purpose is to invest in Qualified Opportunity Zone property. A QOF must hold at least 90% of its assets in qualified Opportunity Zone property. This asset test ensures funds directly support development and economic activity within the designated zones.

Understanding the Tax Incentives

Investing in a QOF provides three federal tax incentives for eligible capital gains: capital gains deferral, a step-up in basis, and a permanent exclusion of gains on the QOF investment itself.

Investors can defer federal tax on eligible capital gains by reinvesting them into a QOF within 180 days of realizing the original gain. Tax on the original gain is not due until the earlier of the date the QOF investment is sold or exchanged, or December 31, 2026. The reinvested gain maintains its original character.

If the QOF investment is held for at least five years, the basis of the original deferred gain increases by 10%. Holding the investment for at least seven years provides an additional 5% increase, for a total basis step-up of 15%. This increase reduces the taxable amount of the deferred gain when it is eventually recognized.

Any capital gains from the appreciation of the QOF investment can be permanently excluded from federal taxation if the investment is held for at least 10 years. Upon selling or exchanging the QOF interest after this 10-year period, investors can elect to adjust the basis of their investment to its fair market value, effectively making the appreciation tax-free.

How to Invest in a QOF

Investing in a Qualified Opportunity Fund begins with identifying eligible capital gains. Only realized capital gains, such as those from the sale of stocks, real estate, or other appreciated assets, are eligible for reinvestment, not ordinary income. The timeframe for reinvestment is 180 days from the date the capital gain is recognized. If only a portion of the eligible gain is invested, only that portion qualifies for tax benefits.

Investors can invest their eligible capital gains into pre-existing QOFs managed by third parties, or establish and self-certify their own QOF by filing Form 8996 with their federal income tax return. This self-certification indicates the entity’s intent to operate as a QOF.

Investors must file Form 8997 annually with their tax return. This form informs the IRS about QOF investments held, new deferred gains, and any dispositions. Form 8997 tracks the investment lifecycle and helps ensure compliance.

Key Requirements for QOFs and Investments

To maintain its status, a Qualified Opportunity Fund (QOF) must adhere to the 90% asset test. This mandates that at least 90% of a QOF’s assets must be held in qualified Opportunity Zone property. Compliance is measured twice annually, typically on June 30 and December 31, and reported to the IRS on Form 8996.

Qualified Opportunity Zone property includes three categories of investments: Qualified Opportunity Zone business property, Qualified Opportunity Zone business stock, or partnership interests. Business property is tangible property used in a trade or business within an Opportunity Zone, acquired after December 31, 2017, and either original use property or substantially improved by the QOF. Substantial improvement means additions to the property’s basis within 30 months that equal or exceed its original basis.

Stock or partnership interests are ownership interests acquired solely for cash in a Qualified Opportunity Zone Business (QOZB). The issuing entity must be a QOZB for substantially all of the QOF’s holding period. A QOZB must meet several conditions: Substantially all of its tangible property must be located within an Opportunity Zone, and at least 50% of its gross income must be derived from active business within the zone. Certain businesses, such as golf courses, country clubs, massage parlors, hot tub facilities, racetracks, gambling facilities, and liquor stores, are excluded from qualifying as QOZBs.

Investment Timelines and Tax Benefit Realization

The tax benefits associated with Qualified Opportunity Fund (QOF) investments are tied to specific holding periods. The initial deferral of capital gains is effective until the earlier of the date the QOF investment is sold or December 31, 2026. This fixed date means investors need to plan for potential tax liabilities by the end of 2026.

If the QOF investment is held for at least five years, the investor’s basis in the original deferred capital gain increases by 10%. An additional 5% basis increase, for a total of 15%, is granted if the investment is held for at least seven years.

The permanent exclusion of gains from the QOF investment’s appreciation is realized by holding the investment for at least 10 years. After this period, investors can elect to adjust their basis in the QOF investment to its fair market value at the time of sale or exchange, resulting in no federal capital gains tax on the appreciation.