Episode 18: Qualified Opportunity Zones (QOZs) - Eliminating Capital Gains Taxes

Welcome to Building Passive Income, the podcast for professionals, entrepreneurs and investors who want to build wealth, diversify beyond Wall street, and create true financial freedom through passive commercial real estate investing. I'm Wayne Courageous III, founding and managing principal of Crei Partners, a leading commercial real estate company, I created CreiCollen, an AI powered resource to serve as your investor education guide. Built on the insights and experience we've developed at Crei Partners, CreiCollen is here to educate you through passive invest tax strategy topics to help your journey in passive investing. Just a quick disclaimer. This podcast and CRA Colin is for educational purposes only and is not legal tax or investment advice. Always consult with your attorney, CPA and financial advisor before making any investment decisions. I've spent nearly two decades helping investors understand the power of commercial real estate from multifamily to storage to retail. Each episode is under 15 minutes, simple to follow and and packed with insights to help you grow your income and protect your capital without becoming a landlord. If you're ready to learn quickly and invest smarter, you're in the right place. Welcome to Building Passive Income. Let's build wealth together. Here's creicollen.

What if I told you there's a legal way to defer capital gains taxes now and potentially eliminate taxes on the new investment's appreciation? I'm Crei Colin and this is Building Passive Income, where we give you the strategies to build real wealth through passive real estate investing. Today we're talking about Qualified opportunity zones or Qozs. This is a major tax incentive created by the 2017 Tax Cuts and Jobs Act. If you have a significant capital gain from stocks, a business sale or a real estate exit and you're looking for a way to defer taxes and potentially eliminate future taxes on appreciation, qozs could be a game changer. But like all powerful tax strategies, there are rules, timelines and risks. So let's break it all down. Let's start with the basics. Qualified Opportunity Zones are designated low income census tracts across the United States that have been nominated by state governors and designated by the US treasury and irs. There are thousands of QOZ designated census tracts nationwide. The goal of the QOZ program is to spur economic development and job creation in distressed communities by incentivizing long term investments. And the incentive? Massive tax benefits for investors who invest capital gains into QOZ projects. Here's how it let's say you sell a stock portfolio, a business or a real estate investment and you realize a $500,000 capital gain. Normally you'd owe capital gains taxes 15 to 20% federal plus state taxes. That could be 75,000 to 150,000 or more. But if you reinvest that gain into a Qualified Opportunity Fund, a special investment vehicle that invests in QOZ properties or businesses, you can defer the original capital gain until the earlier of a qualifying inclusion eventually, like selling your qof interest or December 31, 2026. And if you hold the QOZ investment For at least 10 years, you may be able to exclude federal tax on the appreciation of the QOF investment under the 10 year basis. Step up election subject to the program's rules and deadlines. That's the power of qozs. Defer taxes on your original gain and potentially eliminate federal taxes on the new investment's appreciation. Let's break down the three tax benefits of Qualified Opportunity Zones because this is where it gets interesting. Deferral of Capital Gains taxes When you reinvest an eligible capital gain into a Qualified opportunity fund within 180 days, you defer the original capital gain until the earlier of a qualifying inclusion event or December 31, 2026, and the tax is generally payable with your 2026 return. So if you have a $500,000 gain in 2025 and you Qoz, you don't pay taxes on that gain until 2026 or earlier. If an inclusion event occurs, that gives you time to let the money compound before the tax bill comes due. Benefit 2 partial exclusion of the deferred gain if you invested early enough Historically there was a 10% basis step up if you invested early enough to hold five years before December 31, 2026 and a 15% step up if you invested early enough to to hold seven years before that date. Those windows have already passed for new investments, so most investors today focus on the deferral and the potential 10 year appreciation exclusion. So for most investors today, benefit 2 is off the table, but benefits 1 and 3 are still powerful. Benefit 3 potential exclusion of taxes on appreciation this is the big one. If you hold your QOF investment for at least 10 years, you may be able to exclude federal tax on the appreciation of the QOF investment under the 10 year basis. Step up election subject to the program's rules and deadlines. State treatment varies. Let's say you invest 500,000 into a Qoz in 2025. You hold it for 10 years. In 2035 the investment is worth 1.5 million. That's 1 million in appreciation. If you sell in 2035 or later and make the election, you may pay zero federal taxes on that 1 million. It's potentially tax free for federal purposes. This is why qozs are so powerful for long term investors. You're not just deferring taxes, you're potentially eliminating them on all future appreciation. Now, qozs sound amazing, but there are strict rules and requirements. If you don't follow them, you lose the tax benefits. Rule 1. You must invest within 180 days. The 180 day window depends on the type of gain and for K1 or pass through gains the start date can be different. So confirm the exact timing with your cpa. You generally only need to invest the eligible capital gain amount, not the entire sale proceeds. So if you bought a property for 200,000 and sold it for 500,000, you only need to invest the 300,000 gain, not the full 500,000. Rule 2. You must invest in a Qualified Opportunity Fund. You can't just buy property in a qoz and get the benefits. You must invest in a Qualified Opportunity Fund, a special investment vehicle that generally self certifies with the IRS, typically via Form 8996 and must generally meet a 90% investment standard in Qualified Opportunity Zone property measured on IRS testing dates. Some sponsors set up QOFs for specific projects. Others offer diversified funds that invest in multiple QoZ properties. Rule 3 the QoF must meet substantial improvement requirements. If the QOF acquires an existing building in a qoz, it must substantially improve that building. Substantial improvement generally means that over a 30 month period, the project must invest an amount in improvements at least equal to the adjusted basis of the building excluding land. For for raw land, there's no substantial improvement requirement, but the business still must satisfy other use and asset tests. Rule 4. You must hold the investment for at least 10 years to get the potential appreciation exclusion. If you sell before 10 years, you generally won't qualify for the 10 year appreciation exclusion. And selling can also trigger tax on the deferred original gain if it's an inclusion event. So who should consider investing in qualified opportunity zones? Qozs make sense for three types of investors. Type 1 investors with large one time capital gains. If you just sold a business a large stock portfolio or a highly appreciated property and you're facing a massive tax bill, QoZs can defer and potentially eliminate a significant portion of Future appreciation tax. Type 2 investors with a long term horizon Remember, you need to hold for at least 10 years to get the potential appreciation exclusion. If you're not comfortable locking up capital for a decade, Qozs aren't for you. Type 3 investors who are comfortable with higher risk because many opportunity zones are designated as lower income tracks, risks can be higher in some markets, but conditions vary widely by location and due diligence matters. Qozs are not for conservative investors who prioritize safety and cash flow. They're for investors who are willing to take on more risk in exchange for significant tax benefits and and potential appreciation. Let's talk about the risks. Because qozs are not a guaranteed win, the areas vary widely in quality. Because many opportunity zones are designated as lower income tracks, risks can be higher in some markets, but conditions vary widely by location. Some qozs are in rapidly improving neighborhoods while others are in truly distressed areas. You need to do your due diligence on the market and the sponsor. Just because an area is a QOZ doesn't mean it's going to improve. You need to evaluate the fundamentals population growth, job growth, infrastructure investment just like any other real estate market. Risk 2 the 10 year hold requirement 10 years is a long time. A lot can change. Economic downturns, market shifts, sponsor issues. If you need liquidity before 10 years, you'll either have to sell and potentially lose the appreciation exclusion or you'll be stuck. And remember, selling can also trigger tax on the deferred original gain if it's an inclusion event. Risk 3 Sponsor Quality Qoz funds are only as good as the sponsors running them. You need to vet the sponsor's track record, experience in QOZ projects, and alignment of interests. Bad sponsors can destroy even the best tax benefits. Risk 4 legislative and program risk the QOZ program was created by Congress in 2017. While the current benefits are locked in for investments made under the current rules, there's always a risk that the rules could change. Additionally, the 10 year appreciation exclusion is generally available through 2047 under current law, but program rules and deadlines apply. So if you're interested in Qozs and how do you actually invest. Step 1 Identify your capital gain and confirm the timing. The 180 day clock depends on the type of gain. For K1 or pass through gains, the start date can be different. Talk to your CPA to confirm the exact start date. Research qualified opportunity funds. Look for sponsors who specialize in QOZ investments. Ask about their track record, the specific properties or projects they're investing in, the expected hold period and the projected returns. Step three Conduct due diligence. QOZ investments are still real estate investments. You need to evaluate the market, the property, the business plan, the sponsor, and the deal structure. Don't invest just for the tax benefits. Invest because it's a good deal with strong fundamentals. Step four Work with your CPA and attorney qoz investments are complex. You need to make sure the fund is properly structured, the investment is made within the 180 day window and you're set up to hold for 10 years. File the appropriate tax forms. You'll report the deferral and annual OZ information using forms like Form 8949 and Form 8997 and potentially others depending on the gain. Your CPA should handle this, but make sure they're familiar with QOZ reporting requirements. Alright, let's recap. Qualified Opportunity Zones are a powerful tax incentive that allows you to defer capital gains taxes and potentially eliminate federal taxes on the appreciation of the QOZ investment if held long enough. Here's what you need to 1. You can defer capital gains taxes by investing in a QOF. The deferred gain is generally included no later than December 31, 2026 and is payable with your 2026 return unless an earlier inclusion event occurs. 2. If you hold the Qoz investment for at least 10 years, you may be able to exclude federal tax on the appreciation under the 10 year basis step up election subject to the program's rules and deadlines. State treatment varies. 3. The early basis step up benefits 10 and 15% have already passed for new investments, so focus on the deferral and the 10 year appreciation exclusion. 4. Qozs vary widely by location and can carry higher risk, so thorough due diligence is critical. 5. You must work with a qualified sponsor and conduct thorough due diligence on the market, the property and the business plan. 6. Work with your CPA and attorney to structure the investment correctly, confirm timing and meet all IRS requirements. Here's your action step if you're planning to sell an asset with a significant capital gain in the next year. Talk to your CPA now about whether a QOZ investment makes sense. Research sponsors evaluate deals, confirm your 180 day timeline and start planning. And as always, consult with your CPA attorney and financial advisor before making any investment or tax decisions. If you're ready to explore QOZ investments and other advanced tax strategies, let's talk. Check the show notes for a link to schedule a call with us@creipartners.com Next time on Building Passive Income, we're diving into red flags in syndication deals. What to avoid before you invest. Until then, remember, financial freedom isn't a dream, it's it's a decision. And sometimes it starts with investing strategically in opportunity. I'm C.I. colin. Let's build wealth together.

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