The IRS has released a second set of proposed regulations on the new tax incentives for investments in Qualified Opportunity Zones (QOZs). The incentives, created by the Tax Cuts and Jobs Act, permit taxpayers to defer, reduce and even permanently exclude capital gains on their investments. The proposed regulations — most of which can be relied upon until final regulations are published — include several provisions that are favorable for real estate investors.

Incentives in a nutshell

Investors can form private Qualified Opportunity Funds (QOFs) for development and redevelopment projects in QOZs. The funds must keep at least 90% of their assets in QOZ property. Qualified opportunity zone property includes QOZ stock, QOZ partnership interests or a direct ownership interest in QOZ business property. QOZ business property includes new or substantially improved commercial buildings, equipment and multifamily complexes.

Investors can defer their short- or long-term capital gains on a sale or disposition of their investments as long as they reinvest the gains in a QOF within 180 days. The tax will be deferred until 1) the fund investment is sold or exchanged, or 2) December 31, 2026, whichever is earlier.

After five years, a QOF investor receives a step-up in tax basis for the investment equal to 10% of the original gain, meaning the investor will pay tax on only 90% of that gain. Two years later, the step-up jumps to 15%, further reducing the taxable portion of the original gain. If an investment is held in the QOF for at least ten years, post-acquisition gains are fully tax-exempt.