Funds With Benefits: Investing in Qualified Opportunity Zones
Are you up to date on the two sets of IRS-proposed rules on QOZs?

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The Tax Cuts and Jobs Act1 created qualified opportunity zones (QOZs) to spur economic development throughout the United States by providing tax benefits to investors who make qualifying investments in these zones. Thousands of population census tracts have been designated as QOZs. Under the QOZ program, taxpayers who timely roll over capital gains into equity investments in a qualified opportunity fund (QOF) can qualify for several tax benefits.

Because of the program’s sweeping geographic scope, real estate developers, leasing companies, sports teams, retailers, tech companies, and many other operating businesses can find themselves within a QOZ and may be able to benefit from the QOZ program, either directly or because the program makes available additional sources of capital at favorable rates.

So far, the Internal Revenue Service has issued two sets of proposed regulations that would implement the QOZ program. This article briefly describes the tax benefits available under the QOZ program and a common investment structure and then addresses how, and how soon, an investor in a QOF can receive cash from its investment (either from a sale or exchange of the investment or from a distribution) without jeopardizing those tax benefits.

Overview of Benefits

The QOZ program offers both deferral and exclusion benefits to taxpayers making a qualifying investment in a QOF. A taxpayer makes a qualifying investment with respect to an amount of capital gain by investing that amount in a QOF during the 180-day period beginning on the date of the sale or exchange that gave rise to the capital gain. Assuming the applicable requirements are met, the taxpayer may receive three benefits:

  1. The capital gain timely invested in a QOF may be deferred until December 31, 2026, at the latest.
  2. Ten or fifteen percent of the invested gain may be permanently excluded, if the taxpayer holds the QOF investment for at least five or seven years, respectively, before December 31, 2026. This exclusion is effectuated through an increase in the taxpayer’s basis in the QOF investment, as discussed below.
  3. If the taxpayer holds the QOF investment for at least ten years, the taxpayer may increase its basis to fair market value at the time when the QOF is sold or exchanged, resulting in a permanent exclusion of any additional gains realized with respect to appreciation of the investment.

There is no limitation on the amount of gain that can be deferred or excluded.

Two-Tier Investment Structure

Based on the statute and the two sets of proposed regulations2 that have been released so far, many QOZ investments have been made in a tiered partnership structure. The taxpayer may make an investment with respect to qualified capital gain in a QOF partnership, which in turn invests in a “qualified opportunity zone business” partnership (QOZB).

The statute requires that at least ninety percent of a QOF’s assets be qualified opportunity zone property. An interest in a QOZB can qualify entirely as qualified opportunity zone property if, among other things, the QOZB operates a trade or business and at least seventy percent of the tangible property owned or leased by the QOZB in that business is qualified opportunity zone business property (QOZBP). QOZBP is tangible property used in a trade or business if the property was acquired by the QOZB by purchase after December 31, 2017; the original use of the property in the QOZ commences with the QOZB or if the QOZB substantially improves the property; and during substantially all of the QOZB’s holding period for the property, substantially all of the use of the property was in a QOZ.3 Thus, a QOZB generally has a seventy percent “good asset” threshold, whereas a QOF has a ninety percent “good asset” threshold.

This article will generally assume a two-tier structure in which a QOF partnership has invested in a QOZB partnership.

Sale or Exchange of QOF Interest After Ten Years

The full QOZ benefits are available to a taxpayer that holds a QOF interest for at least ten years from the date of investment. In that case, the taxpayer will have recognized eighty-five to 100 percent of its original deferred gain in 2026 but will have received basis in its QOF interest of 100 percent of the original deferred gain. Section 1400Z-2(c)4 provides that upon sale or exchange of a QOF interest held for at least ten years, the taxpayer may elect to increase its basis further to the fair market value at the time of sale or exchange.

Sale or Exchange of QOF Interest

The ten-year basis increase provided by Section 1400Z-2(c), together with a special deemed asset basis adjustment provided in the second set of proposed regulations, allows a taxpayer to exclude gain resulting both from economic appreciation of the QOF investment and also from tax depreciation taken with respect to the investment.

Generally, a partner selling an interest in a partnership recognizes capital gain, except to the extent of the partner’s share of partnership “unrealized receivables.” Even if a partner would not otherwise recognize gain on the sale of a partnership interest (for example, because the partner’s basis equals the amount realized), Section 751 can cause a partner to recognize ordinary income and an offsetting capital loss.5

In the second set of proposed regulations, the IRS offered a solution to this problem by providing a special asset basis adjustment rule. If the QOF partner’s basis in a qualifying QOF partnership interest is adjusted to fair market value under Section 1400Z-2(c), then immediately before the sale or exchange, the basis of the QOF partnership assets are also deemed to be adjusted.6 The preamble to the proposed regulations notes that the purpose of this rule is to “avoid the creation of capital losses and ordinary income on the sale” of the QOF interest.7

Example 1. Taxpayer A recognizes a $100 capital gain in November 2018 and makes a timely investment of $100 in a QOF on January 1, 2019. The QOF invests the same amount in a QOZB. Both the QOF and QOZB are classified as partnerships for U.S. federal income tax purposes. The QOZB uses the $100 to purchase five-year depreciable property for use in its business. Under the QOZ rules, A’s basis in the QOF is initially zero, but is increased by $10 on January 1, 2024, by another $5 on January 1, 2026, and by the remaining $85 on December 31, 2026.8 Over time, the QOZB allocates $100 in depreciation deductions with respect to the depreciable property to the QOF, which allocates the same amount to A. Depending on the amount of other income, and whether the QOZB or QOF has any debt, the deductions allocated by the QOF to A may be suspended under Section 704(d). Each of A’s basis increases on January 1, 2024, January 1, 2026, and December 31, 2026 will free a corresponding amount of suspended losses. By December 31, 2026, A will have recognized an $85 capital gain but received $100 in depreciation deductions.9

After ten years, A’s basis in the QOF is zero, but A’s interest is worth $1,000. The QOZB has potential Section 1245(a) recapture of $100, all of which would be allocated to the QOF and in turn to A.

If the QOZ rules did not apply, and A sold the QOF interest for $1,000, A would recognize $100 of ordinary income under Section 751 and $900 of capital gain. Under the QOZ rules, if A holds the QOF investment for at least ten years (i.e., through January 1, 2029), A may increase the basis in its QOF interest to fair market value, or $1,000. Immediately before A sells its interest in the QOF, A would be deemed to have a basis adjustment in the QOF assets (the QOZB interest) as if A had just purchased the QOF interest. Thus, with respect to A, the QOF’s basis in the QOZB would be deemed to be $1,000. It is not clear from the text of the proposed regulation whether this basis adjustment is also pushed into the QOZB (whether or not the QOZB has a Section 754 election in effect), but pushing the adjustment down may be the only way to effectuate the intent of the rule.10 Assuming the adjustment is pushed down, A would recognize no gain or loss on the sale of the QOF interest.

The special asset basis adjustment rule in the proposed regulations amplifies A’s QOZ benefits. In this example, A would have had a capital gain of $100 in 2018 but instead takes a capital gain of $85 into account in 2026 (because A held its QOF investment for seven years before December 31, 2026). A benefits from $100 in depreciation deductions, as A receives the ten percent, five percent, and December 31, 2026, basis increases. Upon sale, A receives $1,000 tax free. In total, A has earned $1,000 ($100 of original gain and another $900 on the QOF investment) and has a net $15 deduction ($85 capital gain with respect to the original investment and a $100 depreciation deduction). In other words, the gain exclusion after ten years applies not just to the $900 of economic appreciation but also to the $100 of tax gain that resulted from tax (but not economic) depreciation of the investment.

Sale or Exchange of QOZB or Business

The Section 1400Z-2(c) basis adjustment applies only to a sale or exchange of a QOF interest, and not to the sale or exchange by the QOF of its property. In the proposed regulations, however, the IRS has added an election pursuant to which a QOF investor might be able to exclude capital gain recognized by the QOF on the sale or exchange of the QOF’s own property. That rule provides that if a taxpayer has held a QOF interest for at least ten years, and the QOF disposes of qualified opportunity zone property after the investor’s ten-year holding period, the investor may exclude from gross income the capital gain arising from the disposition allocated to the investor and attributable to the qualifying investment.11

Even with this special election, a QOF investor receiving allocations of gain may not be in the same position as a QOF investor that sells its interest in the QOF directly.

Example 2. Assume the same facts as Example 1, except that A’s QOF sells its interest in the QOZB partnership for $1,000. A’s QOF would recognize $100 of ordinary income and $900 of capital gain under the Section 751 rules. The special deemed asset basis adjustment discussed above does not apply to a QOF’s sale or exchange of its own property. Rather, A may elect to exclude only capital gain allocated to A from the QOF. Here A could exclude $900 but would still have $100 of ordinary income.

The regulations do not allow a similar exclusion if the QOZB sells its property.

Example 3. Assume the same facts as Example 1, except that the QOZB sells the business for $1,000. In this case, A would recognize $900 of capital gain and $100 of ordinary income, because this was neither a sale of A’s interest in the QOF nor the QOF’s sale of its own property.

Commentators have notified the IRS of this disparate treatment of an investor’s sale of a QOF interest, a QOF’s sale of its property, and a QOZB’s sale of its property. If this distinction is preserved in the final regulations, taxpayers will need to structure sales of QOZ businesses carefully to enhance the gain exclusion.

Cash Distributions

Under the proposed regulations, a distribution from a QOF may allow a partial monetization of the QOF investment before ten years, without sacrificing any of the deferral or exclusion benefits. Careful consideration must be given to structuring a distribution, as discussed below.

Code Section 1400Z-2(b)(1) provides that a taxpayer’s deferred gain is included in the taxpayer’s income in 2026 or, if earlier, the date on which the qualifying investment is sold or exchanged (an “inclusion event”). The proposed QOZ regulations expand the concept of an inclusion event generally to include a transfer of a QOF interest that reduces the taxpayer’s equity interest in the QOF, and receipt of property from the QOF in a transaction that is treated as a distribution for federal income tax purposes, whether or not the receipt reduces the taxpayer’s ownership of the QOF.12 The proposed regulations also provide a specific, inexhaustive list of inclusion events.

The proposed regulations, however, apply special rules to a QOF classified as a partnership for U.S. federal income tax purposes. A distribution of cash or property from a partnership QOF to a partner with respect to the partner’s qualifying investment is generally an inclusion event only to the extent that the value of the distributed property exceeds the partner’s basis in its qualifying investment (“outside basis”).13 A partner’s starting outside basis with respect to its qualifying investment in the QOF will be zero, but will be increased by allocations of net income to the partner from the QOF and also will be increased by the partner’s share of the QOF’s liabilities (including the QOF’s share of the QOZB’s liabilities).14 Therefore, an investor in a QOF can generally receive cash distributions that are matched by taxable income allocations, or by the investor’s share of liabilities, without triggering an inclusion event.

Debt-Financed Distributions

For example, a QOF (directly or through a QOZB) may develop a real estate project. Once the project is stabilized, the QOF (or QOZB) may borrow money and distribute some or all of that money to its partners. Under Section 752, debt of the QOF and debt of the QOZB allocated to the QOF will increase the outside basis of the partners in the QOF, allowing a corresponding distribution to be made to those partners.

Example 4. Taxpayers A and B form a QOF on January 1, 2019, and each contributes $200 of qualifying capital gain. Under the QOZ rules, each partner’s initial basis in its QOF interest is zero. On November 18, 2022, the QOF obtains a nonrecourse loan from a bank for $300. Under Section 752, the loan is allocated $150 to A and $150 to B. Several days later, the QOF distributes $150 to A. Taxpayer A does not have an inclusion event, because the amount of the distribution ($150) does not exceed A’s basis in its QOF interest ($150, which is A’s basis in its QOF interest immediately before the distribution).15

As a result of A’s QOF investment on January 1, 2019, A is able to defer paying tax on A’s $200 capital gain until 2026, or the year in which A experiences an inclusion event, if earlier. As the example demonstrates, this deferral continues even when A receives a debt-financed distribution from the QOF of A’s share of the QOF’s debt. If A holds the QOF investment at least until January 1, 2024, A’s basis in the QOF will be increased by $20 (ten percent of the original deferred gain), and the amount of gain on which A will eventually pay tax will be decreased to $180. If A holds the QOF investment at least until January 1, 2026, A’s basis in the QOF will be increased by another $10 (five percent of the original deferred gain), and the amount of gain on which A will pay tax in 2026 will be decreased to $170. In either case, the amount of gain included is limited to the fair market value of the investment on the date of inclusion. If A sells the QOF interest after holding it for at least ten years, A could elect to exclude any additional gains realized from the sale of the interest. None of these benefits are diminished by A’s receipt of the debt-financed distribution from the QOF in November 2022.

Disguised Sale Rules

Notwithstanding the favorable distribution rules discussed above, certain cash distributions can cause an investment to fail to qualify as a good QOF investment. The proposed regulations provide that to the extent a distribution would be treated as a disguised sale under Section 707 if cash contributed had been noncash property, the original contribution is not treated as a qualifying contribution for purposes of the QOZ benefits. For this purpose, a partner’s share of liabilities is deemed to be zero.16 The significance of this point is discussed below.

Generally, under Section 707, if there is a transfer of money or property by a partner to a partnership and a related transfer of money or property by the partnership back to the partner, and the transfers viewed together are properly characterized as a sale of property, the transfers are treated as a sale rather than as a contribution and distribution. When the transfers are not simultaneous but are treated as a sale, the sale is generally treated as taking place on the date of the contribution.17 The disguised sale rules would not normally apply to link a contribution of cash with a distribution of cash to the same partner, but the proposed QOZ regulations require the contributed cash to be treated as property for this purpose.

Whether transfers to and from a partner constitute a sale of property depends on whether, accounting for all facts and circumstances, the transfer of money would not have been made but for the transfer of property, and a subsequent transfer does not depend on the entrepreneurial risk of partnership operations. The regulations under Section 707 provide an inexhaustive list of ten facts and circumstances to consider. Transfers made within two years are presumed to be a sale, unless the facts and circumstances clearly establish that those transfers do not constitute a sale. On the other hand, transfers made more than two years apart are presumed not to be a sale, unless the facts and circumstances clearly establish that those transfers constitute a sale.18 The regulations provide special rules for reasonable preferred returns and guaranteed payments, distributions of operating cash flow, and reimbursement of preformation capital expenditures.19 The Section 707 regulations also provide an exception pursuant to which a debt-financed distribution to a partner is not treated as part of a sale to the extent that the distribution does not exceed the partner’s share of the applicable liability. The proposed QOZ regulations, however, state that a partner’s share of liabilities is deemed to be zero for purposes of applying the QOZ disguised sale rule, effectively causing this exception not to apply to determining whether a contribution to a QOF is a qualifying investment.

In Example 4, the debt-financed distribution is made almost three years after the original contribution. Therefore, the favorable two-year presumption would apply, and the distribution would not be treated as a disguised sale unless the facts clearly establish that the distribution is part of a sale. If the distribution had been made within two years of the contribution, it would be presumed to be part of a sale unless clearly established otherwise.

What is at stake if a distribution is treated as a disguised sale for QOZ purposes? The proposed regulations provide that the original contribution, to the extent that it is treated as a sale, does not constitute a qualifying investment. In that case, the taxpayer should not have been entitled to any deferral for that amount and will not receive the ten or fifteen percent gain exclusion on that amount.


The two sets of proposed regulations have settled many issues in a manner beneficial to QOF investors. Nevertheless, cash distributions from a QOF, and sales of a QOF investment, must be structured carefully to realize the full tax benefits available under the QOZ program.

Jennifer Ray is a principal with the pass-throughs group in the Washington national tax office of Deloitte Tax LLP, a subsidiary of Deloitte LLP.

Please see for a detailed description of our legal structure. Certain services may not be available to attest clients under the rules and regulations of public accounting. This article contains general information only, and Deloitte is not, by means of this column, rendering accounting, business, financial, investment, legal, tax, or other professional advice or services. This column is not a substitute for such professional advice or services, nor should it be used as a basis for any decision or action that may affect your business. Before making any decision or taking any action that may affect your business, you should consult a qualified professional advisor. Deloitte shall not be responsible for any loss sustained by any person who relies on this column.


  1. The TCJA is formally known as “An Act to provide for reconciliation pursuant to titles II and V of the concurrent resolution on the budget for fiscal year 2018,” P.L. 115-97 (2017).
  2. Specifically, 83 Fed. Reg. 54,279 (October 29, 2018) and 84 Fed. Reg. 18,652 (May 1, 2019) (“second set of proposed regulations”).
  3. I.R.C. Section 1400Z-2(d)(2)(D).
  4. All “section” references in the text of this article are to the Internal Revenue Code of 1986, as amended, unless otherwise noted.
  5. Treas. Reg. Section 1.751-1(a); see, e.g., Treas. Reg. Section 1.751-1(g), example 1.
  6. Prop. Treas. Reg. Section 1.1400Z2(c)-1(b)(2)(i).
  7. 84 Fed. Reg. 18,652 (May 1, 2019).
  8. I.R.C. Section 1400Z-2(b)(2)(B); Treas. Reg. Section 1.1400Z2(b)-1(g)(1).
  9. There may be other limitations on A’s ability to use these losses.
  10. See I.R.C. Section 751(f); Prop. Treas. Reg. Section 1.743-1(l); Rev. Rul. 87-115, 1987-2 C.B. 163.
  11. Prop. Treas. Reg. Section 1.1400Z2(c)-1(b)(2)(ii).
  12. Prop. Treas. Reg. Section 1.1400Z2(b)-1(c)(1).
  13. Prop. Treas. Reg. Section 1.1400Z2(b)-1(c)(6)(iii).
  14. I.R.C. Section 1400Z-2(b)(2)(B)(i); Prop. Treas. Reg. Section 1.1400Z2(b)-1(g)(3).
  15. See Prop. Treas. Reg. Section 1.1400Z2(b)-1(f)(1), Example 10.
  16. Prop. Treas. Reg. Section 1.1400Z2(a)-1(b)(10)(ii).
  17. Treas. Reg. Section 1.707-3(a)(2).
  18. Treas. Reg. Section 1.707-3(c), (d).
  19. Treas. Reg. Section 1.707-4.

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