What is a Qualified Opportunity Fund and How Does it Work?
A Qualified Opportunity Fund (QOF) is a type of investment that aims to uplift economically-distressed areas across the U.S. It can be structured as a corporation or partnership, and provides tax benefits for investors.
That said, QOFs can be complex. If you’re interested in investing in one, read the rest of this article to learn about how they work, what you should know about them, and why you should consult with a lawyer for assistance to make them work for you.
How Does a QOF Work?
A QOF is when you invest in a fund that benefits low-income communities, either by investing in startups, developing properties, or redeveloping existing properties, or a combination of these activities. However, the locations have to be in designated areas, referred to as Qualified Opportunity Zones (QOZs).
A general party (GP) will manage a QOF, which can be an entity that already exists or one that has been set up for the purpose of the investment.
Are QOFs Exempt From Registrations?
QOFs are usually exempt from registration and their interests are issued in private placements, instead of featuring in public offerings. This is what enables them to not have to be registered under the Securities Act of 1933.
To enable this, QOFs typically:
- Restrict how many people can invest in the QOF.
- Require investors to have to meet specific criteria.
- Don’t list limited partner, or other equity, interests on public exchanges.
How Can a QOF Benefit You?
When you invest in a QOF that supports low-income communities, you’ll receive tax benefits. That said, there are specific rules that govern them.
- You can defer your capital gains invested in the fund until 2026.
- You can exclude 10 percent of the original gain from your income if you hold the QOF fund for five years.
- You can exclude 15 percent if you hold the fund for seven years.
- If you hold the QOF for a minimum of 10 years, the fund’s appreciation will be tax-free when the fund is sold.
What are Some Risks Associated with QOFs?
QOFs need to match certain criteria and there are specific risks involved with these investments.
- Real estate investments usually include places such as hotels or apartment buildings. These might not always fit the investor’s requirements or goals.
- Some location types are prohibited, such as those associated with gambling, those located on golf clubs, and suntan facilities, so you might not qualify based on this.
- You might not qualify for the early offerings, as they can be quite high.
- If you’re redeveloping a business in a Qualified Opportunity Zone, there will be spending and deadline requirements.
- There are expenses included, as what you’ll experience with other investment types.
- You’re not assured of receiving returns from the investment.
- QOFs are considered highly competitive, which increases risks when developing them.
- You might have in-depth knowledge about the company and investment, but not have clarity on the specific investment or how it will be used.
- You need to understand all state laws that affect you. This is because state laws regarding QOFs can vary quite a bit.
What are Your Filing Requirements?
If you’re investing in a QOF, you’ll have to file an annual form with the Securities and Exchange Commission (SEC). This is called Form 8997, Initial and Annual Statement of Qualified Opportunity Fund (QOF) Investments. When you file your annual tax return, you’ll include it.
Form 8997 requests you to fill in the following information:
- Your taxpayer information
- Information about your company and the investment
- If you deferred capital gains by investing them in the QOF, you’ll include information such as the investment date and the amount you deferred.
How Do You Establish a QOF?
If you want to start a QOF, you need to create an entity, such as a partnership or corporation, and self-certify it with the IRS. This entails completing Form 8996 and adding it to your tax return.
The entity needs to keep at least 90 percent of its assets in a Qualified Opportunity Zone property and invest capital within 180 days in order to be valid.
Do You Need a Lawyer when Investing in a QOF?
It’s in your best interests to work with a qualified lawyer because setting up and operating a QOF can be complex. It’s governed by various rules that you might not be aware of without a strong legal background.
- While it’s easy to forget about the investment once it’s set up, your lawyer will ensure that admin is completed properly and on an ongoing basis. This includes tax reporting every year.
- Your lawyer will structure your entity so that it qualifies for the QOF, considering there are many restrictions.
- They’ll draft and review all your important documents to ensure transparency and avoid vague language.
- They’ll help you with all your IRS filings and ensure you don’t miss any deadlines. This includes completing Form 8996, which can seem complex for first-time users.
- Since investments can be risky, your lawyer will ensure you invest in a quality, valid fund. They will conduct due diligence to protect your assets.
- Your lawyer will see beyond the tax benefits of investing in a QOF to protect your interests and reduce your risks.
- They’ll be meticulous when calculating your tax thresholds so that you receive tax benefits.
Where can you find a lawyer for help with a QOF?
Working with a lawyer for your QOF will give you peace of mind that you are able to navigate it legally and take advantage of the tax benefits. Hire a lawyer on ContractsCounsel, an online legal marketplace that connects lawyers with clients. All lawyers on the platform are vetted and they have the skills to assist you with all aspects of investing in a QOF.
