Opportunity Zone Fund Structure: Key Considerations for Investors

Written By
Carl E. Sera, CMT
Published On
July 16, 2023

If you're interested in investing in an opportunity zone fund, it's important to understand the fund's structure. This guide will walk you through the key components of structuring an opportunity zone fund.

Everyone seems to be talking about Opportunity Zones, which is understandable. Not only does the new legislation enable for the tax deferral, preferential tax treatment, and partial remission of tax on capital gain profits from any source, but it also provides for the investment of those gains to grow tax free if held for a minimum of ten years. Yet, the real estate legislation is complex, and questions exist at this early stage.

As noted above, there are numerous issues that can arise in the structuring and ongoing operation of an OZ fund. Keep reading to learn more about structuring an Opportunity Zone Fund and the legalities involved.

Step 1: Create a Qualified Opportunity Fund (QOF)

Opportunity zone investments are as complex as they are lucrative and require a specific investment structure. To structure a Qualified Opportunity Zone (QOZ) investment that qualifies for the tax incentives, opportunity zone investors are required to set up an investment vehicle called a Qualified Opportunity Fund (QOF) into which they will invest their capital gains within 180 days.

To be considered a Qualified Opportunity Fund, there are five requirements:

Qualified Opportunity Fund must be an investment vehicle organized as a partnership, LLC (with 2+ members), S Corporation, or C Corporation for tax purposes;

Qualified Opportunity Fund must be a legal entity organized under laws of the United States, laws of one of the 50 states, or D.C.;

Qualified Opportunity Fund organizing documents (Operating Agreement/Partnership Agreement/Articles of Incorporation) must state that the purpose of the entity is to “invest in Qualified Opportunity Zone Property.”

Qualified Opportunity Fund organizing documents must include a ‘‘description of the Qualified Opportunity Zone Business that the QOF expects to engage in either directly or through a first-tier operating entity”; and

Qualified Opportunity Fund must self-certify by annually filing Form 8996 upon the conclusion of its taxable year.

Step 2: Investor Contributes to the Qualified Opportunity Fund (QOF)

Investors in opportunity zones must make a cash or other property contribution to the Qualified Opportunity Fund (QOF) in exchange for an eligible interest (equity interest) in the QOF.

While investors in opportunity zones are able to invest an unlimited amount of cash in a Qualified Opportunity Fund, only the share equivalent to their capital gains will qualify for tax-free growth. A qualifying interest is the portion of an investor's qualified interest that qualifies for tax breaks.

Furthermore, donations to the Qualified Opportunity Fund must be made within 180 days of the date capital gain would be recognized for federal income tax purposes in order to qualify for the opportunity zone tax benefits (the sale date or distribution date).

Step 3: Create a Qualified Opportunity Zone Business (QOZB)

After donating funds to the Qualified Opportunity Fund (QOF), the QOF must establish a Qualified Opportunity Zone Business. (QOZB). The QOF is required to begin testing compliance with the 90% Investment Standard at the end of its first tax year.

The 90% Investment Standard mandates that at least 90% of a QOF's assets be Qualified Opportunity Zone Property. (QOZP). Compliance with the 90% Investment Standard is assessed semi-annually throughout the opportunity zone investment process. Failure to comply results in severe fines.

Qualified Opportunity Zone Property (QOZP) includes (i) QOZ Stock in a QOZB; (ii) QOZ Partnership Interests in a QOZB; and (iii) Qualified Opportunity Zone Business Property. (QOZBP). You’ll also need to meet the following Qualified Opportunity Zone Business (QOZB) Requirements:

Eligible entity;

Engaged in a trade or business within the meaning of § 162; and

That satisfies all of the requirements in § 1400Z2(d)(3)(A) as determined at the end of its taxable year.

Step 4: Qualified Opportunity Fund Investment into the Qualified Opportunity Zone Business

After establishing an Opportunity Zone Business (QOZB), the Qualified Opportunity Fund (QOF) will acquire Qualified Opportunity Zone Property (QOZP). The Qualified Opportunity Fund will invest monies donated by investors as well as any loan proceeds in the Qualified Opportunity Zone Business (QOZB) in exchange for QOZ shares or QOZ partnership interests.

Step 5: QOZB Purchase QOZBP

When assessing compliance with the 90% Investment Standard, an Opportunity Zone Business (QOZB) must pass 5 Tests for the Qualified Opportunity Fund (QOF) investment into the QOZB to qualify as QOZP. At the end of the QOZB's fiscal year, compliance with the five test tests is determined each year.

A QOZB with a valid working capital safe harbor, on the other hand, allows the QOZB to be in automatic compliance with QOZB Tests 1-4 for up to 31 months or 62 months with successive overlapping working capital safe harbors. Still, keep in mind that one of the five QOZB compliance tests requires that 70% of all tangible property owned or leased by the QOZB be Qualified Opportunity Zone Business Property. (QOZBP).

While testing for compliance with this criteria is delayed when a legal working capital safe harbor is in place, QOZBs will eventually be required to meet this 70% tangible property standard each year for the balance of the opportunity zone investment.

Final Thoughts

As we mentioned in the introduction, considerable nuances exist in all of the tax treatment and regulations discussed in this article, and investors would be wise to consult their professional advisors well before taking the initial steps to pursue an opportunity zone fund investment.

For a more in-depth discussion of the opportunity zone program and its workings, please get in touch with us at Sera Capital to schedule a free consultation.

DISCLOSURE: Pursuant to IRS Circular 201, this website does not constitute tax advice, and you may not rely upon the information contained herein. The tax code is complex and nuanced rules are summarized on this website. Tax advice may only be relied upon when obtained pursuant to an attorney-client relationship with our firm.

Carl E. Sera, CMT

Carl E. Sera, CMT

Managing Principal, Sera Capital
Carl Sera is a Chartered Market Technician and the Managing Principal at Sera Capital Management, LLC. He has over 16 years of experience in the financial services industry with a focus on investment management.

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