Here are four compelling reasons why taking the gain now and investing in a Qualified Opportunity Fund (QOF) before the end of 2026 can be beneficial.
- Geography - The number and makeup of OZ-designated census tracts WILL change, meaning some tracts that are currently OZ will not be after 12/31/26. There are three major implications of the new law:
First, Changed Definition of “Low Income” - OZ 1.0 (the TCJA version) allowed governors of all states and territories to select 25% of “low-income” census tracts to be opportunity zones. OZ 2.0 (the OBBBA version) is the same, HOWEVER – the definition of “low-income” has been tightened to include median family incomes below 70% of the State or Metro Median, whereas it had been 80%. That means LESS tracts will be eligible in almost every state, as there is a minimum grant of 25 that will benefit states with fewer than 100 qualified tracts.
Second, Changing Demographics - Recall that when the v1.0 zones were designated in 2018, it was done using 2010 census data; now we have 2020 data. This means some tracts will no longer be low income and some new ones will. Novogradac has a great mapping tool available (here) that can provide some insight, but we won’t know for sure until late next year.
Third, Puerto Rico Exception – TCJA came right on the heels of hurricane Maria. In an effort to aid reconstruction on the island, congress allowed Puerto Rico to designate 100% of low-income tracts as Opportunity Zones. As we are now eight years beyond Maria, that benefit is going away; it will be 25% just like the other states after 12/31/26.
NET: Investing now gets you access to more and known census tracts.
- The Tax Bill - When you roll a capital gain into a Qualified Opportunity Fund (QOF), you defer recognition of that gain until the earlier of:
- The date you dispose of your QOF investment, or December 31, 2026 (statutory sunset).
- The amount of gain on that date equals the excess of (i) the lesser of the deferred gain or the Fair Market Value of the investment on the inclusion date, over (ii) the taxpayer’s basis. (§1400Z-2(b)(2)(A))
- The tax payment is due April 15, 2027, when you file your 2026 return.
The ‘gold’ here is in ‘b’: You pay tax on the lesser of your basis or FMV! There is a high likelihood that the FMV of an illiquid, unmarketable, minority investment in a QOF will be lower in the first one or two years of the investment (perhaps 30-40% lower if properly evaluated) than the amount invested. How does deferring one year AND getting a 40% discount on the ultimate tax bill sound?
This language persists in OZ 2.0, but will likely be less valuable because gain recognition is for a rolling 5-year period. The FMV of most investments held five years is going to be more than the basis, even after applying similar discounts.
NET: You can probably reduce your tax bill by investing now, rather than waiting, even though you will have to pay sooner.
- Liquidity & Exit - A key component of the OZ legislation (both versions) is the “10-year” hold. This requires investors to keep their investment in the QOF for 10 years from the date of the investment. Waiting to invest means waiting to exit. Investing now starts the clock.
NET: Investing now gives you earlier access to your funds for reinvestment.
- Future Tax Rates – A key point to remember about an OZ gain deferral is that you lock in the character of the gain (short-term, long-term, section 1231 or 1250, etc.), but you do NOT lock in today’s capital gains tax rate. Investors will be taxed in the year of inclusion at the going rate and tax brackets on that future date. None of us has a crystal ball, but we’re all a lot more certain what to expect in 2026 vs. 2032.
NET: Uncertainty about future capital gains tax rates creates a risk if waiting.
To be fair, we still think the OZ 2.0 program is an amazing opportunity to do well while doing good and we think it is good policy to have it as a permanent part of the tax code. Investments should continue to flow to underserved areas that need them while rewarding the socially-conscious entrepreneurs willing to invest in them.
However, these four points are hard to dispute. There are legitimate reasons why investing now can be of great benefit if you have capital gains available.
For more on the impact of OBBBA on Opportunity Zone Investing, download our free whitepaper HERE.
At Monllor Capital, we’re on the ground and plugged in to OZ investing, and the entire incentives ecosystem in Puerto Rico. Please contact us if you want to know more.
www.monllorcapital.com
Jose A. Torres, Managing Partner Shawn L. Hanson, Managing Partner
jtorres@monllorcapitalpartners.com shanson@monllorcapitalpartners.com
(303) 263-5331 (608) 385-5377
Disclaimer
This content is provided for informational purposes only and does not constitute legal, tax, or investment advice. The authors have made reasonable efforts to ensure the accuracy of the information contained herein as of the date of publication; however, laws, regulations, and guidance may change, and no guarantee is made as to the completeness or accuracy of the content.
Readers should not rely solely on this material for making investment or tax decisions. All investors are strongly encouraged to consult with qualified tax, legal, and financial professionals before acting on any information contained in this document.
Nothing herein constitutes an offer to sell, or a solicitation of an offer to buy, any security or investment product.
