Bloomberg Tax
April 8, 2020, 1:01 PM

INSIGHT: The Opportunity Zone Program—More Than Just a Real Estate Tool

Blake Christian
Blake Christian
Holthouse Carlin & Van Trigt LLP

As we are into the third year of the federal qualified opportunity zone (QOZ) program, we have a much clearer picture of how taxpayers are using this flexible and impactful OZ program as a result of several hundred pages of generally taxpayer-friendly Proposed Regulations, Final Regulations released in late December 2019 along with various IRS FAQ, Rulings and other taxpayer guidance.

While the initial OZ statute and the first set of Treasury regulations focused primarily on real estate projects, the second set of proposed regulations and the final regulations clarified that operating businesses are also a highly appropriate reinvestment option for qualified deferred gains.

In light of the unprecedented economic challenges presented by the Covid-19 virus outbreak, taxpayers with short-or long-term capital gain income generated in calendar 2019, or early 2020 can use the OZ program to “park” the qualified gains in a qualified opportunity fund (QOF) for a period of time to allow the investors adequate time to perform due diligence on various investments and make qualified opportunity zone business (QOZB) and/ or QOZB property investments. Once the capital gains have been re-invested into a QOF and then dropped into a QOZB –taxpayers have up to 62 months to reinvest the proceeds into various OZ projects. With the tremendous uncertainty in the current market, taxpayers will generally view this extended reinvestment period as a godsend.

Not surprisingly, the vast majority of early (QOFs) formed thus far are focused solely on real estate projects. As regulatory guidance has been finalized and investors and advisors have grasped the full power and flexibility of the OZ program, private investors, private equity firms, and venture capital firms have come to realize that using the OZ program for operating businesses may yield even greater long-term benefits than real estate investments—for investors as well as OZ communities.

As we will explore, the OZ program is becoming equally, if not more, attractive to business operators, private equity, and venture fund investors.


Both the QOZ architects and the Trump Administration view the use of the OZ program as a valuable tax and economic development tool for operating businesses based on the following anticipated benefits:

  • Increased overall commerce in OZ census tracts and adjacent neighborhoods

  • Increased employment and workforce training within OZ communities

  • Development of affordable/attainable/workforce housing in OZ communities

  • Reduced poverty levels within OZ communities

  • Accelerated long-term business growth

  • Modernized local infrastructure

Compared to real estate projects, operating business investments offer the following advantages:

  • Less (or nonexistent) entitlements

  • Less capital outlay

  • Arguably less risk

  • Quicker path to revenue generation

  • Ability to alter business plan

  • Mobility

  • Potential for a higher multiple upon exit

As a result of these incremental benefits, serial entrepreneurs and investors with connections to successful business operators should consider operating businesses as a highly attractive OZ business investment.

The regulations also provided more liberal reinvestment periods and other more flexible provisions as compared to real estate projects—now allowing up to 62-months to reinvest the qualified funds once they are moved downstream from the QOF to the QOZB entity.

The following analysis will address these issues and compare and contrast the various ways an OZ investor might acquire an operating business within a QOZB. We will analyze the three general ways in order of easiest to most complex.


A real estate investment’s ROI will primarily be tied to real estate inflation in that geographic region with additional increases related to developer’s profit for ground-up builds. Operating business valuations, however, are generally tied to their earnings history (i.e. EBITDA multiple).

As an example, a $1 million QOF real estate investment that is improved by a $600,000 loan, would appreciate to approximately $4.1 million assuming a 10% compounded annual appreciation—a rate most would consider a home run for a real estate investment. This would result in an approximate $2.5 million ($4.1 million - $1.6 million) tax-free return to the investors if held 10 years. Of course, there would be earnings and depreciation occurring during the 10-year holding period, which would alter these figures.

Alternatively, if the investors choose to invest in, or start-up, a QOZB, they can start with the same $1,000,000 of gain deferral and borrow $600,000 for expansion/operating capital. If the company is generating EBITDA of $500,000 after 10 years, a valuation at a seven multiple of earnings would yield a sales price of $3.5 million (before looking at their net cash position) and a tax-free gain of approximately $1.9 million ($3.5 million - $1.6 million). Assuming the business accumulated net cash from operations of another million dollars there would be a total after-tax ROI of approximately $2.9 million—larger than the real estate ROI.

It is important to note that even though the debt portion of QOF/QOZB financing is not eligible for the five and seven-year tax “step-ups,” the ultimate tax exemption after the 10-year hold applies to both the equity and debt portions of the investment. So, leverage is your friend in the land of OZ.


The core requirements for a business to qualify as a QOZB include the following statutory requirements:

(1) At least 70% of the QOZB’s assets must be QOZB property used in primarily in OZ census tracts,

(2) At least 40% of all QOZB intangibles must be used in OZ census tracts,

(3) At least 50% of the QOZB income must be associated with OZ-sourced income, determined under one of the three “safe harbor” rules contained in the second set of Proposed Regulations.

There is no minimum amount required to invest in an operating business, and taxpayers can invest both qualified deferred gain and after-tax money into the business; however, only the qualified deferred gains invested into the QOF/QOZB are eligible for the various OZ tax benefits.

The three general ways that OZ investors can get involved with an operating business are summarized below.

1. Establishing a New Business Within an OZ Census Tract

Establishing a new business (or starting a new division which offers a new product or service) within a single or multiple OZ census tracts is the most straightforward way to qualify an operating business under the code and regulations.

The reason that a new start-up business is the cleanest way to meet the OZ qualifications is that the tangible property acquired for use in the new business will generally be treated as eligible QOZBP unless the property had been used in an OZ census tract before acquisition or was acquired from a related party (more than 20% common ownership in the QOF).

Leased assets, even if acquired from a related party, are treated as first used by the acquiring taxpayer and therefore do not need to be “substantially improved” by doubling the tax basis of the acquired asset. However, special related party lease rules (which are much less onerous than the related party rules applicable to purchased assets) must be followed to ensure QOZBP eligibility.

Another possible method for getting assets into a new business is for the QOF investor to contribute qualifying assets into the QOF, in which case the related party rules are not applicable. The downside of a contribution of assets (in lieu of cash) to a QOF is that no eligible gain is triggered for OZ reinvestment and the contributing taxpayer’s eligible QOF reinvestment is limited to the lesser of their: (1) tax basis in the property contributed, or the (2) fair market value in the contributed asset. The secondary problem is that the contributed asset is not treated as QOZBP since it was not “purchased” after 2017. Dropping the assets down into a QOZB also causes technical issues which will complicate meeting the aforementioned 70/30 QOZB qualification test.

Based on the statute and regulations it is important that the QOZB purchase the assets and primarily run the business operation, rather than the QOF. This is to allow the operating business to obtain the 31-month or the newly introduced 62-month “start-up” business working capital safe harbor relief, and also secure the more liberal 70% QOZBP requirement vs. the stringent 90% requirement for QOF’s. This means the QOF can hold up to 30% non-QOZBP—or “bad assets” without subjecting the QOF to penalties (currently 5% annualized) for failing the semi-annual qualification testing.

2. Acquiring or Relocating an Existing Non-OZ Business Into an OZ Census Tract(s)

Moving an existing business that has not previously operated in an OZ into an OZ census tract can offer a number of complexities; however, with advanced planning and cash infusions, acquiring an existing business and qualifying it as a QOZB is possible.

If the business is currently owned by more than 20% of the ultimate QOF equity owners, then the assets brought into the QOF or QOZB will be ineligible non-QOZBP. This does not eliminate the possibility of qualifying the business as a QOZB provided the investors plan on investing material amounts into the transferred business.

For example if the QOZB acquires business assets not previously used in an OZ census tract from a related party for $500,000, such assets are non-QOZBP, but provided this amount remains less than 30% of total QOZB assets, the QOZB can still meet the qualification tests. Therefore, provided the QOZB has at least $1,666,667 of total assets ($500,000/30%), then the QOZB should meet the qualification test.

If tangible assets are acquired from a third-party, and if the QOZB makes “substantial improvements” by doubling the basis in the depreciable assets (excluding land) acquired within 30 months, then QOZB will be treated as the “original user” and all the acquired assets will be QOZBP, and the total investment can be minimized as compared to the related party acquisition. Note that raw land and intangibles are not required to be “substantially improved.”

3. Qualifying an Existing OZ Operating Business for OZ Benefits

In a case where an existing business has already been operating within an OZ census tract prior to 2018, all of the operating assets of the business are treated as ineligible and non-QOZBP since the assets had been used in the OZ before acquisition. As a result, an existing entity with $500,000 of tangible assets will only qualify as a QOZB if the new investors make significant investments sufficient to drive down the non-qualified assets below 30%. Similar to the calculation in 2 above, the QOF/QOZB must be willing to invest at least 234% of additional funds ([$1,666,667 - $500,000]/$500,000) into the business in order to dilute the $500,000 of non-QOZBP/ “bad assets” below 30%.

Similar investments will be required whether the existing business attempts to qualify itself as an OZ business for a third-party acquisition by making the additional expansion investment, or the business sells its assets to a QOF or equity to a QOZB before the additional cash infusion. The new owner must invest at least 2.34 times/ 234% more into the business to meet the 70% for at least the 31- or 62-month working capital safe harbor period.

Note that the QOF does not need to acquire 100% of the existing business in either 2 or 3.


While the new OZ program is arguably the most powerful and flexible tax diversification tool in the last four decades, tax code Section 1202—qualified small business stock (QSBS) may very well be a close second.

The QSBS eligible gain exclusion amount is the greater of: (1) 10 times the taxpayer’s adjusted basis in the QSBS disposed of in that year (annual limitation); or (2) $10 million reduced by the aggregate amount of QSBS gain on stock of that issuer excluded by the taxpayer in prior years (aggregate limitation).

While these annual and cumulative limits (per investor) are more restrictive than the absolute 100% OZ Program exclusion after a 10-year hold, most investors will be content with a 1,000% ROI or a $10 million gain (per qualified investor) exclusion.

For the sale of QSBS by non-C Corporation taxpayers, a partial or full exclusion for gain is allowed under Section 1202. Section 1202 defines QSBS as stock:

i. issued by a domestic C Corporation with gross assets equal to or less than $50 million;

ii. issued after Aug. 10, 1993, for money, other property (not including stock), or as compensation for services;

iii. issued by a corporation that uses at least 80% (by value) of its assets in the active conduct of one or more qualified trades or businesses during substantially all of the taxpayer’s holding period for such stock, and such corporation must be an eligible corporation;

iv. held by a person that is not a C corporation;

v. held for more than five years;

vi. with some exceptions, acquired at original issue; and

vii. qualified small business issuer may not redeem its stock within specified time periods.

The portion of the taxpayer’s eligible gain exclusion varies based on when the taxpayer acquired the stock. For QSBS acquired between:

  • Aug. 11, 1993, and Feb. 17, 2009, the gain exclusion is 50%;

  • Feb. 18, 2009, and Sept. 27, 2010, the gain exclusion is 75%;

  • Sept.28, 2010, and thereafter, the gain exclusion is 100%

Therefore, properly structuring a QSBS entity within a QOZB can yield more flexibility and possibly more favorable tax results upon an exit prior to 10 years.

To the extent a QOF establishes or acquires QSBS pursuant to Section 1202 (being cognizant of certain non-qualifying trades or business such as most service and real estate operations) the entity may be eligible for a 100% federal (and most state) gain exclusion after the fund holds the entity for at least five years—rather than the 10-year OZ holding period. Private equity and venture funds tend to like this strategy since a five-year holding period is more in line with their general disposition time-frame.

A strategy to consider is initially establishing the QOZB as an LLC/partnership to allow start-up losses to flow-through to the members/ partners and then convert to the required 1202 C corporation status once the entity turns profitable; thereby starting the five-year QSBS holding period clock ticking.

Therefore, combining the new OZ provisions with QSBS classification can give investors two bites at the federal exemption apple and dramatically enhance the investment flexibility.


Section 1045 is another taxpayer-friendly section that coincides with Section 1202. Section 1045 allows non-C corporation taxpayers to elect to defer recognition of gain from the sale of QSBS if the taxpayer purchases replacement QSBS within a 60-day period beginning on the date of the QSBS sale. The election must be made on a timely filed tax return (including extensions). The amount of gain deferred is calculated in a manner similar to gain deferred in a like-kind exchange. Unlike Section 1202, the minimum holding period of the relinquished QSBS under Section 1045 is only six months and there is no limit to the amount of the gain deferral.

This further allows interim dispositions within the OZ fund without triggering gain.


The added advantage of using the OZ program for operating businesses is that additional federal and state tax incentives, including various hiring and asset tax credits, grants, exemptions, and other benefits are available to the QOZB, QOF and/or equity-holders. This can further compound the after-tax ROI on OZ investments.

This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners.

Author Information

Blake Christian, CPA/ MBT is a Tax Partner in HCVT LLP’s Long Beach, CA, and Park City, UT offices of HCVT CPAs He has assisted over 35 clients in establishing QOFs and QOZBs throughout the U.S. He is a frequent speaker and author on the subject of Opportunity Zone Fund formation and investing. He can be reached at: or (435) 200-9262.

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