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Thinking It Through: What Opportunity Zone Investors (and Observers) Should Consider Today

Investors should consider the full range of outcomes before putting their money to work in qualified opportunity zones.


  • Created by the Tax Cuts and Jobs Act of 2017, qualified opportunity zones continue to make headlines as a new investment opportunity.
  • Offering tax incentives to investors who allocate capital to the over 8,700 census tracts that have been designated opportunity zones, the program seeks to foster sustained economic development and community benefit in distressed areas.
  • Northern Trust experts discuss five considerations for investors who want to be thoughtful about the pros and cons of opportunity zones: Community Benefit, Exit Strategy and Reinvestment, Wealth Transfer Planning Implications, Operating Businesses and "Substantial Improvement" to Property.

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As an investor, you want to anticipate all the risks, pitfalls and ranges of outcomes before you put money to work. Qualified opportunity zones continue to make headlines and do present a new investment opportunity. As you may know, opportunity zones are a creature of the federal tax overhaul that was enacted at the end of 2017. The program offers tax incentives to investors who allocate capital to the over 8,700 census tracts that have been designated as opportunity zones. The policy goal is sustained economic development and community benefit.

Federal tax benefits are an important part of the opportunity zone puzzle. For a more fulsome tax discussion, Qualified Opportunity Zones Gaining Momentum is available for you at: But, as funds and their investors make progress on execution, investment returns and community impacts are also important topics. And, those elements invariably are related to the tax rules.

The Internal Revenue Service (“IRS”) recently held public hearings on its proposed opportunity zone regulations. Public hearings give IRS officials insight into how the proposed rules will work not only from a tax perspective, but also from a practical, real-world perspective. Although the IRS does not change its position in response to every comment, they do use this public feedback to write final regulations that, in their view, are fair and functional.

In light of the recent IRS hearings, this piece highlights five current investment, tax and community considerations for investors who want to be thoughtful about the pros and cons of opportunity zones. They are:

1. Community Benefit
2. Exit Strategy and Reinvestment
3. Wealth Transfer Planning Implications
4. Operating Businesses
5. "Substantial Improvement" to Property

Consideration 1: Community Benefit

The opportunity zones program is designed to encourage economic growth and job creation in economically distressed communities. Governors and leaders of U.S. states and territories have designated over 8,700 census tracts as opportunity zones, and investors stand ready to commit capital. That being said, investors must also be thoughtful about the impact of that capital.

First, there is concern that rural opportunity zones will not attract as much capital as urban areas, with which investors may be more familiar. Second, some commentators have asked the IRS to use its regulatory authority to promote diversity. Proposed ideas include a requirement that boards and investment committees of opportunity zone funds have racial and gender diversity, and also that the investor base for any opportunity zone fund should be diverse.

Third, there have been calls for housing mitigation. For example, there could be a requirement that opportunity zone funds dedicate a certain percentage of their capital to affordable or rent-controlled housing or that they support local organizations that work on housing issues.

It is unclear whether the IRS has the authority to enact rules about rural development, racial and gender diversity, or housing mitigation. But, community impact is the heart of the opportunity zones program and should not be ignored.

Bottom Line
Opportunity zone investments cannot be made in a vacuum. Like any investment, opportunity zone investments impact real people in real communities, and investors must be thoughtful about how their capital will be deployed and whether their activity will in fact have a positive impact.

Consideration 2: Exit Strategy and Reinvestment

The opportunity zone rules seem to envision tax benefits for investors who sell their interests in the fund itself. What happens, however, when the opportunity zone fund, which is either a partnership or a corporation, sells the opportunity zone businesses or properties that it owns? Can the fund reinvest the proceeds of an asset sale into different opportunity zone property? If so, how quickly does the fund have to reinvest its proceeds? Will a sale and reinvestment at the fund level adversely impact the investor’s tax benefits? For instance, does trading at the fund level increase the amount of time that the investor must hold the fund in order to be eligible for tax basis increases? Many commentators believe that, as long as the investor remains in the fund for 10 years, it should not matter whether the fund itself buys and sells qualified assets in the interim. The IRS has not clarified these open questions around fund-level reinvestment.

Additionally, it is not clear whether the familiar partnership tax rules apply if an opportunity zone fund is structured as a partnership for federal tax purposes. For example, if the opportunity zone fund sells a building and recognizes gain, the partnership tax rules say not only that the partners recognize the gain and pay tax on it, but also that each partner’s basis in the fund is increased by the amount of the gain that he or she recognized. This rule prevents double taxation on the sale of the partnership asset — once when the partnership sells the asset and once when the partner sells his partnership interest or receives a partnership distribution. Although it would make sense that the partnership tax rules apply to opportunity zone funds that are structured as partnerships, it will be important for the IRS to clarify this point.

If it turns out that opportunity zone funds are not able to sell assets, this will greatly impact the value of an opportunity zone investment. Buyers often prefer to buy assets from an entity and will demand a purchase price discount if they must buy interests in the entity itself. The discount is designed to compensate the buyer for any latent legal or tax liability that he is assuming as the new owner of the entity; asset sales generally do not require the buyer to assume these liabilities. It could facilitate liquidity if the IRS does confirm that opportunity zone funds can sell assets and can reinvest the sale proceeds. If asset sales are prohibited in the opportunity zone fund space, it is possible that there would be fewer diversified funds and more single-asset or concentrated funds. This is because fund sponsors know that it could be more difficult to find a buyer for a large, diversified portfolio than it could be to find a buyer for an entity that owns one or two assets.

Finally, regardless of how an exit is structured, investors must consider exit risk. If many opportunity zone assets come to market concurrently, asset prices could be depressed. For example, investors may look to exit simultaneously around the 10 year mark, after they have met the holding period that allows them to optimize their tax benefits.

Bottom Line
Asset sales can be an important exit strategy for any business or investment fund. But, it remains to be seen whether the IRS will allow opportunity zone funds to sell assets. If asset sales are prohibited, it could be more difficult to maximize value on exit.

Consideration 3: Wealth Transfer Planning Implications

What happens if you die while owning an opportunity zone fund? Generally, property that you own at death receives a basis adjustment. For example, say you purchase shares of publicly traded stock for $75 per share. On the day you die, the stock is worth $100 per share. Your beneficiaries who inherit the stock also will receive a tax benefit. Their tax basis in the stock will be $100 per share, rather than your tax basis of $75 per share. Neither you nor your beneficiaries will have to pay tax on the $25 of gain, which is a big benefit.

It is unclear how an opportunity zone fund investment will be treated at death. If the original investor has owned the opportunity zone fund for less than 10 years, then his tax basis likely is zero, or perhaps 10 or 15 percent of the amount of gain that he originally deferred. Given this low (or even non-existent) tax basis in the fund, it could be very beneficial if the person who inherits the opportunity zone fund can receive an increased tax basis in the fund when the original owner dies. It is unclear, though, whether this “stepped-up” tax basis will be available for inherited opportunity zone funds. The IRS has not addressed this question in its current proposed regulations, but may do so in a second round of proposed regulations.

If the original investor has owned the opportunity zone fund for more than 10 years, then he can make a special tax election when he sells. The election increases his tax basis in the fund to fair market value, which means that significant appreciation in the opportunity zone fund investment will never be taxed. What happens, however, if the original investor dies within 10 years of making the opportunity zone investment? Will his beneficiary receive credit for the time that he held the fund? Or, will the beneficiary himself have to hold the fund for an additional 10 years before he can make the special tax basis election? Is the beneficiary eligible to make the special election at all? If the beneficiary cannot take full advantage of the special 10 year election, then many of the tax benefits associated with an opportunity zone fund will prove elusive if the original investor dies within 10 years of investing in the fund.

Finally, tax basis aside, the opportunity zone rules say that tax on any deferred gain is due on December 31, 2026. A beneficiary who inherits an opportunity zone fund before that date could find himself with a big tax bill and a very illiquid investment. If you are considering an opportunity zone investment, it could make sense to revise your wealth transfer plan. The person who inherits the opportunity zone fund also may need to inherit cash or liquid assets to pay the tax liability associated with the fund.

Bottom Line
An opportunity zone investment can defer, and even partially eliminate, the federal tax that you would otherwise owe on capital gains. But, for the vast majority of property, you can eliminate tax on the imbedded gain simply by holding the property until you die. It is uncertain whether the tax benefits of an opportunity zone fund will survive the death of the original owner, so it pays to consider the long-term future consequences of an opportunity zone investment today. Holding existing assets until death may well be a better tax strategy.

Consideration 4: Operating Businesses

Congress wanted opportunity zone funds to invest not only in real estate inside the designated communities, but also to own equity of operating businesses in those communities. Many are expressing concern that businesses inside opportunity zones will find it impossible to attract capital from opportunity zone investors because the definition of a qualifying business is so stringent. Specifically, the proposed opportunity zone regulations say that, for each taxable year, at least 50 percent of the gross income of a qualified opportunity zone business must be derived from the active conduct of a trade or business in the opportunity zone. If the business does not meet the income test, it is not a qualified opportunity zone property. This means that an opportunity zone fund, which must hold at least 90 percent of its assets in qualified opportunity zone property, will be unlikely to invest in the business. If the fund has less than 90 percent qualified property, then the fund pays a monthly penalty until it corrects the problem.

IRS officials have questioned whether they have any latitude to change this 50 percent income test in order to allow a broader range of community operating businesses to qualify for opportunity zone money. This is because the opportunity zone statute itself contains a 50 percent gross income test for operating businesses, and regulations cannot override a statute. Even assuming that there must be a 50 percent gross income test, how does this play out in practice? Companies that do not have any actual activity in the zone perhaps should not be qualified opportunity zone businesses. But, what about a manufacturing business that is located inside the zone but sells products nationwide? What about an e-commerce or software business in the zone that has a national client base? Or, a homebuilder who gets his start building inside an opportunity zone but who later finds success outside of the zone as well? Under the current proposed regulations, it is not clear that opportunity zone funds could invest in these businesses because they derive a majority of their revenue from outside the zone. From a policy perspective, however, this may not have been what Congress intended. Certainly, companies that do not contribute to the economic health of an opportunity zone should not be eligible, taxsubsidized investments. But, in the age of technology and e-commerce, it may not be realistic to say that a business must generate a significant amount of local revenue in order to benefit from opportunity zone capital.

Bottom Line
If you want to invest in an operating business, wait for clarification from the IRS before you invest through an opportunity zone fund.

Consideration 5: "Substantial Improvement" to Property

Many investors are exploring real estate investments inside opportunity zones. One qualification is that the “original use” of the real estate inside the opportunity zone must begin with the opportunity zone fund or, in the alternative, that the opportunity zone fund must “substantially improve” the property. Congress included this original use or substantial improvement requirement to support its policy objective: Tax incentives should be awarded for new economic activity. If an opportunity zone fund invests in business property that does not meet the test for original use or substantial improvement, then the property is not qualified property. And, as mentioned above, at least 90 percent of the assets of an opportunity zone fund must be qualified property.

So, what is original use? What does it mean to substantially improve property? The IRS has not issued comprehensive guidance on original use, and the original use test could be hard to meet. For example, the IRS has stated that raw land can never have its original use in an opportunity zone fund because the land is already in the zone. Beyond raw land, though, if a building has been abandoned for a year or more, should an opportunity zone fund be considered the original user of the building when it buys it? Many argue that the fund should get credit for being the original user, but it is not clear whether the IRS will adopt this definition of original use.

Substantial improvement may be an easier test to meet than original use. The rule is that during any 30 month period beginning after the date that the fund acquires the property, the fund must make improvements that more than double its tax basis in the property (as measured at the beginning of the 30 month period). Fortunately for opportunity zone funds, the value of any land associated with the property does not count toward the substantial improvement test. For example:

Although the proposed guidance on land provides helpful clarification for opportunity zone funds, there are open questions around substantial improvement. For example, what happens if construction delays extend a renovation project beyond 30 months? What happens if a natural disaster delays construction? Will the opportunity zone fund be penalized because it does not have 90 percent of its assets in qualifying property (in other words, property that has been substantially improved)? Some commentators are encouraging the IRS to provide a grace period for the completion of substantial improvements, but it is not clear whether the IRS will adopt this suggestion.

Bottom Line
If you want to renovate opportunity zone real estate, be aware that you have a strict 30 month construction window.


Opportunity zones have garnered significant press, and opportunity zone funds are attracting capital. But, significant unanswered questions remain. We are hopeful that the IRS will provide guidance on investments in operating businesses, substantial improvement of property and investment exit. That being said, it ultimately will be important to keep the larger picture in mind. The opportunity zone program was designed to have a positive community impact, and it is that objective that should remain central.


As a premier financial firm, Northern Trust specializes in Goals Driven Wealth Management backed by innovative technology and a strong fiduciary heritage. Our Wealth Planning Advisory Services team leverages our collective experience to provide financial planning, family education and governance, philanthropic advisory services, business owner services, tax strategy and wealth transfer services to our clients. It is our privilege to put our expertise and resources to work for you.

If you would like to learn more about these and other services offered by Northern Trust, contact a Northern Trust professional at a location near you or visit us at

Suzanne L. Shier

Wealth Planning Practice Executive & Chief Tax Strategist/ Tax Counsel
Suzanne L. Shier is the Wealth Planning Practice Executive and Chief Tax Strategist/Tax Counsel for Wealth Management at Northern Trust and serves on the Wealth Management Operating Group.


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