Latest / The High Net Worth Podcast with Fexingo: Wealth Management, Tax Strategy, and Affluent Finance / How Ultra-Wealthy Families Use Opportunity Zone Funds for Tax Deferral
Transcript
- Lucas: If you sold a business in 2019 and had a $50 million capital gain, you could have rolled that entire gain into a Qualified Opportunity Zone fund, deferred the tax until 2026, and if you held it long enough, permanently excluded up to 15 percent of the gain from taxation. Luna: Fifteen percent exclusion — that's $7.5 million saved. But I imagine not all gains are eligible, right? Lucas: Any capital gain — from stocks, real estate, business sale — can be invested in a QOZ fund within 180 days of the sale. The fund then invests at least 90 percent of its assets into designated Opportunity Zones, which are low-income census tracts certified by the Treasury. Luna: So the federal government essentially rewards you for investing in distressed communities. That's the dual purpose — tax savings for the wealthy, development for underserved areas. Lucas: Exactly. The Tax Cuts and Jobs Act of 2017 created the program. To maximize the benefit, you had to hold the investment for at least 10 years. After five years, your deferred gain gets a 10 percent step-up in basis. After seven years, an additional 5 percent. So total exclusion of 15 percent on the original gain. Luna: And after 10 years, you can sell the QOZ investment itself with zero capital gains tax on the appreciation. That's the real windfall. Lucas: Correct. The appreciation piece is often the bigger number. Let me give you a concrete case. There's a family office in California that sold a portfolio of commercial properties in 2021. They realized about $50 million in long-term capital gains. Their advisors recommended a QOZ fund managed by a firm called something like 'Urban Renewal Partners' — not the real name, but the structure is representative. Luna: I like concrete examples. What did that fund invest in? Lucas: They invested in a mixed-use development in a low-income area in Phoenix. Apartment units above retail, with a community health center on the ground floor. The family office committed $30 million, and the fund raised $200 million total from about a dozen high-net-worth investors and institutions. Luna: So they deferred $50 million in tax, and if they hold until 2031, they'll never pay tax on the appreciation from that Phoenix development. That's a powerful incentive. Lucas: Powerful but not without risks. The main one is liquidity. QOZ funds are illiquid for at least 10 years. You can't redeem early without losing the tax benefits. Also, fund manager fees can be high — we've seen funds charging 2 percent management fees plus 20 percent carried interest. Luna: And there's the reputational risk. Some critics call it 'gentrification incentives' — wealthy investors profiting from tax breaks while displacing long-time residents. Lucas: That's a real concern. The Treasury has tried to tighten rules to ensure 'community benefit' — things like mandatory reporting on affordable housing units, wage requirements, and local hiring. The 2024 proposed regulations added a 'community impact report' requirement. Luna: But enforcement is patchy. And the program has a sunset: the deferral ends in 2026. So gains from 2021 must be recognized by December 31, 2026. That's less than six months from now. Lucas: That's June 2026 — the date today. So anyone who deferred gains in 2020 or 2021 is looking at a tax bill coming due. But they can still sell their QOZ investment tax-free on the appreciation if they've held 10 years. Luna: Let's talk about who actually uses these. Is it just the ultra-wealthy, or can smaller investors participate? Lucas: Technically any taxpayer with a capital gain can invest, but the minimums are high. Most funds require $100,000 to $1 million minimums. And you need to have a gain large enough that the tax savings justify the 10-year lockup. So it's predominantly high-net-worth individuals and family offices. Luna: There are also publicly traded QOZ funds — like some REITs — with lower minimums. But the tax treatment is different: you don't get the same exclusion on the appreciation. Lucas: Right. The IRS has specific rules about 'Qualified Opportunity Zone businesses' — they can't be golf courses, country clubs, massage parlors, or gambling facilities. They also have to meet a 70 percent 'qualified business property' test. Luna: So no investing in a luxury spa in a low-income zone. That makes sense. Lucas: There is one nuance that often surprises people: the 180-day rule. If you sell a stock in January, you have to roll the gain into a QOZ fund by July. Miss the deadline, and you lose the deferral. Advisors have to be on top of that. Luna: That's tight. And if you have multiple gains, you can do multiple rollovers. But each one has its own 180-day clock. Lucas: Exactly. For family offices, it's a common strategy to bundle gains from multiple sales into one QOZ fund. But they have to be careful about the 'original use' requirement — the property must be new or substantially improved within 30 months. Luna: That means you can't just buy an existing building. You have to renovate or build new. That's where the development risk comes in — construction delays, cost overruns. Lucas: Those are real. Last year, a QOZ fund in New Orleans ran into permitting issues and missed the 30-month improvement deadline. They lost the QOZ certification. The investors had to recapture all deferred gains plus penalties. Luna: Ouch. So it's not a set-it-and-forget-it strategy. Due diligence on the fund manager is critical. Lucas: Absolutely. You're essentially betting on the manager's ability to execute a real estate project in a challenging market. And the tax benefits are only as good as the fund's compliance. Luna: Let's step back for a moment. You know, listening to this, I'm reminded that the best financial strategies often come with a trade-off — and it's our job to help listeners see both sides. If these conversations have helped you think about a decision differently, or saved you from a costly mistake, that's exactly why we do this show. Lucas: Yeah. And we're able to keep the podcast ad-free and focused on substance because listeners like you support the show. If you find value in what we do, you can help at buy me a coffee dot com slash fexingo. That's buy me a coffee dot com slash fexingo. Luna: It's a simple way to keep the show independent. And we appreciate it. Now, back to Opportunity Zones — one thing we haven't touched on is the interaction with state taxes. Lucas: Good point. Most states have not conformed to the federal QOZ rules. So while your federal gain is deferred, you might still owe state tax on that gain in the year of the sale. Some states, like California, do not recognize QOZ deferral at all. Luna: That could be a nasty surprise. A family office in California would need to pay state tax on the gain upfront, even while deferring federal tax. That reduces the net benefit. Lucas: Right. So the strategy is most attractive for investors in states that do conform — like New York, which has its own version of the Opportunity Zone program. And for those who expect to move to a lower-tax state before 2026. Luna: What about the future of the program? With the deferral sunset in 2026 and potential tax reform under a new administration, are we still recommending new QOZ investments? Lucas: For new gains today, the deferral window would only be a few months — gains recognized now would have to be deferred by late 2026. That's a compressed timeline. But if you have a gain from earlier that you haven't rolled yet, you might still be able to. The IRS has granted some extensions during disasters. Luna: So the window is closing. But for those already in the program, the 10-year hold for tax-free appreciation remains valuable. Lucas: Exactly. The program's sunset doesn't affect the appreciation exclusion — that's still available if you hold until 2029 or later. And there's bipartisan talk of extending the deferral period or even creating new zones. Nothing is certain. Luna: Let's end with a big-picture question. Do you think QOZ funds actually help the communities they target? Or are they just a tax shelter with a charitable veneer? Lucas: I think the evidence is mixed. A 2024 study from the Urban Institute found that Opportunity Zones attracted about $75 billion in private investment, but only about 30 percent of that went to truly distressed neighborhoods. The rest went to areas already on the verge of gentrification. So the community benefit is real in some places, but not uniform. Luna: So it's a tool, not a silver bullet. For a family office with a long horizon and a tolerance for illiquidity — and a desire to have some positive impact — it can be part of a broader strategy. Lucas: That's the right frame. It's not for everyone, but for the right investor with the right advisor, it can be a powerful way to align tax planning with place-based investment. And that's a conversation worth having.