The Qualified Opportunity Zone (QOZ) program created under the Tax Cuts and Jobs Act remains one of the most consequential tax incentive structures available to private lenders, fund managers, and real estate investors operating in distressed and emerging markets. Since the IRS released its foundational proposed regulations, subsequent guidance has layered in critical clarifications that directly affect how Qualified Opportunity Funds (QOFs) are formed, managed, and ultimately wound down.
This guide synthesizes the key regulatory clarifications that fund managers and private lending professionals need to understand when structuring a QOF — from asset deployment timelines and lease restrictions to the treatment of carried interest and partnership roll-up mechanics.
For fund formation counsel or compliance guidance specific to your QOF structure, contact Geraci LLP at (949) 403-3488 or visit our offices at 90 Discovery, Irvine, CA 92618.
Investment Timelines and the 180-Day Reinvestment Window
One of the most time-sensitive aspects of QOF participation is the reinvestment window. Under the program rules, Section 1231 gains — taxed at capital gain rates — must first be netted against losses before a taxpayer can determine the eligible amount available for deferment. That determination is made as of the last day of the taxpayer’s taxable year.
For fund managers advising investors on rolling eligible gains into a QOF, the 180-day clock begins on the last day of the taxable year in which those gains are recognized. This means individual taxpayers who generated capital gains during a given tax year have until 180 days after December 31 of that year to complete their qualifying investment in a QOF.
Fund managers should also be aware of the tiered basis step-up structure. A 10% basis step-up applies to investments held for at least five years. Investments held for a minimum of seven years qualify for an additional 5% basis step-up, bringing the total to 15%. The 10-year holding period eliminates federal capital gains tax on appreciation entirely. Proper investor communications should reflect which tiers remain accessible given the fund’s timeline.
Defining “Substantially All”: The 90% and 70% Thresholds
The phrase “substantially all” appears throughout QOZ regulations and carries different numerical meanings depending on context. Failure to apply the correct threshold in the correct scenario is a common structuring error that can jeopardize a fund’s qualified status.
The regulatory framework establishes the following distinctions:
- 90% threshold — Applies when measuring a QOF’s holding period of tangible property as qualified opportunity zone business property, as well as when measuring interests held through a QOZ partnership or corporation.
- 70% threshold — Applies in two distinct ways: (1) at least 70% of a property’s use must occur within a QOZ; and (2) at least 70% of the property owned or leased by a QOZ Business must independently satisfy the definition of qualified opportunity zone business property.
Fund managers structuring investments that flow through operating entities — as opposed to direct property ownership — must apply both thresholds appropriately at each level of the structure. Geraci LLP’s fund formation team routinely assists managers in mapping these requirements against proposed deal structures before capital is committed.
Investor Death During the Holding Period
The IRS has addressed the disposition treatment that occurs when an investor dies during the QOF holding period — a scenario that is particularly relevant for older investors or longer-duration funds.
Under the applicable guidance, if an investor dies while holding a QOF interest, the investment passes to the investor’s heirs rather than triggering an inclusion event. The heirs step into the decedent’s position, inheriting both the original tax carryover basis and the existing holding period for the investment. Critically, the holding period does not reset upon inheritance — the heir’s holding period is measured from the original date of the decedent’s investment.
This carryover treatment preserves the tax benefits that motivated the original investment and provides meaningful estate planning continuity for fund investors. Fund documents should address this scenario explicitly to avoid administrative confusion at the time of transfer.
Related-Party Lease Arrangements: Restrictions and Requirements
Related-party leases arise when a QOF enters a lease with a landowner to develop property, then operates rental activities following construction. While permissible, these arrangements are subject to several structural restrictions designed to prevent abusive transactions:
- Lease payments must reflect market lease rates; below-market arrangements between related parties will draw scrutiny.
- The lessee may not make advance lease payments to the lessor in excess of 12 months.
- For purposes of the 90% asset test, the value of leasehold improvements is calculated using either applicable financial statement values or the present value of all payments under the negotiated lease.
- The “substantial improvement” requirement — which generally obligates a QOF to double the adjusted basis of purchased property — does not apply to leased property.
- Only the capital gains allocable to the leasehold improvement component of a related-party lease are eligible for the 10-year permanent gain deferral.
Fund managers considering development strategies that incorporate landowner leases should coordinate with legal counsel to document arm’s-length pricing and ensure lease terms are structured to survive regulatory challenge.
Real Property That Straddles a Qualified Opportunity Zone Boundary
A recurring practical issue in QOF real estate development involves parcels that extend across QOZ boundaries — where a portion of a development site sits inside a designated zone and a portion does not.
The regulatory framework addresses this scenario with the following rules:
- A QOF may acquire the non-QOZ portion of a straddling parcel as part of a larger development project.
- The out-of-zone parcel is counted toward the QOZ investment provided its square footage is smaller than the portion of the project located within the QOZ.
- Once acquired as part of a unified development project, the non-QOZ portion is treated as contiguous with the QOZ property, and the entire project qualifies as QOZ business property.
This rule enables fund managers to pursue development projects that require cohesive site control, even when ideal parcels do not fall entirely within zone boundaries. The square footage test, however, requires careful site analysis before acquisition commitments are made.
Operating Businesses in a QOZ: Three Safe Harbor Tests
The QOZ program is not limited to real estate development. Operating businesses located within a qualified opportunity zone can satisfy the QOZ business property requirements under one of three safe harbors. A business need only meet one of the following tests:
1. Hours-based safe harbor — At least 50% of total hours worked by employees and independent contractors performing services for the QOZ Business occur within the QOZ.
2. Payments-based safe harbor — A minimum of 50% of all service payments made to employees, contractors, and contractors’ employees are attributable to services performed within the QOZ.
3. Facts and circumstances test — The business satisfies this test if: (a) its tangible property is located within the QOZ; and (b) the management or operational functions performed within the QOZ are necessary to generate at least 50% of total gross income.
Additionally, QOFs investing in operating businesses have a 12-month reinvestment window to sell assets and redeploy proceeds into another eligible opportunity zone investment without triggering an inclusion event. This window provides meaningful flexibility for funds managing active business portfolios.
Vacant Property and the Original Use Requirement
The original use requirement — which mandates that property placed into service within a QOZ be new or substantially improved — can create barriers for funds targeting distressed urban areas where vacant structures are common.
The regulations provide a practical exception: if a building or structure has been vacant and unused for at least five consecutive years immediately preceding its acquisition by a QOF, that property satisfies the original use requirement without any further improvement obligation. This exception is a meaningful tool for fund managers pursuing redevelopment strategies in historically underinvested QOZ communities.
Documentation of the vacancy period through local permit records, utility disconnection histories, or municipal records is advisable to substantiate reliance on this exception.
Triple Net Leases Are Ineligible Investments
Triple net lease structures — in which tenants assume responsibility for property taxes, insurance, and maintenance costs — are specifically excluded from QOF eligibility. The disqualification is grounded in the passive nature of the investment: a landlord holding triple net leased property bears no meaningful operational engagement with the asset, which conflicts with the active business requirement that undergirds the QOZ program’s statutory design.
Fund managers evaluating net lease assets should confirm that proposed lease structures do not cross into triple net territory, as inclusion of such assets could impair the fund’s ability to satisfy applicable asset tests.
Rolling Up QOF Interests into a Parent Partnership
The regulations permit a structuring technique that allows investors to transfer their QOF interests to a parent partnership without triggering an inclusion event — provided the QOF itself remains operational.
Under this mechanism, the parent partnership acquires and holds the QOF interest in place of the individual investor. The parent partnership steps into the investor’s shoes for gain deferral reporting purposes. This structure can be particularly useful for estate planning, multi-investor consolidation, or fund-of-funds arrangements where centralized ownership is preferable.
The non-inclusion treatment is contingent on the QOF remaining active at the time of transfer. Fund managers should document these transfers carefully and confirm compliance with all applicable partnership agreement terms before executing the roll-up.
Secondary Market Purchases of QOF Partnership Interests
An investor seeking QOZ tax benefits is not limited to investing directly into a newly formed fund at inception. The regulations permit an investor to acquire a QOF partnership interest in the secondary market — purchasing directly from an existing QOF partner.
In this scenario, the acquiring investor may defer capital gains in an amount equal to the purchase price paid for the QOF interest. The deferred gain is subject to the same holding period requirements that apply to any other QOF investment. Fund managers facilitating secondary transfers should ensure offering documents and operating agreements contemplate this possibility and include appropriate transfer mechanics.
Carried Interest and QOZ Benefits: A Critical Limitation
Fund managers and general partners who receive a profits interest in a QOF as compensation for services rendered should be aware of a significant limitation: that carried interest does not qualify as a QOZ investment.
The regulatory position is clear — when a person receives an interest in a QOF in exchange for services, the portion of the interest attributable to those services is not treated as a qualifying investment. As a result, the profits generated by that carried interest are not eligible for QOZ tax benefits, nor is any other capital interest received in exchange for services.
This limitation has direct implications for fund waterfall design and GP compensation structures. General partners who wish to participate in QOZ benefits must do so through a separately structured capital co-investment, not through their carried interest allocation.
Structuring Your QOF with Experienced Private Lending Counsel
The regulatory framework governing qualified opportunity funds is detailed, technically demanding, and continues to evolve as Treasury guidance develops. Fund managers operating in the private lending space face the added complexity of ensuring QOF structures align with applicable securities laws, state lending regulations, and investor disclosure requirements.
Geraci LLP’s fund formation attorneys have over 15 years of experience structuring private credit vehicles, including QOFs, debt funds, and hybrid equity-debt structures for lenders and developers operating across the United States. We assist fund sponsors with:
- QOF entity formation and operating agreement drafting
- Investor subscription documents and private placement memoranda
- Regulatory compliance review under applicable IRS guidance
- Asset test documentation and ongoing compliance monitoring
- Secondary transfer mechanics and partnership restructuring
To discuss your fund formation needs, contact Geraci LLP at (949) 403-3488 or visit us at 90 Discovery, Irvine, CA 92618.
