QOZs for Venture Capital Investors and Startups
Legal + Tax Planning
Qualified Opportunity Zone (QOZ) program is often associated with real estate investments but it is also designed for venture capital investors to defer and reduce their capital gain tax burden by reinvesting, through Qualified Opportunity Funds (QOF), in startups meeting the definition of a “Qualified Opportunity Zone Business.” (QOZB)
By reinvesting capital gains into a QOF within 180 days after the gains are realized, investors can defer recognition of those gains until as late as December 31, 2026.
Venture capital QOF portfolio may contain any startups designated as QOZB in any attractive business area.
Additionally, if a taxpayer holds his or her investment in a QOF for at least 10 years, then any gain on that investment between purchase and sale will escape federal income taxation altogether.
For example, blockchain enthusiasts may be holding Bitcoin that appreciated in their hands (and Bitcoin is considered property for the purposes of the federal capital gain tax). Such investors may be incentivized to sell the cryptocurrency to reinvest the sales proceeds into a QOF holding shares in a blockchain startup of the investor’s interest that operates in a QOZ located, for example, in NYC or San Francisco area. With proper legal and tax structuring, taxation of realized capital gains from the sale of Bitcoin will be deferred and/or reduced as per QOZB tax guidelines outlined below.
Gains from sale of all kinds of capital assets can be reinvested in startups and VC QOFs located in QOZs, including:
- Stocks, bonds, and other investments;
- Art and other collectibles;
- Automobiles, aircraft, and equipment;
- Bitcoin and other digital assets;
- Intellectual property and other intangible assets; and
- Real estate.
Consulted a client on obtaining a capital gain deferral after the sale of the client's digital currency portfolio by purchasing a development project in a qualified opportunity zone in Brooklyn, New York
Advised a client on optimizing capital gains from the sale of digital assets by setting up a qualified opportunity VC fund in Bushwick, Brooklyn
Tax Advantages of Investing in a Venture Capital QOF Holding Shares of QOZB Startups
The Tax Cuts & Jobs Act added Section 1400Z-2 to the Internal Revenue Code effectuating the QOZB program. That section provides three tax advantages for taxpayers who invest in Qualified Opportunity Funds:
- Deferred recognition of capital gains realized no more than 180 days before the investment;
- A reduction in the amount of the deferred gains that must be recognized based on the holding period of the QOF investment; and
- An exclusion of federal income tax on the capital gained from the QOF investment held for at least 10 years by elective increase in its basis to the fair market value.
Requirements for QOF and Its Portfolio Startups
QOZB program eligibility requirements include:
- Venture capital QOF must hold 90% of its assets as investments in QOZ startup(s) that is a QOZB;
- To be a QOZB, a startup should own or lease “substantially all” tangible property that is a QOZ business property;
- Also, to be a QOZB, a startup should derive 50% of its gross income from the active conduct of the business in the QOZ.
The U.S. Department of Treasury and IRS issued several proposed regulations containing guidance on how to interpret and implement each requirement.
For example, per an additional guidance, a startup can meet the QOZ active conduct requirement when 50% or more of the services are performed by its employees/independent contractors within the QOZ based on the (a) hours, (b) payments or (3) tangible property and managerial functions that are performed in a QOZ. Alternatively, a startup may be determined to generate at least 50% of its gross income from the active conduct of the business in the QOZ based on all the facts and circumstances.
Some of the requirements are still open to interpretation, extremely circumstantial and require careful consideration pending additional clarification from the executive agencies.
Formation of QOFs to Invest in Startups Operating in QOZs to Defer and Reduce Capital Gain Tax, Attract Venture Capital Investments and Promote Innovation and Revitalization
Our attorneys offer comprehensive Venture Capital QOF strategies and guidance at every step of the QOZB investment process. We also advise on maintaining the Venture Capital QOF illegibility for the QOZ program. Our services include:
- Explaining the QOF process to both venture capital investors and startups interested in benefiting from it;
- Assessing each client’s unique circumstances and goals to develop a qualified opportunity fund strategy custom-made for him or her;
- Forming corporations, partnerships, LLCs, or other entities, and drafting corporate governance documents to ensure eligibility for the QOZ program;
- Assisting clients in funding QOFs using the capital gains to be deferred under the QOZ program;
- Advising on compliance with respect to the established QOF.
Contact Us to Learn More About Our Qualified Opportunity Fund Services
Send us an email or call 212.457.9797 to schedule a consultation at our Manhattan office
- US. Treasury and IRS 1st Guidance – Investing in Qualified Opportunity Funds
- US. Treasury and IRS 2nd Guidance – Investing in Qualified Opportunity Funds
- US. Treasury and IRS 3rd Guidance – Investing in Qualified Opportunity Funds
- Opportunity Zones Frequently Asked Questions
- Investing in Qualified Opportunity Funds
- Map of Designated Qualified Opportunity Zones
- Opportunity Zone Program in New York State