What are the tax advantages of Opportunity Zones?

The tax advantages of Opportunity Zones apply to capital gains. The program incentivizes long-term investments in underdeveloped areas by offering significant four significant tax benefits for Opportunity Zone investors:

  1. Capital Gain Deferral
  2. Partial Reduction of Deferred Gain
  3. Tax-Free Appreciation
  4. Elimination of Depreciation Recapture

Below, we’ll break down each of these benefits and explain how investors can take advantage.

The tax advantages of Opportunity Zones are regulated by the IRS.

OZ Tax Advantage #1: Capital Gain Deferral

The first advantage of Opportunity Zone investing is the ability to defer recognition of a capital gain until 2026. When the program was first introduced in 2018, this was a fairly significant benefit. In 2025, this benefit is not all that enticing. This tax deferral applies to investors who reinvest their eligible capital gains into a Qualified Opportunity Fund (QOF) within 180 days of realizing the gain.

How the Deferral Works

Capital gains derived from the sale of assets, such as stocks, real estate, or business interests, can be deferred if they are invested in a QOF. The deferral period lasts until the earlier of:

  • The date the QOF investment is sold or exchanged; or
  • December 31, 2026.

By reinvesting capital gains into a QOF, taxpayers do not have to pay taxes on the original gain for several years. This deferral can improve cash flow and allow the invested amount to potentially grow within the QOF.

Example

An investor realizes a capital gain of $500,000 from selling stocks in March 2025. By reinvesting this gain into a QOF within 180 days, the investor defers paying capital gains tax on the $500,000 until the earlier of selling the QOF interest or December 31, 2026.

Important Considerations

While the gain is deferred, it is not eliminated. Taxes on the deferred gain will become due in April 2027. However, the benefit lies in the opportunity to invest pre-tax dollars and potentially generate additional tax-free returns (as explained later).

OZ Tax Advantage #2: Partial Reduction of Deferred Gain

The OZ program also allows for a basis step-up that partially reduces the amount of deferred gain subject to tax. However, it’s important to note that this benefit has expired for investments made after 2021.

Understanding the Basis Step-Up

Investors who invested eligible gains into a QOF prior to December 31, 2021, could receive up to two basis adjustments:

  • A 10% increase in basis if the investment is held for at least 5 years.
  • An additional 5% increase in basis if held for 7 years.
  • This totaled a 15% reduction in the amount of deferred gain.

Why the Step-Up Benefit Expired

Since the gain recognition is deferred until December 31, 2026, the last possible date to receive the 7-year step-up was at the end of 2019. Similarly, the 5-year step-up expired at the end of 2021.

Example

An investor who placed $1 million of capital gains into a QOF in 2020 will be eligible for a 10% reduction in the deferred gain if the investment is held for at least 5 years. When the deferred gain is recognized in 2026, only $900,000 of the original gain will be subject to tax. This tax liability would be due in April 2027.

What About New Investors?

Investors who place gains into QOFs after 2021 will not receive the basis step-up benefit. However, they can still take advantage of other significant tax benefits, particularly tax-free appreciation if the investment is held for at least 10 years.

OZ Tax Advantage #3: Tax-Free Appreciation

The most important of the four tax advantages of Opportunity Zones is the potential elimination of capital gains tax on appreciation. This benefit applies to gains generated from the investment itself, not the original deferred gain.

How It Works

If an investor holds the QOF investment for at least 10 years, any gains realized from selling the investment are completely tax-free. This means that any increase in the value of the investment after the initial contribution can be realized without incurring capital gains tax.

Example

An investor places $1 million into a QOF in 2025. After holding the investment for 10 years, the QOF interest is sold for $3 million. The $2 million gain from the appreciation is entirely tax-free.

Why This Matters

This benefit aligns with the program’s goal of encouraging long-term investment in Opportunity Zones. It significantly enhances the after-tax return on investment, particularly for real estate projects or business developments that appreciate over a decade.

Key Considerations

  • To qualify for this benefit, the investment must be held for at least 10 years.
  • The investor must dispose of the QOF interest after the 10-year holding period to claim the tax-free appreciation benefit.
  • The investment can be held until 2047 to claim this benefit, as per current IRS regulations.

OZ Tax Advantage #4: Elimination of Depreciation Recapture

An additional and often overlooked tax advantage of Opportunity Zones is the elimination of depreciation recapture. Normally, when a property is sold, any depreciation taken over the holding period is “recaptured” and taxed at higher ordinary income rates. However, for QOF investments held for at least 10 years, this recapture tax is eliminated.

How It Works

When a property within a QOF is improved and depreciated over the investment period, the investor typically would owe depreciation recapture tax upon sale. However, if the QOF investment is held for 10 years, both the appreciation and the recaptured depreciation are excluded from taxable income.

Example

A QOF invests in a building that undergoes significant improvements, allowing the fund to claim $500,000 in depreciation over the holding period. If the investment is held for 10 years and the building appreciates in value, the sale of the property does not trigger a depreciation recapture tax.

Why It Matters

Depreciation recapture can significantly erode the after-tax profits of real estate investors. Eliminating this tax burden makes QOFs even more attractive for long-term real estate projects.

Conclusion

The Opportunity Zone program offers substantial tax incentives designed to encourage long-term investment in economically distressed areas. The four main tax advantages of Opportunity Zones—deferral of capital gains, partial reduction of deferred gain (for pre-2022 investments), tax-free appreciation after 10 years, and elimination of depreciation recapture—combine to make QOF investments an appealing option for investors seeking both tax efficiency and community impact.

Although the step-up in basis benefits have expired for new investments, the potential for tax-free growth and the elimination of depreciation recapture continue to offer significant value. As with any investment strategy, understanding these tax benefits and how to maximize them is essential to making informed investment decisions in Opportunity Zones.