Opportunity Zones are economically distressed areas where new qualifying investments are eligible for preferential tax treatment for the investors. The purpose of opportunity zones is to encourage economic growth and investment. 

Distressed areas are first nominated for designation as an opportunity zone and are ultimately certified by the U.S. Treasury Department. Investors can defer capital gains on the sale of other assets by investing those proceeds into a Qualified Opportunity Fund (QOF). 

Example of a QOF Investment

John holds stock in a publicly traded company. In 2019, he sold the stock for $1,000,000, and his original cost basis for the shares was $100,000. John has a $900,000 long-term capital gain on the stock sale. John can invest the $900,000 in an opportunity zone to defer paying taxes. Within 180 days of realizing the gain, John invests $900,000 in a QOF, which he will hold until 2030. John defers the gain on $900,000 and reports the deferral on Form 8997 (Initial and Annual Statement of QOF Investments) and Form 8949 (Sale and Dispositions of Capital Assets).

John must recognize the $900,000 of deferred gain in 2026. By holding the investment for seven years, John can increase his cost basis in the original deferred gain by 15%, which helps lower the recognized gain. 

In 2026, John must recognize deferred long-term capital gain of $765,000. The calculation is as follows:

Original Sale Proceeds: $1,000,000
Original Cost Basis: $100,000
Original Deferred Gain: $900,000

Increase to Cost Basis: $135,000 ($900,000 times 15%).
Adjusted Cost Basis: $235,000 ($100,000 + $135,000)
Adjusted LTCG: $765,000 ($1,000,000 minus $235,000)

When John sells the QOF investment in 2030 after holding the investment for more than ten years, he will not owe any capital gains taxes on the appreciated asset. 

Federal Income Tax Reporting on Form 1040

Our channel has a video tutorial on how to prepare Form 8997 and Form 8949 to report the deferred gain on investments in a QOF.

Additional Information

Investors looking for more information on Qualified Opportunity Zones can visit the IRS website and review the Form 8997 instructions.