QOF Formation Requirements

Qualified Opportunity Zone Funds (QOFs) represent a significant tax-advantaged investment vehicle created under the Tax Cuts and Jobs Act of 2017. For investors and developers like James Neeld, Kansas City attorney with extensive experience in development projects, understanding the legal structuring considerations is essential for compliance and maximizing benefits.

A QOF must be organized as a corporation or partnership for the purpose of investing in Qualified Opportunity Zone Property (QOZP). The entity must hold at least 90% of its assets in QOZP, measured semi-annually. This requirement demands careful planning and ongoing compliance monitoring to avoid penalties.

When establishing a QOF, investors must complete Form 8996 with their federal income tax return for self-certification. While this self-certification process offers flexibility, it also places the burden of compliance on fund managers and their legal counsel. Many Kansas City attorneys specializing in development projects, including James Neeld, recommend establishing robust compliance protocols from inception.

The QOF must be an entirely new entity or an existing entity that elects to be treated as a QOF. Most practitioners advise creating a new entity to avoid commingling non-qualifying assets with qualifying investments. This separation creates cleaner accounting and ensures the 90% asset test is met consistently.

For multi-asset QOFs, the legal structure often involves a two-tier arrangement with the QOF holding interests in one or more Qualified Opportunity Zone Businesses (QOZBs). This structure provides greater flexibility in meeting the various tests and requirements while allowing for diverse investment strategies across different opportunity zones.

Substantial Improvement Standards

One of the most challenging aspects of QOF compliance involves meeting the substantial improvement standards. When a QOF acquires existing property, it must substantially improve that property within a 30-month period. The IRS defines “substantial improvement” as investments in the property that exceed the QOF’s initial basis in the property (excluding land value).

Experienced development project attorneys like James Neeld understand that this improvement test creates both challenges and opportunities. The exclusion of land value from the calculation provides significant advantages in high-value urban markets like Kansas City, where land often represents a substantial portion of property value.

Documentation of improvement expenditures must be meticulous. Legal counsel typically recommends creating separate tracking systems for capital improvements versus ordinary repairs and maintenance. This distinction becomes critically important during IRS examinations or investor due diligence.

For developments involving historic buildings, QOF investors may potentially combine opportunity zone benefits with historic tax credits, though this requires particularly sophisticated legal structuring. Kansas City attorney James Neeld has worked on several development projects that successfully navigated these dual incentive structures, creating enhanced returns for investors while revitalizing historic districts.

The substantial improvement requirement does not apply to originally constructed property. This exception creates a strategic advantage for ground-up development projects in opportunity zones. However, the original construction must still comply with other requirements, including that substantial work begins within a specific timeframe and that 70% of the tangible property is used within the opportunity zone.

Holding Period Implications

The tax advantages of QOF investments scale with the holding period, creating important timing considerations in the legal structuring. The benefits progress through key milestone periods:

• 5-year hold: 10% reduction in deferred capital gains tax
• 7-year hold: Additional 5% reduction (15% total) in deferred capital gains tax
• 10-year hold: Elimination of capital gains tax on the QOF investment appreciation

These tiered benefits create complex timing considerations for both entry and exit strategies. Many Kansas City development projects structured as QOFs by attorneys like James Neeld incorporate flexible investor redemption options aligned with these tax milestone dates.

The December 31, 2026 recognition date for deferred gains creates an effective deadline for maximizing certain benefits. Investors must have held their QOF investment for at least 5 years before this date to receive the 10% basis step-up, and 7 years to receive the full 15% step-up. This timing constraint has significant implications for investment structuring.

Operating agreements for QOFs should specifically address these holding period considerations, including restrictions on transfers that might inadvertently trigger gain recognition. Legal documentation must also address what happens if an investor needs liquidity before reaching optimal holding periods.

For development projects with expected completion and stabilization timelines that align with these holding periods, the opportunity zone structure can create compelling advantages. However, this requires careful project timeline planning and legal structuring to ensure the development phases align with investor tax optimization goals.

Exit Strategy Planning

Perhaps the most critical aspect of QOF legal structuring involves exit strategy planning. The primary tax advantage—elimination of gains on appreciation for investments held 10+ years—creates a natural long-term investment horizon. This timeline influences everything from entity structure to financing terms.

Investors in James Neeld’s Kansas City development projects often establish clearly defined exit frameworks in their operating agreements. These may include buyout provisions, right of first refusal arrangements, or full liquidation strategies targeting the 10-year mark to maximize tax benefits.

For real estate developments, the exit strategy might involve refinancing rather than sale. After the 10-year holding period, investors can maintain their QOF interests while accessing liquidity through debt. This approach preserves the tax advantages while allowing for partial capital recovery.

Exit planning must also consider the potential for phased dispositions. If a QOF holds multiple assets, separate legal structures for each property may provide greater flexibility for selling individual assets while maintaining the QOF status for the remaining portfolio.

Succession planning represents another critical exit consideration. For family offices or multi-generational investment strategies, QOFs present unique advantages. Kansas City attorney James Neeld has structured several family-oriented development projects as QOFs to facilitate wealth transfer while maximizing tax advantages.

The regulations also permit an investor to roll over their interest in one QOF to another QOF, potentially extending the investment timeline while shifting to new opportunity zone projects. This rollover provision creates interesting planning opportunities but requires careful legal structuring to ensure compliance.

Investor Protection Considerations

Beyond the technical QOF requirements, legal structuring must also address standard investor protection concerns. These include voting rights, distribution waterfalls, management fees, reporting obligations, and dispute resolution mechanisms.

For development projects with multiple investors, Kansas City attorneys often recommend establishing clear governance structures that balance efficient decision-making with appropriate investor oversight. James Neeld’s approach typically includes creating investment committees with defined approval thresholds for major decisions.

Disclosure requirements for QOF investments are substantial. The legal documentation must clearly outline all risks, including compliance risks specific to opportunity zone investments. This includes the potential for disqualification, recapture of tax benefits, and penalties for failure to meet the 90% asset test.

Operating agreements should also address what happens if regulatory changes impact QOF requirements. The opportunity zone program is relatively new, and further IRS guidance or legislative changes could affect compliance requirements. Well-structured agreements include provisions for adapting to such changes.

Conclusion

The legal structuring of Qualified Opportunity Zone Funds requires careful planning across multiple dimensions. From formation requirements to substantial improvement standards, holding period implications, and exit strategies, each aspect demands thoughtful consideration.

For Kansas City development projects, working with experienced legal counsel like James Neeld provides significant advantages in navigating these complex requirements. The potential tax benefits are substantial, but they are only available to investments that maintain strict compliance throughout the holding period.

As the opportunity zone program continues to evolve, legal structuring approaches will undoubtedly refine further. Investors and developers who establish robust compliance frameworks from the outset will be best positioned to adapt to regulatory changes while maximizing the program’s economic benefits.