Manage capital gains between Qualified Opportunity Zone programs

Key takeaways

• The current QOZ investment program no longer provides significant capital gains deferral given its upcoming expiration on December 31, 2026.
• Instead of waiting for the 2027 QOZ program, consider different strategies to help clients manage capital gains taxes and reduce the risk of holding concentrated stock positions.
• Accumulate capital losses in advance of your clients’ deferred capital gains coming due.

QOZ funds are less effective for tax deferral as the current program soon expires

The Qualified Opportunity Zone (QOZ) program launched under the Tax Cuts and Jobs Act of 2017 drove increased investment in economically distressed areas that are designated as QOZs. The program provides several tax incentives including the deferral of capital gains invested in a Qualified Opportunity Fund (QOF) until December 31, 2026, a 10% step-up in basis on capital gains that remain invested in a QOF for five years and an additional 5% step-up after seven years, as well as tax-free appreciation on QOF investments that are held for 10 years.

While QOFs remain attractive for investors who are seeking tax-exempt long-term capital appreciation, they are less effective for deferring capital gains under the current program given its expiration at the end of 2026. The good news is that a new QOZ investment program under the One Big Beautiful Bill Act is set to roll out at the beginning of 2027, and this time, it’s permanent with rolling five-year deferral periods from the date of investment in a QOF.

Help clients bridge the gap between QOZ programs

Until the new QOZ program takes effect in 2027, investors do not have the ability to materially defer capital gains using a QOF. Waiting for the new program to realize gains can be risky, especially for clients holding highly appreciated concentrated stock positions. Consider these strategies to help your clients manage capital gains taxes and concentration risk to bridge the gap between deferral periods.

• Long/short tax-managed strategies seek to speed up diversification without triggering capital gains upfront. By shorting stocks that behave similarly to the concentrated stock and buying stocks that do not, you can help your clients reduce their concentrated stock risk without incurring an immediate capital gains tax hit. Consider partnering with an experienced provider of tax-managed long/short separately managed accounts (SMAs) who can help you implement customized solutions for your clients.
• Option overlay strategies seek to tax-efficiently reduce the risk of a concentrated stock position by using a package of actively managed options instead of selling the stock. Different option strategies can offer various risk targets and come with different tradeoffs. An experienced options manager can help you choose the appropriate option overlay strategies for your clients and tailor them to your clients’ existing portfolios and risk levels.

Prepare for deferred capital gains taxes coming due

Investors ultimately have to pay taxes on the capital gains they have deferred under the QOZ program. The accumulation of deferred gains over multiple years can lead to tax bills that may be larger than what your clients are accustomed to. You can help to offset the tax impact of deferring capital gains by harvesting losses on assets that have declined in value.

You don’t have to wait until the year a client divests from a QOF or other recognition event to start harvesting tax losses. An individual’s excess capital losses can be banked and carried forward to offset future capital gains. For some clients, direct indexing may be an appropriate strategy for efficient, systematic tax loss harvesting over time.

BlackRock can help

There are a number of ways you can help your clients manage taxes. Ask your BlackRock representative for more information or explore our online resources, where you will find tools, solutions and insights to help you keep taxes at the forefront of your investment process all year round.