An opportunity zone fund can remain illiquid when tax on the client’s original deferred gain becomes payable. A client who invested all available cash…

An opportunity zone fund can remain illiquid when tax on the client’s original deferred gain becomes payable. A client who invested all available cash may have to sell another asset or borrow to pay the bill due this coming April.

For legacy investments, deferred gain must be included no later than December 31, 2026. That mandatory inclusion cannot simply be deferred again by making another qualified opportunity fund investment. For qualifying investments made after December 31, 2026, the outside inclusion date is generally the fifth anniversary, with earlier inclusion events still possible.

Assume, solely for illustration, that the resulting included gain after the applicable basis adjustments and other rules is $900,000, and the combined tax rate is 30 percent. That creates a $270,000 tax obligation. You continue to own your interest in the fund, the investment continues to grow. Your tax does not wait, however.

If the fund retains its cash, that $270,000 must come from elsewhere. Selling securities may generate an additional tax bill. Holding a reserve has an opportunity cost. Borrowing has a financing cost. Where will you your clients find cash to pay their upcoming bill?

With rising interest rates, refinancing may not be a good solution. You may need to tap into external sources to cover the tax.

This could be the last tax you pay for this investment. A sale after ten years will result in tax-free capital gains. Most of the benefit of the opportunity was not the deferral that pushed everyone to make these investments in the first place. Over 70% of the value is in the tax-free gains after year ten - investors can look forward to the final tax-free check.

This post is part of the Opportunity Zone series from Secret Art of Planning.