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A little clarity for your next decision.
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Investor WorkspaceA little clarity for your next decision.
By Jerry Baker
An Opportunity Zone fund can claim depreciation on qualifying business assets, but the deduction you can use depends on the fund’s structure and your own tax limits. A large first-year write-off does not make your cash payments tax-free or guarantee a tax-free exit. Review the asset schedule, your basis, the loss rules, and the planned sale together.
Depreciation lets a business recover the tax cost of certain assets over time. It is a tax deduction, not a check from the government. The fund must first own or otherwise have a qualifying tax interest in property used for business or income. An Opportunity Zone address does not create a deduction by itself. [1]
This guide focuses on QOFs taxed as partnerships, where tax items can pass through to investors. A corporate fund can have a different result. Confirm the entity’s tax treatment before applying any example.
Three numbers deserve separate lines in a review: cash the property earns, tax income the fund reports, and cash the fund pays you. Those figures can differ. Depreciation helps explain part of the gap. Debt payments, reserves, capital spending, fees, and the agreement’s payout rules can explain other parts.
The fund’s basis in purchased property generally starts with cost, subject to the proper adjustments. That cost must be divided among the assets acquired. Land is not depreciable. A building, equipment, and certain site improvements can follow different rules. [2]
Consider a hypothetical $5 million purchase. Assume a supported allocation assigns $1 million to land and $4 million to a residential rental building. Ignore other assets and costs. The fund does not start with $5 million of depreciable building basis. It starts with the $4 million assigned to the building.
Under the general depreciation system, residential rental property usually has a 27.5-year recovery period. Nonresidential real property usually has a 39-year period. Other systems, elections, and property types can change the answer. [1]
For scale only, $4 million divided by 27.5 is about $145,455 a year. That is a simplified full-year illustration, not the first year’s deduction. The actual schedule must apply the service date, required convention, method, and any other limits. The same $4 million spread over 39 years is about $102,564 before those details.
Depreciation generally starts when property is ready and available for its intended use. Sending money to a fund does not place its building in service. Buying land does not do so either. A project may take months or years to reach that point. [1]
Ask when each phase is expected to be ready, and what evidence supports that date. An apartment project with several buildings may not have one shared service date for every asset. A model should reflect its real construction and leasing plan.
Suppose the model expects a building to open in December. A permit delay pushes the opening into the next year. The deduction may move too. That change can affect an investor who was counting on a current-year loss. The tax model should include a delayed-opening case, not just a footnote saying dates may change.
A working-capital safe harbor can help address specified OZ qualification issues. It does not deem an unfinished building ready for depreciation. Keep the OZ compliance schedule separate from the fixed-asset schedule.
A cost segregation study identifies assets and assigns supported costs to their tax classes. Some assets may have shorter recovery periods than the building. The process does not create more total cost or turn land into depreciable property.
The IRS examination guide stresses accurate classifications, source records, and reconciliation to the project’s actual costs. It is a guide for examining studies, not a law that approves every report bearing the words “cost segregation.” [3]
Ask who prepared the study, which assets were inspected, and how the amounts tie to invoices or a supported purchase allocation. A proposed percentage in a sales deck is not the same as a finished study. Reclassifying an asset also changes the schedule of deductions in later years.
For example, suppose a valid study identifies $600,000 of eligible shorter-life assets within the $4 million cost above. The remaining building amount becomes $3.4 million, assuming no other changes. The model cannot claim deductions on the full $4 million building and then claim the same $600,000 again as separate assets. Every dollar needs one supported place.
The 2025 tax law restored permanent 100% additional first-year depreciation for eligible property acquired after January 19, 2025. Notice 2026-11 provides interim guidance on that rule, including acquisition timing and elections. The property must still meet the eligibility requirements. [4]
Ordinary building shells with 27.5- or 39-year recovery periods do not become eligible for Section 168(k) merely because the percentage is 100%. Eligible shorter-life property is a different question. Required use of the alternative depreciation system, acquisition facts, and other exceptions can affect the result. [1]
In the $600,000 illustration, assume all of that amount actually qualifies for a 100% allowance and the fund claims it. The first-year asset deduction would be $600,000. This is an assumption to explain the math, not a finding that a particular building contains that much eligible property.
Check older acquisitions separately. Do not apply the new percentage just because the deduction appears on a 2026 return. A binding contract, construction history, or earlier acquisition may change which rules apply. Also ask whether the fund plans an election that changes the amount claimed.
The law also added Section 168(n) for qualified production property. This is a distinct, temporary provision with specific use, timing, and election rules. Notice 2026-16 addresses it. It is not a general write-off for all apartments, office buildings, or warehouses. [5]
If a fund cites that rule, ask exactly which portion of the property qualifies, who uses it, and what production occurs there. A manufacturing tenant’s presence is not enough to assume that the landlord qualifies. The notice addresses ownership and use, excluded portions, and later changes in use.
A clear model names the section being used. “New bonus rules” is too vague when two provisions have different requirements. Your reviewer should be able to trace the deduction to the actual assets and the right rule.
A qualifying deferred-gain investment in a QOF generally starts with zero investor basis. For a partnership, the rules account for a proper share of debt and later changes. The fund’s basis in purchased assets is a separate record. [6]
This means a fund may have a valid depreciation deduction while an investor cannot yet deduct an allocated loss. Imagine you invest $200,000 of eligible gain. Assume zero outside basis, no allocated debt, and no other basis increases. A $20,000 loss on your K-1 does not by itself give you a current $20,000 deduction.
The basis limitation must be applied. A loss held back under that rule may become usable after a valid basis increase, but other limits still need review. The OZ regulations expressly address specified basis adjustments for suspended partnership losses. [6]
Ask for the investor-level schedule as well as the property schedule. A fund-wide deduction divided by your ownership share is only one step. It does not complete your tax return.
For an individual partner, loss review can involve basis, at-risk rules, passive activity rules, and the excess business loss limit. The order matters. A loss that clears one test can still be limited by the next. [7]
Basis measures a tax investment account. The at-risk rules ask a different question about amounts exposed to loss. Passive activity rules limit how passive losses can offset other income. These are related concepts, but none is a substitute for the others.
Do not assume a passive QOF loss offsets wages, interest, or a stock gain. Tax rules generally keep portfolio income outside passive activity income, and wages are not passive income. Rental activities and participation exceptions need fact-specific review. [7]
Consider two investors with the same fund interest and the same K-1 loss. One may have usable passive income and enough basis. The other may have no such income or may fail an earlier limit. Their current tax savings can differ even if their economic ownership is identical.
Suppose an investor’s share of income before depreciation is $18,000. Assume an $11,000 depreciation deduction properly applies to that income. The simplified tax income is $7,000. Assume the investor receives $15,000 in cash under the fund’s payout plan.
The example has three different numbers: $18,000 before depreciation, $7,000 of tax income, and $15,000 of cash. It does not establish that the $8,000 gap between cash and tax income is permanently tax-free. The basis and distribution rules must also be checked.
If the investor can use the $11,000 deduction at a hypothetical 24% federal marginal rate, its simple current-year tax effect is $2,640. At 32%, the same arithmetic is $3,520. Those are examples, not assumed investor tax rates. They exclude other taxes, state rules, and later consequences.
Keep projected tax savings outside the fund’s operating cash-flow line. A tax saving on your personal return does not help the property pay its lender unless you put money back into the project. A model that adds both without explanation can make a weak deal look stronger than it is.
A proper share of partnership debt may increase outside basis. It does not guarantee an equal increase in the amount at risk. The debt terms and allocation rules matter. [6] [7]
Do not judge a loan by the deductions it may unlock. Look at its interest cost, maturity date, required payments, and refinancing risk. A deduction may reduce tax while the loan raises the risk of losing capital.
For a simple comparison, assume added debt costs the project $80,000 a year in interest. A proposed tax benefit of $20,000 at the investor level does not mean that debt is free. The costs and benefits may occur in different accounts, affect different people, and arrive in different years.
A fund’s election out of the business interest limit can also affect depreciation methods for specified real property. Review that election with the fund’s tax adviser instead of modeling maximum interest deductions and maximum depreciation as if they were unrelated choices. [1]
Depreciation generally reduces an asset’s adjusted basis. This includes amounts allowed or allowable under the applicable rules. A lower basis can increase gain when the property is sold. [2]
Assume a depreciable asset starts with $1 million of basis. It has $300,000 of basis reductions for depreciation and no other changes. Its adjusted basis is $700,000. A sale for $1.2 million, ignoring selling costs, produces $500,000 of gain in this simplified example.
The gain’s tax character is a separate step. Section 1245 recapture can produce ordinary income. Unrecaptured Section 1250 gain is a different category from ordinary recapture. Do not apply one blanket tax rate to all depreciation-related gain. [8]
This is why a model should show more than the first year. A large early deduction can shift the timing and character of later tax. Compare the full holding period, including a sale that happens earlier than expected.
The legacy OZ regulations allow special treatment for qualifying investments held at least ten years when the required election and other conditions are met. An interest sale and a fund asset sale have different mechanisms. [9]
For certain partnership and S corporation asset sales, the election covers qualifying gains and losses for the year. It excludes ordinary-course inventory items. Covered sale gain can include depreciation-related gain; the rule is not limited to a property’s increase above its original price. That does not erase all operating income or every tax item. [9]
Do not assume the election saves a sale in year eight, a nonqualifying capital portion, or a transaction outside its scope. A fund may also have owners with different holding periods. Their results need not match.
The 2025 law changes the system for qualifying amounts invested after December 31, 2026, including a 30-year valuation boundary. Legacy gain generally still reaches mandatory inclusion in 2026. Those original-gain rules are separate from depreciation and the later appreciation benefit. Check the investment’s cohort before using an exit model. [10] [11]
Federal tax treatment does not settle state tax. California, for example, does not conform to federal OZ benefits. Its depreciation instructions also identify federal bonus and qualified production property rules that California has not adopted. [12] [13]
A federal deduction can therefore require a state adjustment and separate basis records. Moving to another state later does not automatically remove every filing or sourcing issue. Ask which states are involved because of your residence, the fund, and its properties.
For review purposes, request separate federal and state columns. A single “tax-adjusted return” line can hide major assumptions. It should name the assumed rates, the year a deduction is used, and whether state benefits actually apply.
Start with the assets. Obtain the cost allocation, depreciation classes, service dates, and any study supporting shorter lives. Then identify the fund’s elections and the person responsible for preparing the tax package.
Next, have your preparer model your share. Ask which deductions are expected to be currently usable, which may be suspended, and what would release them. Include existing losses and other investments. A projection built for an unnamed “typical investor” cannot answer those questions.
Finally, compare three cases: the planned hold, an early sale, and a construction delay. Keep fees, debt, and tax assumptions visible in each. A strong first-year deduction should support the investment review, not replace it.
Two deductions of the same size may have different value to you. One can reduce this year’s tax. The other may sit on a carryforward schedule until the rules allow its use. A return model should not treat both as cash saved today.
Assume a $30,000 loss is valid and ultimately usable. At a hypothetical 24% rate, its simple tax effect is $7,200. If the loss is suspended this year, the current saving from that loss is zero. The future amount will depend on when it can be used, the tax rate then, and the facts at that time. Neither the $30,000 nor the $7,200 is a promised fund distribution.
It helps to use three separate columns: loss allocated, loss used, and loss carried forward. Add a short note naming the limit that caused the carryforward. This makes it easier to see whether a later basis increase solves the problem or leaves a passive-loss limit in place.
Also compare the size of a tax benefit with the size of the capital at risk. A hypothetical $7,200 saving does not offset a $50,000 loss of investment value. The difference is $42,800 before other tax effects. That simple comparison is not a forecast. It is a reminder to keep the real estate or business plan at the center of the decision.
Before filing, replace projected inputs with the final records. Check the amount actually placed in service, any changes to asset classes, your share of debt, and the final K-1. If a deduction changed, update the later years too. Otherwise the model may keep the old future deductions while also claiming a larger amount now.
A useful tax projection can explain both the benefit and what would prevent it. If the only answer is that depreciation makes the investment attractive, the review is not finished.
No. The fund must own or invest through a structure with depreciable business assets. Land alone is not depreciable. The entity’s tax classification also affects whether deductions pass through to you. [1] [2]
Not merely because you invested in a QOF. Your contribution is not the same as eligible depreciable asset cost. Bonus rules, allocations, basis, and loss limits must all be reviewed. [4] [7]
Do not assume so. Passive activity and other loss limits may prevent that use. Your preparer must review the activity, your participation, basis, and other facts before claiming an offset. [7]
No. It assigns supported costs to the proper asset classes. The study must reconcile to total cost and avoid counting the same asset twice. [3]
No. Section 168(k) has eligible-property rules. The separate production-property provision also has strict limits. Neither is a general immediate deduction for any building in an Opportunity Zone. [4] [5]
Not automatically. Tax income, cash payments, outside basis, and debt changes are separate parts of the analysis. A distribution can raise a tax issue even when the fund reports large deductions. [6]
No. A qualifying election can affect covered sale gains, including depreciation-related gain, but its scope and conditions matter. Early sales, nonqualifying capital, inventory, and state taxes need separate review. [9]
Ask whether you can use the projected losses, which basis records are needed, how state rules differ, and what happens under an early exit. Bring the fund’s actual tax assumptions and documents rather than only a return summary.
Educational information, not an offer or a personal tax, legal, or investment recommendation. Examples are hypothetical and omit stated adjustments. Tax treatment depends on your facts and current law. Review your transaction with your CPA, attorney, and qualified intermediary. Real estate investments can lose value and may be illiquid.
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