Why Opportunity Zone investments must be equity

Because the statute grants the tax benefits only for an investment in a Qualified Opportunity Fund, and the Treasury regulations define that investment as an equity interest issued by the fund. A Qualified Opportunity Fund (QOF) is a corporation or partnership organized to invest in Opportunity Zone property that holds at least 90% of its assets in that property.¹ An investor who sells an asset at a gain may elect to defer the gain by investing the same amount in a QOF within 180 days.¹

The regulations call the qualifying investment an "eligible interest." It is an equity interest issued by the QOF, including preferred stock or a partnership interest with special allocations. It does not include any debt instrument.^2,4 A capital gain lent to a fund, even at a market interest rate and even if the fund uses it for the same building, earns no deferral, no five-year basis step-up and no 10-year exclusion.

The logic follows the program's design. The benefits reward investors who share the risk and upside of a project in a zone. A creditor's return is fixed, so the code gives the incentive to owners instead. For how the full sequence works, see how Opportunity Zones work, step by step.

Almost any true equity interest qualifies, including interests with economic preferences. Practitioner commentary on the regulations notes that QOF equity can carry a fixed coupon and a liquidation preference and still be an eligible interest, so long as it is equity for tax purposes.^5,4 That gives sponsors room to offer preferred returns, distribution waterfalls and classes of units with different rights.

• Stock in a QOF corporation, common or preferred.
• An interest in a QOF partnership, or in an LLC taxed as a partnership, including interests with special allocations.
• An interest acquired from another investor, rather than directly from the fund, can also be an eligible interest if the buyer invests eligible gain within its own 180-day period.²

The test is substance, not labels. An instrument called "preferred equity" that has a fixed maturity, a mandatory redemption and creditor remedies may be debt for tax purposes. The IRS has declined to say whether a loan later converted into equity would qualify, and has pointed instead to ordinary debt-versus-equity principles.⁵ Treat any hybrid instrument as a question for tax counsel before it is signed.

Can an investor borrow against the QOF interest?

Yes. Under the regulations, using an eligible interest as collateral for a loan, including a purchase-money loan, does not impair its status, provided the investor is the owner of the interest for federal tax purposes.^2,4 There is also no tracing requirement: an investor with eligible gain may fund the investment with other cash, including borrowed money, as long as the amount invested does not exceed the gain being deferred and the investment is made within the 180-day period.⁴

Yes. When a QOF invests through an operating subsidiary, the QOF's interest in that subsidiary must also be equity. The statute counts as Opportunity Zone property only QOZ stock or a QOZ partnership interest that the fund acquires at original issue, solely in exchange for cash, from an entity that is (or is being organized as) a Qualified Opportunity Zone Business.¹ A Qualified Opportunity Zone Business (QOZB) is an operating business in which at least 70% of the tangible property it owns or leases is qualified zone business property and which meets the income and asset tests.³

A loan from the QOF to its QOZB is not QOZ property. It counts against the fund's 90% asset test, and a large intercompany loan can push the fund below the threshold. See the QOF 90% asset test for the semiannual testing mechanics.

The investment is split in two. Under §1400Z-2(e)(1), an investment in a QOF only part of which consists of gain covered by a deferral election is treated as two separate investments: one consisting only of the deferred gain, and one consisting of everything else.¹ Only the first gets the deferral, the five-year basis step-up and the 10-year exclusion. Practitioners call this a mixed-funds investment.

For partnership funds, the regulations require a partner holding both kinds of interest to allocate income, gain, loss, deduction and §752 liabilities between the two interests in proportion. A profits interest received for services to the QOF, such as a sponsor's carried interest, is treated as a non-qualifying investment, under special allocation rules keyed to the partner's highest share of residual profits from that interest.⁶

Worked example: a mixed-funds investment (illustrative)

Assume an investor puts $10 million into a QOF partnership: $7 million of eligible capital gain and $3 million of other cash. The fund holds the investment for 10 years and the interest is sold for $20 million. Assume a 20% federal long-term capital gains rate plus the 3.8% net investment income tax (23.8% total), no state tax, and ignore depreciation recapture and the tax on the deferred gain at year five, which applies only to the qualifying piece.

• Qualifying piece: 70% of the interest, worth $14 million. The investor elects basis equal to fair market value, so the $7 million of appreciation is excluded. Tax on exit: $0.
• Non-qualifying piece: 30% of the interest, worth $6 million, with $3 million of basis. The $3 million of appreciation is taxable: $3 million x 23.8% = $714,000.

The tax on the deferred gain itself is separate. For investments made on or after January 1, 2027, the deferred $7 million is included in income on the earlier of a sale or the fifth anniversary, with a 10% basis step-up if the investment has been held five years, so 90% of it is taxed.⁷ See the five-year deferral and the 10-year hold for the full math.

Yes, and most do. The equity rule governs how the investor enters the fund, not how the project is financed. A QOF or QOZB can take construction loans, term loans and other financing from third parties. A partnership QOF offers a further advantage: a partner's basis in its QOF interest is increased by its allocable share of the partnership's liabilities, which lets partners use depreciation deductions even though their basis from the deferred gain starts at zero.⁸

Leverage also affects distributions. Practitioner summaries of the final regulations generally read them to mean that a debt-financed distribution made more than two years after the investment, and not exceeding the investor's basis, is not an inclusion event, while a distribution within the first two years risks treatment as a disguised sale of part of the investor's interest under §707.^8,2 The rules are fact-specific, so confirm any refinancing distribution with counsel. An inclusion event is a transaction that triggers recognition of the deferred gain early; see inclusion events.

For a full treatment of how lenders, credit support and refinancing fit around the equity rule, see debt and financing in Opportunity Zone projects.

Data centers are capital intensive, so the equity rule shapes the whole capital stack. The Opportunity Zone equity is usually the first money in, funding land, power studies, utility deposits and early design, with construction debt layered on once the project has a tenant and an energization date. The QOF's money must go into the QOZB as newly issued equity for cash, and every dollar of it then needs a written working capital plan if it is not spent at once.³

• Sponsor promote. A developer's carried interest in a QOF partnership is non-qualifying. Sponsors who want Opportunity Zone treatment on their own money must invest their own eligible gain alongside investors.⁶
• Non-gain investors. Pension funds, foreign investors and others without eligible gain can still invest, either as a non-qualifying piece of the QOF or directly in the QOZB, but they get no Opportunity Zone benefits.
• Tenant contributions. A hyperscale tenant that funds its own fit-out owns that equipment; it does not become QOF equity and does not count in the landlord QOZB's tangible property tests.¹⁰
• Hybrid instruments. Mezzanine loans and preferred equity offered by third-party capital providers sit below the QOF and do not need to qualify, but they must not be confused with the investors' own eligible interests.

OZ Data Centers structures its funds so that investor capital enters as fund equity and project lenders lend at the QOZB level, which keeps the qualifying and non-qualifying pieces cleanly separated. For how those layers stack up in practice, see the capital stack for an Opportunity Zone data center.

Check the instrument, the timing, the amount and the reporting before funding. Investors report the election on Form 8949 with the QOF's EIN and investment date, and report the holding on Form 8997 each year.⁹ Treasury's request for comments in Notice 2026-55 covers several §1400Z-2 issues, including inclusion events, so watch for changes.¹¹

If a single document is ambiguous on debt versus equity, resolve it before the money moves. A qualifying investment cannot be created after the 180-day period closes. Investors evaluating a sponsor should also review the Opportunity Zone fund due diligence checklist.