How to Evaluate an OZ Fund

How to Evaluate an Opportunity Zone Fund: 9 Questions

This framework reflects operator judgment and should be tested against the offering documents, third-party diligence, and the investor's advisers. These are the nine questions I would ask before putting a dollar into any OZ fund, including one of my own.

Question 1: Does the deal work on a pre-tax basis?

This is the single most important question. I ask to see the projected IRR and return profile without factoring in the OZ tax benefits. The investment must make sense on its own real estate or business fundamentals.

OZ is a tax structure, not an asset class. Evaluate projected pre-tax returns, downside cases, assumptions, fees, and comparable alternatives before considering tax effects. Operator judgment: A proposal that depends on tax benefits to overcome weak underlying economics deserves additional scrutiny.

Pre-TCO acquisitions change the risk profile materially, trading construction risk for lease-up risk, see the pre-TCO acquisition strategy →.

Question 2: How is the capital stack structured to survive a 10-year hold?

The OZ benefit requires a 10-year hold. The capital stack must be built to survive that full duration without a forced sale or refinancing crisis.

I look for red flags here first:

• Short-duration bridge loans with a maturity of 2-3 years
• Mezzanine debt or preferred equity with fixed returns that create refinancing pressure at exactly the wrong time
• High loan-to-cost ratios that leave no room for value fluctuation

Operator judgment: I generally prefer capital structures with enough duration and downside capacity to survive construction, lease-up, and refinancing uncertainty. That preference is not law and no leverage range guarantees performance. Evaluate the actual debt, covenants, maturities, extension rights, and downside cases.

Why the capital stack matters more than most investors realize

Question 3: What is the plan for the phantom tax?

Investors will owe federal capital gains tax on their original deferred gain at the end of the deferral period. Under OZ 1.0, that bill is due April 2027. Under OZ 2.0, it comes five years from the investment date. The fund almost certainly will not distribute cash to cover it.

I ask every sponsor:

• Will the fund execute a refinance before the deferral date?
• Will distributions be made to help investors fund the tax bill?
• What liquidity should investors set aside independently?

Operator judgment: A missing plan for the deferred-gain inclusion is a material diligence concern. The investor still needs an independent liquidity plan rather than relying on the sponsor.

Full phantom tax explainer

Question 4: Is the sponsor vertically integrated?

Many institutional OZ funds raise capital and then allocate it to third-party developers, adding a fee layer at the fund level on top of fees at the project level. I call this "margin on margin." It reduces investor returns and adds execution risk.

I ask directly: Does the sponsor serve as its own general contractor? Does the sponsor manage its own properties? Vertical integration can concentrate execution responsibility, but it can also create related-party pricing, fee, and oversight conflicts. Ask how contracts are priced, who approves related-party work, what independent controls exist, and how performance is compared with outside providers. Independent managers can provide diversification and oversight, depending on mandate and fees.

Question 5: Does the GP co-invest alongside LPs?

I ask what percentage of the sponsor's own capital is invested in this specific fund or project. A GP who has real money at risk alongside investors has aligned incentives. A GP collecting a management fee on other people's capital while investing none of their own does not.

Question 6: What are all the fees and the promote structure?

I want the complete picture:

• Management fee (% of committed or invested capital, per year)
• Acquisition fee
• Disposition fee
• Promote / carried interest structure and hurdle rate
• Whether the promote is at the fund level, the project level, or both

Fee stacking is common in OZ funds. Some sponsors charge at both levels. Ask for a simple waterfall chart showing how a dollar of profit flows from the project to you.

Before evaluating any individual fund, it helps to understand which QOF structure fits the investor's situation, operator-managed commingled, diversified institutional, captive, or advisor-managed.

Question 7: Does the fund use a QOF-to-QOZB two-tier structure?

Development structures often use a QOZB to access the Working Capital Safe Harbor, but structure depends on the assets and facts. Ask counsel to explain how the QOF and any QOZB satisfy their separate tests rather than treating one architecture as proof of competence.

Ask for a plain-English explanation of the legal structure and how compliance testing is managed.

QOF vs. QOZB explained

Question 8: Who handles compliance and reporting?

OZ compliance is technical and ongoing:

• Semi-annual 90% asset testing on June 30 and December 31
• Annual QOZB tests (70% tangible property, 50% income, 40% intangible)
• Working Capital Safe Harbor documentation
• OZ 2.0 mandatory reporting under OBBBA

I ask which law firm handles OZ compliance, which CPA firm prepares Form 8996, and who is responsible for the OBBBA reporting. reporting penalties depend on the applicable filing year, failure, fund size, and whether disregard is intentional (up to $50,000 for large funds). This is not an area where casual documentation is acceptable.

Question 9: What is the exit strategy?

The intended ten-year exit must be supported by the documents and entity structure. The final regulations address both a QOF-interest-sale route and an eligible asset-sale route for specified entities and assets. I ask:

• What is the projected exit timeline?
• What extension periods exist if the market is down at year 10?
• Can investors receive a tax-free FMV basis election at the time of sale?
• Is there a GP option or preferred buyout structure that could trigger an early inclusion event?

The worst version of this: a GP with a buy-sell option that can force a sale at year 7 or 8, killing the investor's 10-year exclusion. Read the operating agreement.

What to Read Next

• OZ fund red flags: the patterns I have seen go wrong

• Why the capital stack is the real risk in OZ

• Bishop Ridge: what a full-lifecycle OZ project looks like

• What tax forms do OZ investors need to know?

Exit routes to verify

Do not assume the investor must sell the QOF interest. Treas. Reg. section 1.1400Z2(c)-1(b)(2)(i) addresses the QOF-interest-sale basis adjustment. Section (b)(2)(ii) addresses an election for eligible asset sales by QOF partnerships or S corporations and eligible underlying partnership chains after the applicable ten-year hold, subject to elections and the ordinary-course inventory exception. Ask counsel which route the documents support.

Primary sources

• Final regulations, T.D. 9889
• Form 8996 instructions