Anyone in the real estate business is aware of the powerful, impactful and flexible Opportunity Zone (OZ) Program which became effective Jan. 1, 2018 as part of the Trump Administration’s bi-partisan Tax Cuts and Jobs Act (2017 Tax Act). However, developers are generally required to modify their traditional game plan of contributing property, receiving equity as “carried interest” in the partnership and navigating the related-party and self-constructed asset rules in order to comply with some of the unique structuring requirements under Internal Revenue Code (IRC) Section 1400Z and related Regulations which control the OZ Program.
The OZ program currently allows up to a current five-year federal (and in all states other than CA, MS, NC, NY and MA) tax deferral on virtually any U.S. short-term or long-term capital gain, other than gains generated on related-party transactions (20% common ownership). For gains invested into a Qualified Opportunity Fund (QOF) by Dec. 31, 2021, the OZ program allows the taxpayer to increase their tax basis in the QOF by 10% after holding the QOF interest for 5 years. Provided the taxpayer has held the QOF for the required five-year holding period on the earlier of: i) Dec. 31, 2026, or ii) the disposition date of the QOF interest the taxpayer only reports 90% of the deferred tax gain. For example, a taxpayer deferring a $1 million gain will report $900,000 on Dec. 31, 2026 (or on an earlier disposition or “Inclusion Event” date).
The Internal Revenue Service has started sending letters to taxpayers that may need to take additional actions related to Qualified Opportunity Funds (QOF).
Taxpayers who attached or indicated they attached a Form 8996 to their return may receive Letter 6250, Self-certifying as Qualified Opportunity Fund (QOF). This letter lets them know that if they intended to self-certify as a QOF they may need to take additional action to meet the annual self-certification requirement.
To correct a 2018 self-certification as a QOF, these taxpayers should file an amended return or an administrative adjustment request (AAR). If an entity that receives the letter fails to take action to self-certify as a QOF, the IRS may refer its tax account for examination. Investors who made an election to defer tax on eligible gains invested in that entity may also be subject to examination for an invalid election.
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The Internal Revenue Service issued guidance providing additional details about investment in qualified opportunity zones.
The proposed regulations allow the deferral of all or part of a gain that is invested into a Qualified Opportunity Fund (QO Fund) that would otherwise be includible in income. The gain is deferred until the investment is sold or exchanged or Dec. 31, 2026, whichever is earlier. If the investment is held for at least 10 years, investors may be able to permanently exclude gain from the sale or exchange of an investment in a QO Fund.
Qualified opportunity zone business property is tangible property used in a trade or business of the QO Fund if the property was purchased after Dec. 31, 2017. The guidance permits tangible property acquired after Dec. 31, 2017, under a market rate lease to qualify as “qualified opportunity zone business property” if during substantially all of the holding period of the property, substantially all of the use of the property was in a qualified opportunity zone.
If you have a large capital gain from the sale of a stock, asset, or business and would like to defer that gain with the possibility of excluding some of it from taxation, you may want to check out the new investment vehicle created by tax reform, called a qualified opportunity fund (QOF).
Congress, as a means of helping communities that have not recovered from the past decade’s economic downturn, included a provision in the Tax Cuts and Jobs Act intended to promote investments in certain economically distressed communities through QOFs. Investments in QOFs provide unique tax incentives that lawmakers designed to encourage taxpayers to participate in these funds.
Reinvesting Gains – Taxpayers who have a capital gain from selling or exchanging any non-QOF property to an unrelated party may elect to defer that gain if it is reinvested in a QOF within 180 days of the sale or exchange. Only one election may be made with respect to a given sale or exchange. If the taxpayer reinvests less than the full amount of the gain in the QOF, the remainder is taxable in the sale year, as usual. Only the gain need be reinvested in a QOF, not the entire proceeds from the sale. This is in sharp contrast to a 1031 exchange where the entire proceeds must be reinvested to defer the gain.