Rolling Over Capital Gains Into a Qualified Opportunity Fund
For clients who are planning to sell a business interest, real estate, or other highly appreciated property, AAFCPAs would like to make you aware of a strategy to “roll over” capital gains into a qualified opportunity fund (QOF).
What is a QOF?
A QOF is an investment fund, organized as a corporation or partnership, designed to invest in one or more Qualified Opportunity Zones (QOZs). A QOZ is a distressed area that meets certain low-income criteria, as designated by the U.S. Treasury Department.
Currently, there are more than 9,000 QOZs in the United States and its territories. QOFs can be structured as multi-investor funds or as single-investor funds established by an individual or business. To qualify for tax benefits, at least 90% of a QOF’s funds must be QOZ property, which includes:
QOZ business property. This is tangible property that is used by a trade or business within a QOZ and that meets certain other requirements.
QOZ stock or partnership interests. These are equity interests in corporations or partnerships, with substantially all their assets in QOZ property.
Final regulations define “substantially all” to mean at least 70%.
What are the benefits?
If you recognize capital gain by selling or exchanging property, and you reinvest an amount up to the amount of gain in a QOF within 180 days, you may enjoy several tax benefits:
- Taxes will be deferred on the reinvested gain until the earlier of December 31, 2026, or the date you dispose of your QOF investment.
- There will be a permanent reduction of the taxability of your gain by 10% if you hold the QOF investment for at least five years, and an additional 5% if you hold it for at least seven years.
- If you hold the QOF investment for at least 10 years, you will incur tax-free capital gains attributable to appreciation of the QOF investment itself.
The only way to obtain these benefits is to first sell or exchange a capital asset in a transaction that results in gain recognition. You then would reinvest some or all of the gain in a QOF. You cannot simply invest cash.
You or your heirs will eventually be liable for taxes on some or all of the original gain. AAFCPAs encourages clients to consider ways to avoid those taxes, such as holding the original property for life or doing a tax-free exchange.
How do you report QOF gains?
In February 2020, the IRS issued guidance on reporting gains from QOFs. It gives instructions on how to report the deferral of eligible gains and how to include those gains when the QOF investment is sold or exchanged.
Taxpayers who defer eligible gains from such property (including gains from installment sales and like-kind exchanges) by investing in a QOF must report the deferral election on Form 8949, “Sales and Other Dispositions of Capital Assets,” in the deferral tax year. And taxpayers selling or exchanging a QOF investment must report the inclusion of the eligible gain on the form.
We can help.
The rules surrounding these QOFs are complex. AAFCPAs provides guidance to clients who are interested in exploring this strategy further.