By Blake Christian, CPA, and Alejandra Lopez in Tax Insider™, December 19, 2019
The federal qualified opportunity zone (QOZ) program was enacted as part of the law known as the Tax Cuts and Jobs Act (TCJA), P.L. 115-97, to spur economic development and job creation in 8,700 distressed communities throughout the country and in U.S. territories. Money is pouring into funds nationally, and Dec. 31 will see another massive influx into qualified opportunity funds (QOFs) since that is the deadline to maximize the 15% "step-up" in tax basis after holding a QOF for at least seven years.
The formation of the QOF, which is the required depository of taxpayers' capital gains, is a fairly straightforward process. However, now that hundreds, if not thousands, of QOFs have been formed, the QOZ program's complexities begin to surface and will generally require year-end action on the part of the fund managers.
In summary, the QOZ program allows taxpayers to diversify out of one asset class, such as real estate, stocks, a private business, collectibles, cryptocurrency, etc., and defer their federal (and most states') capital gain tax until 2026 and potentially obtain a full tax exemption on post-reinvestment appreciation by making an appropriate investment into a QOF within 180 days of recognizing a short-term or long-term capital gain. For detailed information on what defines a QOF, which gains are eligible and the types of qualifying OZ investments, please see the information at this link.
A QOF is an investment vehicle formed as a corporation or a partnership that is established with the primary purpose of investing in qualified opportunity zone property (QOZP). Once formed, the QOF must self-certify on IRS Form 8996, Qualified Opportunity Fund, by the extended filing deadline for the QOF in the subsequent year. Care must be exercised to elect a certification date prior to the first date eligible capital gain deferral is invested into the QOF — otherwise some of the investments may not qualify for the QOZ program benefits. Once the QOF is formed and self-certified, there is a semiannual testing requirement to ensure that the QOF is maintaining its qualification requirements.