The Qualified Opportunity Zone (QOZ) tax incentive program provides an opportunity for a taxpayer to defer and potentially eliminate the recognition of capital gains if, within certain 6-month time frames, the taxpayer makes a qualifying investment into a Qualified Opportunity Fund (QOF). For more information relating to the QOZ program, please click here. Listed below are some important deadlines and structuring considerations that taxpayers should consider when contemplating a QOF investment.
June 28, 2019, Deadline for 'Rollover' of Dec. 31, 2018, Schedule K-1 Gain
If a taxpayer has received a Schedule K-1 from a partnership with a Dec. 31, 2018, taxable year – i.e., most partnerships, and the K-1 reflects capital gain ("2018 K-1 Gain"), an important deadline is quickly approaching. To defer such gain and obtain other benefits of the QOZ program, the taxpayer must make an investment in a QOF on or before June 28, 2019. A valid QOF investment is a contribution of cash or, according to proposed regulations, property, to a QOF. A commitment to fund future capital calls does not qualify as a valid QOF investment.
Making a QOF Investment With Section 1231 Gain
Section 1231 Property and Calculation of Eligible "Rollover" Amount. Section 1231 provides special rules addressing the tax treatment of gains and losses on the sale or exchange of real or depreciable property used in a trade or business and held over one year. As a general matter, a taxpayer computes its "net" Section 1231 gain or loss at the close of a taxable year. Under recently issued proposed Treasury regulations, if a taxpayer wants to make a QOF investment to defer net Section 1231 gain, the taxpayer must make such investment during the 180-day period beginning on the last day of its taxable year. For example, if a partnership with a tax year ending Dec. 31 intends to make a QOF investment to defer net Section 1231 gain realized during tax year 2019, the partnership (or its partners, assuming they are on a Dec. 31 taxable year) must make an investment on or after (but, importantly, not before) Dec. 31, 2019. Although IRS officials have discussed changing this rule, until further guidance is issued, taxpayers may want to consider the timing of Section 1231 losses that could offset 1231 gains, thereby eliminating the opportunity to make a QOF investment using Section 1231 gain. If a taxpayer is otherwise in control of when it will realize 1231 gains or losses, as applicable, it may want to have gains and losses straddle tax years.
1231 Gain and Loss in Tiered Partnership Structures. A partnership with capital gain income can make a QOF investment with such gain, or a partner of the partnership can make a QOF investment with its distributive share of such partnership gain, but not both. In a tiered partnership structure, this means that taxpayers have flexibility as to which level of a tiered partnership structure to make a QOF investment. Consider the following:
"Holdco," an entity taxed as a partnership, holds 99% ownership interests in sister partnerships, Partnership A and Partnership B. Partnership A has a net Section 1231 gain of $100 and Partnership B has a net Section 1231 loss of ($80). Partnership A may make a QOF investment using all of its $100 net Section 1231 gain, whereas HoldCo would be limited to making an investment with $20, its "net" Section 1231 gain resulting from its share of Partnership A's net Section 1231 gain and Partnership B's net Section 1231 loss.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.