There are several key distinctions that were made in the final regulations that are important to QOF investors:
How is the 180-day Reinvestment Period Impacted by Capital Gains from a Flow-through Entity?
In order to qualify, a capital gain must be reinvested in a QOF within 180 days. For an individual selling a share of publicly traded stock, the start of that 180-day window is easy to determine. It begins on the date the sale occurs and the capital gain is incurred.
But what if an investor incurs a capital gain through a partnership investment? In some cases, the investor may not be aware of the capital gain that will be taxed to them until their receive their K-1, likely long after the event creating the capital gain took place. This was considered by the IRS, and relief was provided in the final regulations. An investor who is deferring capital gain from a flow-through entity has 180 days from any of the following:
- The date the flow-through entity incurred the gain,
- The final day of the flow-through entity’s tax year (December 31 for a calendar year entity), or
- The original due date of the flow-through entity’s tax return, not including extensions.
Based on these rules, the maximum amount of time a taxpayer has to reinvest capital gains reported to them by a partnership would be 180 days from March 15 (partnership tax return due date) or September 11.
Are Section 1231 Gains Eligible for Investment, and When?
The regulations are clear that capital gains arising from ANY source (that is not a related party) are eligible for the tax incentives when invested within the prescribed timeline. That includes Section 1231 gains, which arise from the sale of business assets, such as rental real estate, and are treated as capital gains.
The previously proposed regulations created much concern about the deferral of Section 1231 gains and the timing of investment. Because gains from Section 1231 assets must be netted against losses incurred from similar transactions to determine their ultimate taxability, the proposed regulations dictated that investors were required to wait until December 31 each year before their gains from 1231 assets were eligible for reinvestment, after they had been netted against other losses. Fortunately for investors, the final regulations removed the delay. Gross 1231 gains are eligible for deferral when incurred, and there is no requirement to wait until the end of the year to invest. This gives investors a bigger time window and the potential for more gain to invest and tax to defer.
Are Capital Gains Related to Installment Sales Eligible?
One limitation on capital gains that are eligible for deferral under the QOF rules is that they are incurred by the taxpayer after December 31, 2017. One question left unanswered by the two previous rounds of proposed regulations was how that rule applied to installment payments received after 12/31/17, but that originated from installment agreements entered into prior to that date. The final regulations offered another taxpayer-friendly answer. Under the QOF rules, each installment payment carries with it eligible gain, and the option of its own 180-day investment window. So even if the initial sale giving rise to the installment agreement originated before 2018, each payment received is considered a new occurrence of capital gain which can be eligible for deferral. Investors also have the option of two choices when it comes to the eligible investment period for installment sale gain: the 180-day window for investment can begin on the date of each installment payment during the year, or investors can opt to use December 31 of the tax year to begin the 180-day window for all the installment payments received during the year. This gives the investor options with which to maximize their investment and tax deferral.
As with nearly all areas of tax law, there are many nuances and complications to be aware of when considering an investment into a Qualified Opportunity Fund. While there are significant tax incentives available, planning with tax and investment advisors will help ensure the benefits are maximized without creating unintended consequences.