“When Form 8996 was introduced in 2018, it was only two pages and was pretty much used to calculate a penalty if the fund did not invest 90% of its assets into QOZ business property,” said Steven Rossman, a CPA and partner at Armanino LLP in Philadelphia. “Beginning with the 2019 tax year, the 8996 was expanded to four pages and requires information about the assets held in the QOF, including assets held directly by the QOF, the QOZ where QOZ business property owned or leased by the QOF is located, as well as stock or partnership interests in other QOZ businesses.”
Failure to provide this information could result in an audit of the QOF, “or even worse, disqualification of the fund as a QOF,” Rossman said. “Disqualification of the fund ... would make the deferred capital gains currently taxable for the investors.”
Late last year, two IRS private letter rulings indicated that the 8996 needs careful preparation. The first letter gave more time to taxpayers who failed to attach or include the form after requesting an extension to certify for OZ incentives. The second addressed a taxpayer whose advisors mistakenly believed Form 8996 would be filed by others; the IRS determined that in both cases taxpayers had acted reasonably and in good faith.
In April, the IRS announced that the agency will be sending letters to taxpayers who may need to provide additional information about their QOF investments. Taxpayers who attached an 8896 to their QOF return may receive a letter asking for more information to support the annual certification that the fund meets QOZ investment standards.
If the QOF receives the letter, called a Letter 6501, and doesn’t act, the IRS may refer the account for examination. “Investors who elected to defer tax on gains invested in the QOF may also be subject to examination,” Rossman added.
Forster said that clients can ask for retroactive relief for deficient self-certifications by filing a private letter ruling request with the IRS national office. “If the investment standard isn’t met, a penalty may also be imposed for each month that it’s not satisfied,” Forster added. “This penalty may be waived if the taxpayer can demonstrate reasonable cause.”