Opportunity zones can offer investors strong tax breaks—if the forms are filed right.

A qualified opportunity zone (QOZ) program aims to entice long-term private investments in distressed communities with federal tax incentives to investors, including deferring capital gains taxes.

The new IRS Form 8996 is used to certify that the corporation or partnership is a qualified opportunity fund (QOF) and to annually report whether the fund met the investment standard during its tax year.

The 8996 is tricky, some filers say, and mistakes or inaccuracies can cost investors. For example, one line requires calculation and forethought regarding when the entity elects to become an Opportunity Fund.

This form seems to have caused confusion, planners say.

“Recently, the IRS issued soft notices to some taxpayers that filed Form 8996 to address potential inconsistencies,” said Miri Forster, partner and national tax controversy leader at EisnerAmper in Iselin, N.J. Common errors on 8996 include incorrect calculation of the investment standard, omission or misreporting of the 11-digit number for the QOZ or a missing or incorrect employer identification number, she said.  

“The soft notices advise taxpayers to file a corrected 8996 with an amended return or administrative adjustment request,” Forster said.

Failure to correct could result in an IRS examination, a penalty or having the amounts reported as QOZ property not included in the investment standard calculation—jeopardizing tax breaks.

This is the second year in a row that the IRS is sending soft notices related to QOZ reporting. Others have questioned dates of investment or inquired about discrepancies on other forms.

“While no one likes to get a notice from the IRS, soft notices allow the IRS to educate taxpayers on the proper completion of forms and provide taxpayers with the opportunity to get into compliance,” Forster said.

“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.”