The Internal Revenue Service has provided additional pandemic-related reporting relief to Qualified Opportunity Zone (QOZ) funds and their investors.
The QOZ program aims to entice long-term private investments in distressed communities with federal tax incentives to investors, including deferring capital gains. The new program’s effectiveness remains largely unproven, but the pandemic has made more time for investors almost indispensable.
The relief measures include providing more time to make investments and defer gain; delaying penalties for failing to meet the semi-annual compliance testing dates and the deadlines for the 30-month substantial improvement test; granting more time to spend working capital; and allowing more time to reinvest proceeds from the sale of QOZ property into new property.
Extending investment times has allowed for the stock market to recover from early days of the pandemic and helped investors who looked to generate capital gains for opportunity zone investment through their stock holdings, said Sean Haggerty, a Kansas City, Mo.-based director at CBIZ MHM.
Even though QOZs were created by the tax reform of 2017, regulations for opportunity zone projects took almost two years to finalize. “Within three months of those final regulations we were facing a global pandemic,” Haggerty added. “Most [opportunity zone] funds, projects and businesses are still in their infancy.”
The Coronavirus Aid, Relief, and Economic Security (CARES) Act made “a few key changes” with QOZs, said Matt Price, a Houston-based partner with the Price Group at Steward Partners. “These investments are long-term holds, which makes it hard to know if they are living up to expectations.”
“There is no longer a substantial improvement requirement, which has to do with vacant properties. This makes using QOZ’s easier to find,” he added. “Funds received after July 2020 will have a 12-month window to reinvest. Before, it was only a six-month window. The CARES Act allowed net operating losses from 2020 to be carried back five years to offset ordinary income.”
To enforce the relatively new QOZ program—and presumably to gather more information about its effectiveness—QOZ Funds file IRS Form 8996 annually with the Fund’s federal tax return, said Steven R. Rossman, a CPA and shareholder at Drucker & Scaccetti in Philadelphia. He added that the form is now four pages (up from the original two for tax year 2018) and requires information about the assets held in the fund, as well as stock or partnership interests in other QOZ businesses.
The overall benefits of the QOZ program for both investors and communities remain far from realized, most say. “There’s been a fair amount of interest in opportunity zones, but it took a while for investors to get familiar with them as there are a number of complex provisions to deal with,” said Jim Brandenburg, a Milwaukee-based tax partner at Sikich.
One issue for QOZ investors relates to the “settlement date” with opportunity zones on Dec. 31, 2026. Those that deferred capital gains or are looking to do so now will defer the capital gains tax upon their reinvestment. This deferred gain will then be triggered on Dec. 31, 2026, at the tax rates and capital gain rules in place on that date.
“Many investors are wondering if they defer a gain now with lower or modest income tax rates, could they be stuck with recognizing these OZ gains at much higher tax rates in 2026,” Brandenburg said.
“If you’re co-investing directly with a developer/sponsor that owns the property and you can look at the real economics, then I think a QOZ investment can definitely meet expectations,” said Michael Winn, managing partner at Audent Family Wealth Advisors in Los Angeles. “On the other hand, I’m not in favor of the idea of raising funds from investors, taking a management fee and then going out to find [QOZ] opportunities.
“It’s crucial to understand the tax benefits, but probably even more important to make sure you’re with the right sponsor, the right developer and that the project makes economic sense before diving into it,” he said.