Some QOZs Are Not So Underserved And Not So Economically Challenged

Don’t assume that all QOZs are similar from the perspective of their need for investment and revitalization. Already there are QOZs in California, New York, New Jersey, Washington and elsewhere in which personal income, property values and other indicators are higher than might be expected of a QOZ. This reality suggests not only an opportunity but also the need for strong and thorough diligence during the investment process.

Consider The State Tax Implications

All of these tax incentives have been incorporated into the federal income tax, but that does not necessarily mean that they will be available for state income tax purposes (in states that have income taxes). Some states conform generally to federal law for tax purposes, while others conform but only with respect to the federal tax law in effect on a certain date, which may precede the enactment of the TCJA. Still other states offer limited or no conformity to the federal tax law. In any event, investors should not assume that they will receive the same deferral or tax reduction opportunities for state tax purposes. They will need to investigate the state tax laws of their resident state and of the states in which any applicable QOZs are located.

Holding A QOF For 10 Or More Years Can Still Lead To Taxation Under Certain Circumstances

By holding a QOF interest for at least 10 years, the investor can avoid paying federal income tax on any appreciation in the QOF investment. Yet, this does not necessarily mean that the QOF investment will produce no income tax liability for the investor over the course of the holding period. The basis increase earned by the investor for holding the QOF investment for at least 10 years does not happen until the QOF investment is sold. If the QOF sells an appreciated asset held by the QOF during the holding period, then that sale could lead to taxable income for the QOF investors if the QOF is taxed as a pass-through entity.

You’ll Need To Have The Cash Necessary To Pay The Deferred Tax When Due

Remember that the deferral opportunity for QOFs currently is scheduled to end no later than December 31, 2026. If the deferred gain is still invested in the QOF when the tax is due, it may be necessary to allocate other available funds to pay these taxes.

The 180-Day Rollover Period Can Be Longer Than 180 Days

Investors will need to be careful about rolling over their eligible gains into a QOF within 180 days, or they will lose the QOF opportunities afforded by the TCJA. So, if a gain was recognized at the beginning of this year, it’s too late to do a tax-advantaged rollover, right? Not necessarily. If the gain was recognized inside a partnership, then it appears that the 180-day period may not actually begin until the end of the partnership’s taxable year. As stated in recently issued proposed regulations regarding QOFs, “the partner’s 180-day period generally begins on the last day of the partnership’s taxable year, because that is the day on which the partner would be required to recognize the gain if the gain is not deferred.” The proposed regulations also provide that if the partnership decides not to elect deferral of its gain at the partnership level, then the partner may choose to begin the 180-day period when the partnership’s 180-day period begins.