Editor: Susan Minasian Grais, CPA, J.D., LL.M.
On Sept. 25, 2019, the IRS released draft Form 8997, Initial and Annual Statement of Qualified Opportunity Fund (QOF) Investments, that investors in qualified opportunity funds (QOFs) must file to report QOF investments held at the beginning and end of the current tax year, current-tax-year capital gains deferred by investing in QOFs, and QOF investments disposed of during the current tax year.
Eligible taxpayers — including individuals, C corporations, regulated investment companies, real estate investment trusts, partnerships, S corporations, trusts, and estates — holding a QOF investment at any time during the tax year must file Form 8997.
Definition of QOZs
The law known as the Tax Cuts and Jobs Act (TCJA), P.L. 115-97, created qualified opportunity zones (QOZs) by adding Secs. 1400Z-1 and 1400Z-2 to the Code to encourage investment in economically distressed areas by giving tax incentives to taxpayers who invest and hold on to investments in QOZs through QOFs.
Sec. 1400Z-1 allows certain economically distressed areas to be designated as QOZs. Sec. 1400Z-2 provides benefits for investments in QOFs. A QOF is a corporation or partnership that holds at least 90% of its assets in QOZ property. Investors in QOFs must make a Sec. 1400Z-2(a) election to defer eligible gain. The investment interest must be an equity interest and may include preferred stock or a partnership interest with allocations. In general, the investment must have been made within 180 days after the deferred gain was realized.
Investors can generally defer tax on eligible gains invested in a QOF until the earlier of the date on which the investment in a QOF is sold or exchanged or Dec. 31, 2026. If the QOF investment is held for longer than five years by the date the investment is sold or the end of the deferral period, 10% of the deferred gain is excluded; a 15% exclusion applies if the investment is held for more than seven years by the date the investment is sold or the end of the deferral period. If the investment is held for at least 10 years, the investor is eligible for an increase in basis of the QOF investment equal to its fair market value on the date that the QOF investment is sold or exchanged, thus excluding 100% of the gain that would have been realized from disposing of the appreciated QOF. For more, see Nitti, "Opportunities Beckon in New Qualified Opportunity Zones," 50 The Tax Adviser 356 (May 2019).
What must be reported
The draft 2019 Form 8997 requires taxpayers to report for each QOF investment:
- QOF investments held at the beginning of the current tax year, including the amount of short-term and long-term deferred gain remaining in each QOF;
- Short-term and long-term current-year capital gains deferred by investing in QOFs;
- QOF investments disposed of during the current tax year, including the amount of previously deferred short-term and long-term gain now included in taxable income; and
- QOF investments held at the end of the current tax year due to current-year capital gain deferral and prior-tax-year deferrals, including the amount of short-term and long-term deferred gain invested in each QOF.
Taxpayers holding a QOF investment at any point during the tax year must file Form 8997. This requirement for QOF investors is new and in addition to the requirement that QOF investors make Sec. 1400Z-2(a) elections to defer eligible gains invested into QOFs, using Form 8949, Sales and Other Dispositions of Capital Assets. The Form 8997 requirement for QOF investors is also separate from the requirement that QOFs self-certify and annually report compliance with the Sec. 1400Z-2(d) 90% investment requirement, using Form 8996, Qualified Opportunity Fund.
QOF investors should consult with their tax advisers and preparers regarding compliance with the reporting requirements related to their QOF investments. Additionally, QOFs may want to inform their investors of this new requirement. It is expected that the IRS will continue providing guidance on opportunity zones, which will likely include finalizing a version of draft Form 8997, as well as providing additional reporting requirements for QOF investors and/or QOFs.
Susan Minasian Grais, CPA, J.D., LL.M., is a managing director at Ernst & Young LLP in Washington, D.C.
For additional information about these items, contact Ms. Grais at 202-327-8788 or email@example.com.
Contributors are members of or associated with Ernst & Young LLP. Versions of many of these items were previously published as Ernst & Young Tax Alerts.