Get the Maximum QOF Tax Benefits Before We Ring in the New Year
October 17, 2019
By Lisa Knee
There should be a lot of activity at the end of this year as December 31, 2019, is a significant date in the world of Qualified Opportunity Funds (“QOFs”). In order to qualify for the maximum combined tax benefits, an investor must invest in a QOF by December 31, 2019. These tax benefits are deferral, reduction and elimination.
Deferral – The maximum benefit for a taxpayer is comprised first of the deferral of the gain until the earlier of (i) the sale of its interest in the QOF; or (ii) December 31, 2026.
Reduction – A reduction of 10% of the taxpayer’s original deferred gain is provided for if the investment is held for more than five years (prior to December 31, 2026); a 15% reduction is allowed if the investment is held for more than seven years (prior to December 31, 2026).
Elimination – If the investor holds its QOF interest for at least 10 years, there is no tax on the gain realized by the investor at exit.
Not only is December 31, 2019, the last day in which to invest in a QOF to get maximum tax benefits (i.e., the seven-year window for the 15% reduction will not be available after December 31, 2019), it is also the first day for investors with certain capital gains that flow from pass-through entities via Schedule K-1 (i.e., assuming the pass-through entities did not provide the actual date a gain was recognized). A further obstacle arises for investors with capital gains from Section 1231 property, both incurred directly and through pass-through entities. Because capital gains from Section 1231 property are determinable only as of the last day of the taxable year, the proposed regulations provide that the 180-day period—for investing in a QOF—begins on the last day of the taxable year. This gives investors one day to invest if they want to fulfill the seven-year holding requirement for the 15% gain reduction.
We encourage clients to proactively look now if they are considering investing in QOFs, making sure the due diligence period is completed with plenty of time prior to December 31, 2019. We also suggest clients avoid a last-minute rush to complete legal documentation and investing without the benefit of proper planning. There are still inherent risks with any investment, regardless of the tax benefits. We continue to recommend that investors seek opportunities and investments that make economic sense independent of the potential tax benefits.