Be on the Alert for IRS Inquiries Regarding QOF Investment
January 15, 2021
By Lisa Li
The 2017 Tax Cuts and Jobs Act designated certain census tracts as qualified opportunity zones (“QOZs”) and provided tax benefits for investment in those QOZs through investment in qualified opportunity funds (“QOFs”).
Compliance with applicable rules governing QOFs requires (i) a QOF to file Form 8996, Qualified Opportunity Fund, annually with its partnership or corporation income tax return; and (ii) investors in QOFs to annually file Form 8997, Initial and Annual Statement of Qualified Opportunity Fund (QOF) Investments. Investors should also file Form 8949, Sales and Other Dispositions of Capital Assets, to elect to defer capital gains invested in a QOF. Forms 8997 and 8949 must be timely filed with investors’ income tax returns.
The IRS is strictly enforcing the above reporting requirements. On December 9, 2020, the IRS announced (IR-2020-274) that it “has started sending letters to taxpayers that may need to take additional actions related to QOFs.” QOFs that filed Form 8996 with their tax return may receive Letter 6250, Self-Certifying as Qualified Opportunity Fund (QOF), from the IRS advising that if they intended to self-certify as a QOF, they may need to take additional action to meet the annual self-certification requirement. The letter states that to correct a 2018 self-certification as a QOF, recipients of the letter should file an amended return or an administrative adjustment request (“AAR”). If an entity that receives the letter fails to take action to self-certify as a QOF, the IRS may refer its tax account for examination. Investors who made an election to defer tax on eligible gains invested in that entity may also be subject to examination for an invalid election.
For QOF investors, “taxpayers may receive Letter 6251, Reporting Qualified Opportunity Fund (QOF) Investments, notifying them they may not have properly followed the instructions for Form 8949, Sales and Other Dispositions of Capital Assets, or do not appear to have an eligible gain that would enable them to make a valid deferral election for gains invested in a QOF.” Investors may need to file an amended return or an AAR.
“Failure to act will mean those who received the letter may not have a qualifying investment in a QOF, and the IRS may refer their tax accounts for examination. This may result in letter recipients owing taxes, interest and penalties on gains that were not properly deferred.”
Therefore, QOFs and QOF investors should pay serious attention to these letters and prepare to face possible scrutiny from the IRS. Additionally, QOFs and QOF investors should carefully file Forms 8996, 8997 and 8949 in compliance with the IRS requirements.