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The IRS is Issuing Warning Letters Regarding Qualified Opportunity Zone Elections

January 19, 2021

Opportunity Zone investors, you’ll want to read up on a new IRS ruling regarding qualified opportunity zone elections. You could be hearing from the IRS if you don’t comply.

Do you invest in Opportunity Zones? The IRS has begun sending warning letters to investors who have not taken action to self-certify as a Qualified Opportunity Fund (QOF). Here’s how you can avoid scrutiny from the IRS.

What is an opportunity zone?

As we cover in this blog, Opportunity Zones: Invest in your Community while Saving Tax, The Tax Cuts and Jobs Act (TCJA) introduces a new investment vehicle called Opportunity Funds which help direct resources to low income communities, known as Qualified Opportunity Zones, to help investors avoid capital gains tax.

Opportunity zones are designed to spur economic development and job creation in struggling communities. Governors in every state designate opportunity zones that are deemed economically distressed, so investments in these zones are potentially eligible for preferential tax treatment.

What is a QOF?

If you timely invest capital gains into an qualified opportunity zone fund (QOF), you may be able to defer or eliminate the tax that would come with the sale of your current investments. A QOF is the intermediary between the investor and the actual investments in the opportunity zones. A QOF may be set up as either a partnership or a corporation which must invest in “qualified opportunity zone property”. The fund must hold at least 90% of its assets in “qualified opportunity zone property”.

An OZ investment generally needs to be made within 180 days of the realization of the capital gain in order to be eligible for deferral and potential exclusion of the gain from your income.

What paperwork is required to establish a QOF?

A QOF must self-certify with the IRS by filing Form 8996 with its timely filed tax return for each year the fund will operate as a QOF. This form will also be where the QOF certifies it meets the 90% requirement.

What do these warning letters say?

Any taxpayer that attached or indicated that they attached that form to their return may receive Letter 6250. This letter lets them know that they may need to take additional steps to meet the annual self-certification requirements.

If the QOF that receives this letter fails to take necessary steps to self-certify the IRS may refer the returns for examination. Also, investors who made an election to defer gains after investing in the QOF may also be subject to examination.

Taxpayers may also receive an IRS Letter 6251 if they made an election to defer their capital gains by investing in a QOF and did not properly follow all of the instructions for Form 8949 that outlines the procedures to defer gains. They may also receive a letter if they do not appear to have an eligible gain that would allow the taxpayer to make a valid deferral.

Failure to act and respond to the letter could cause a taxpayer’s investment in the QOF to not be qualified or eligible for deferral. It is also possible that the IRS may refer the returns for examination which could result in additional taxes, interest and penalties on gain not deferred correct.

Did you get a letter? Please contact us so that we can assist and help you navigate these Qualified Opportunity Zone letters.

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