Qualified Opportunity Fund (QOF) : New Way to Defer Capital Gains

Invest in qualified opportunity fund (QOF) to Defer Capital Gains

 Anyone having Long term capital gains or short term capital gains can now save on tax by investment in qualified opportunity fund (QOF), which was created under the new code Sections 1400Z-1 and 1400Z-2 of the Tax Cuts and Job Act . This is in addition to  Section 1031 exchange rule under which one can defer tax on capital gains now!The purpose of the introduction of Qualified Opportunity Funds is to promote investment in certain economically distressed communities in Qualified Opportunity Zones. What is Qualified Opportunity Funds? Basically, the QOF or Qualified Opportunity Fund is a special investment vehicle, organized as a corporation or a partnership for the purpose of investing in properties after December 31, 2017, within qualified opportunity zones.

Who can invest in QOF and defer tax on gains?

Anyone who earned

  1. Capital gain -either short-term, long-term, ordinary gains
  2. From selling or exchanging any non-QOF property to an unrelated party

Conditions to fulfil to Get Tax Benefits?

The conditions are basically time limit to invest in QOF and the quantum of investment decides how much deferment of capital gains possible. So here are the two main conditions

  1. Investment in QOF must be within 180 days of the sale or exchange of the assets.
  2. The amount of capital gains which is not reinvested in QOF is taxable in the sale year.
  3. Only one election may be made with respect to a given sale or exchange.

Readers should note that it is not the sale amount but the gains that should be invested. For example , if your sale value is $ 1,000,000 and capital computed is $ 500,000, then $ 500,000 is the amount that will be taken for determining the amount of deferment of capital gains.

How long Gain is deferred?

You can defer the tax on gains till the date of sale of  Qualified Opportunity Fund investments or December 31, 2026 – whichever is earlier.

What happens when I sale QOF?

When you sale QOF investment, the least of the following shall be taxable in the year of sale of QOF

a. The deferred gain
b. The fair market value of the investment, as determined at the end of the deferral period, reduced by the taxpayer’s basis in the property.

Please note that if you hold a QOF investment for 10 years or more before selling it , you can elect to permanently exclude the gain from the sale that is in excess of the originally deferred gain

How is the basis determined in case of QOF?

Since the basis in property reduces taxable gains, it is important to understand it. The different basis are computed based on holding period of QOF investments. The basis of a QOF that is purchased with a deferred gain is $0 unless it is held for more 5 years .or more, then one of the following rules shall apply.

(a) If the investment is held for 5 years, the QOF’s basis increases from $0 to 10% of the deferred gain.
(b) If the investment is held for 7 years, the QOF’s basis increases from $0 to 15% of the deferred gain.
(c) If the investment is held for 10 years, the QOF’s basis increases at the option of taxpayer to the property’s fair market value

(d) If you hold the QOF till  December 31, 2026, the original deferred gain must be included as gross income on that taxpayer’s 2026 return; the basis of the investment will then be increased by the amount of this included gain.

Robert
Sold property on  1st Sept. 2018 for $ 3 00,000
Resulting Gain $100,000
Investment in QOF within 180 days $100,000 ( thus gain is deferred)
On 1st May 2027, sold QOF for $150,000
Basis to enhance QOF value by  15% because the QOF was held by Robert for more than 7 years $100,000 x 15%= $15000
Taxable gains in the year of sale that must be included in the tax return ( This is because QOF sale value is more than deferred gains) = $135,000 ( $150,000 minus $15000)

 

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