To operate a business in a Qualified Opportunity Zone (QOZ), certain criteria must be met to be designated as a Qualified Opportunity Zone Business (QOZB). Opportunity Zones were established under the Tax Cuts and Jobs Act (TCJA) of 2017.
The legislative intent behind this enacted tax code was to stimulate economic growth by incentivizing new, old, small, or even large organizations to establish their businesses within a designated zone. What is the incentive? In exchange for investing in these locations, taxpayers are offered deferred tax benefits based on the duration of time the business is owned or leased within the designated QOZ.
There are currently 8,764 designated opportunity zones. The governors of each state and territory nominated opportunity zone locations that have been approved by the US Treasury as qualified opportunity zones. Section 13823 of the TCJA includes section 1400Z-1, which identifies these specific census tracts as eligible qualified opportunity zones.
How to Claim and File a QOZB
Once an individual has found a Qualified Opportunity Fund (QOF) that has filed an annual Form 8996 and meets other requirements, such as 90% investment test and reporting disposal of equity interest through Form 1099, the QOF has to invest into a Qualified Opportunity Zone Business (QOZB). The QOZB does not have to claim or file anything, it is up to the QOZB and QOF to ensure that the business meets all necessary requirements.
Special Considerations for Deferral of Capital Gain
The individual investor is able to claim deferrals on both capital gains and gains recognized in Section 1231 of the Internal Revenue Code. Section 1231 refers to the sale of a property used in a trade or business, which is eligible for special tax treatment when the property is held for at least one year. These gains are reported in Form 4797. There is a catch with these eligible gains. They must have been recognized for federal income tax purposes prior to January 1, 2027, and have not been processed as a transaction with a related individual. They must also have been made in a timely manner, within 180 days of the sale where the capital gains were collected, in exchange for equity interest in a selected QOF.
Non-cash property may be exchanged in the QOF for equity interest, however, the amount of gain may only be recognized in part, limited to the basis of the property regardless if the value of the property is greater. When satisfying the above capital gains requirements, the individual may claim the deferral for the taxable year the gain would have been recognized, if it was not deferred.
Individuals have options when filing, and some may opt to elect part of their capital gains when filing a federal income tax return instead of deferring their capital gains entirely. Many individual investors encounter trouble when reporting the deferred gain. If not reported correctly, investors may not recognize these tax benefits as they were designed, or may find themselves flagged for audit. Form 8949: Sales and other Dispositions of Capital Assets has specific instructions for reporting gain deferrals. Under this form, “How To Report an Election To Defer Tax on Eligible Gain Invested in a QOF” is included, detailing required steps, as listed below:
“Report the deferral of the eligible gain on its own row of Form 8949 in Part I with box C checked or Part II with box F checked (depending on whether the gain being deferred is short term or long term). If you made multiple investments in different QOFs or in the same QOF on different dates, use a separate row for each investment. If you invested eligible gains of the same character (but from different transactions) on the same date into the same QOF, you can group those investments on the same row. In column (a), enter only the EIN of the QOF into which you invested. In column (b), enter the date you invested in the QOF. Leave columns (c), (d), and (e) blank. Enter code “Z” in column (f) and the amount of the deferred gain as a negative number (in parentheses) in column (g).”
Filing Similarities Between QSBS and QOZB
QOZB and QSBS are similar in some ways, the first is how businesses that meet the requirements established in Section 1202 and qualify as QSBS are not required to file documentation with the IRS. Similarly, QOZBs that meet their requirements under 1400Z2(d) are also not required to file anything. However, both QSBS businesses and QOZBs need to follow the legislative requirements, and investors need to ensure all criteria are met.
The major difference is that individuals claiming QSBS tax incentives have no duty to file a specific report; rather, they should have documentation that helps provide the IRS that said capital gains were derived from QSBS. In this case, QOZB investors would have to ensure that the QOF they invested in meets all the requirements and that the QOZB that the fund invested in has met all the requirements for a QOZB to be qualified. Furthermore, QOZB investors must file Form 8949 to elect to defer tax on eligible gain invested in a QOF.
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