Investors who’ve filed some of the first tax returns that included qualified opportunity fund (QOF) engagements may get a letter from the IRS that sounds a tad more ominous than it really is.
The agency said Dec. 9 that it has started sending out Letter 6250 and Letter 6251 to tax filers who may need to do a bit more to prove they meet the annual self-certification requirement for QOFs, the investment vehicle by which investments are made into an opportunity zone (OZ).
Letter 6251 refers to Form 8949, used to report sales of capital assets. Letter 6250 refers to filers of Form 8996, required to certify that a corporation or partnership is indeed a QOF and met the investment standard during the given tax year.
That certification is needed to claim the generous capital gains deferrals the Opportunity Zone Program grants in exchange for capital investments in the more than 8,000 census tracts designated as OZs.
The letters from the IRS contain this friendly reminder: "If these taxpayers intended to make a valid deferral election, they can 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."
Is it a cure in search of an ailment?
While it sounds pretty blunt, what’s going on here is that the IRS is apparently sharing its growing pains with participants in opportunity zone investing, in this case offering a documentation cure for rules it’s still seeing in action for the first time.
"What’s really interesting is that it seems that the IRS is providing a cure period for QOFs that messed up the self-certification process by not completing the required forms correctly," says Ashley Tison, a Charlotte, North Carolina, attorney and investor who operates Opportunity Zone Consultants.
After all, the Opportunity Zone Program was only created in 2017 as part of the Tax Cuts and Jobs Act, and the first set of finalized IRS guidelines around it wasn’t issued until December 2019. The first returns including QOF investments would be from tax year 2018, and the IRS letter of Dec. 9 itself says it’s offering filers the opportunity to correct a 2018 self-certification as a QOF."
So, it wouldn’t seem there’s all that many taxpayers involved here, and this is more about growing pains and getting the ground rules straight as opportunity zone investment funds gather cash and momentum heading into 2021.
Not shooting from the hip -- it’s about intent
"It’s not that I want to apologize for the IRS, but I don’t think they’re really shooting from the hip here. I think these are growing pains as all these rules and guidance are still coming out," says Mike Krueger, a partner with Newmeyer Dillion in Walnut Creek, California, who now advises high-net-worth clients in OZ investments.
The IRS's bottom line is to ensure tax filers prove the right intent: that they put a capital gain in a properly certified QOF within the designated time frame for that tax year.
"I’m not a tax professional, but I think that’s what they want to see," Krueger says.
The Millionacres bottom line
As Krueger points out, the IRS and everyone else is working with very little data so far on cash going into QOFs and how the investments are then being properly invested within those zones.
The year ahead should see a lot of that investment taking tangible form inside those zones, and there’ll be growing scrutiny of how those investments return benefits to those communities as well as the investors.
The IRS will be a part of that process, because lawmakers will use its data to assess the tax revenue impact to the federal treasury.
As far as your personal treasury, if you’re a QOF investor, consult a professional.
"That’s my top- and bottom-line advice," Tison says. "If you received this letter, you should definitely reach out to a knowledgeable tax professional for assistance with responding and/or amending your return."