"Virginia, Joe, Laura, and Ishmael formed a new partnership in January 2019 for the purposes of operating as a QOF. It chooses April 2019 as its first month for certification."
So begins Example 2 on page 4 of the seven pages of instructions the IRS released in January 2020 for Form 8996, one of several that taxpayers who are including opportunity zone investments in their annual returns will encounter.
QOF stands for qualified opportunity fund, a pool of money put together for investing in qualified opportunity zones (OZs). Those are low-income, otherwise-depressed census tracts -- rural, small town, and urban alike -- that earned that designation after Congress created the opportunity zone program as part of the 2017 Tax Cuts and Jobs Act.
Proving it's a qualified investment that merits the tax incentive
The program offers the QOF investor such benefits as tax deferrals, step-up basis for capital gains, and capital gains exclusion, providing an inviting safe harbor for profits from prior sales while investing in tangible property in areas that can really use the attention.
In that sense, opportunity zone investing is akin to long-standing programs like 1031 exchanges and the historic tax credit, both of which establish an investment standard around the level of substantial improvement, for example.
The IRS only issued its first set of final opportunity zone rules on December 19, 2019, in the form of a 544-page document. Meanwhile, billions of dollars have poured into qualified opportunity funds from individual and institutional investors alike, including banks.
Understanding why Form 8996 was created
The IRS says a corporation or partnership will use Form 8996 to certify it's organized to invest in a QOZ property, including a QOZ business. "In addition, a corporation or partnership files Form 8996 annually to report that the QOF meets the 90% investment standard of section 1400Z-2 or to figure the penalty if it fails to meet the investment standard," the agency says on the first page of the instructions.
Form 8996 is a new reporting requirement, introduced in time for the 2019 tax year with the intent of tracking how well the opportunity zone program is working.
"We want to understand where opportunity zone investments are going and strengthening the economy so that investors and communities can learn from the successes of this bipartisan, pro-growth policy," Treasury Secretary Steven Mnuchin said when Form 8996 was introduced.
Actually, the Form 8996 released in January is a new version. The big difference from the IRS's first version, circa October 2019, is that it requires the QOF investor to provide more details about how each qualifying investment earned the tax benefit.
According to tax attorneys Maureen Flahive and David Jackson of Bricker & Eckler in Columbus, Ohio: "Newly added Part V is for QOZ business property that the QOF directly owned or leased, and newly added Part VI is for investments in qualified opportunity zone stock or partnership interests with values apportioned to census tracts based on where the tangible property of the QOZ business is located."
Not ideal for DIYers -- unless you're a CPA or just really confident
Form 8996 is not the only additional IRS form qualified opportunity fund investors get to wrangle with each tax year. There are also Forms 8949 and 8997 that cover the sale of capital assets and reporting QOF investments, respectively.
This doesn't seem like work fit for amateurs, especially as the rules and guidance for federal income tax purposes seem to be rapidly evolving for this very new program.
Flahive and Jackson, in their blog post, include this caveat: "Note that this information is intended only as a high-level summary of the reporting obligations applicable to QOF investors and QOFs. These taxpayers should consult with their tax advisors and preparers regarding compliance with the reporting requirements related to their QOF investments."
Probably not a bad idea. Unless you have a good comfort level in dealing with concepts like leased tangible property, eligible gain, and working capital assets, it might be best to let a professional handle that work.
Meanwhile, those seven pages of instructions that take you line by line through filling out Form 8996 concludes: "If you have suggestions for making this form simpler, we would be happy to hear from you. See the instructions for your income tax return."