The IRS recently updated the Qualified Opportunity Zone (QOZ) FAQ section on their website to include additional guidance on 1231 gains invested before the second set of proposed regulations were released. The second set of proposed regulations (published May 1, 2019) contained rules mandating that the 180-day period for investing in QOZs begins at the end of the tax year, and that only net 1231 gains are eligible for tax deferral when invested in QOZs. This created a potential issue for QOZ investors, as some had already invested 1231 gains in QOZs before the end of their tax year and before netting other 1231 losses.
Significantly, the new IRS FAQ appears to establish that if 1231 gains were invested: 1) prior to the end of the taxpayer’s tax year, 2) prior to the release of the new regulations and 3) were less than their net 1231 gain for the tax year, they are still eligible for the deferral election.
The new guidance reads as follows:
“Q: Before the last day of my 2018 tax year but during the 180-day period beginning with the realization of a section 1231 gain, I invested the amount of that section 1231 gain into a QOF. The amount that I invested was less than my 2018 net section 1231 gain. Can I make a valid deferral election based on that investment, even though proposed regulations say that the 180-day period for my net section 1231 gain began on December 31, 2018?
A: Yes. Under these facts, because your tax year ended before May 1, 2019, your QOF investment can support a valid deferral election. Making that election will not impair your ability consistently to rely on all other aspects of proposed regulations published on May 1, 2019.”
Although not official guidance, this is great news for investors that had invested 1231 gains prior to the guidance noted above. Moreover, it shows the IRS taking a reasonable approach to QOZ investments made in good faith before guidance was available. However, open questions remain regarding:
- Whether taxpayers that invested more than their net 1231 gain before the release of the regulations would still be allowed to defer gain on the actual net 1231 gain portion of the investment and treat the excess as a separate non-qualified investment
- Whether section 1231 gains realized in early 2019 and invested in a QOF before May 1, 2019 would be considered a valid deferral election
If either of these situations apply, you should consult with your tax advisor before taking action.