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If we set aside a reserve to pay the 2026 capital gains tax liability, is that taxable?

We are forming an Opportunity Fund, an LLC with a corporate manager is the plan. If we set aside a reserve to pay the capital gains tax, is that taxable? Can we structure around this?

  • Brad Cohen
    July 18, 2019

    It may cause you to fail the working capital test. Best to set up a line of credit and borrow before time of distribution.

  • Paul Wassgren
    July 15, 2019

    The reserve is not taxable. The issue is whether the reserve will cause the QOF to fail the 90% test. Cash held in excess of 10% of the QOF's total assets will trigger a penalty at the underpayment rate.

  • Matthew Rappaport
    July 15, 2019

    It's impractical to build a reserve because you'll fail your compliance testing. It's not so much about whether the reserve itself would be taxable, but more about the idea of whether the reserve constitutes a bad asset for all the rules under the program. My suggestion would be to have each investor build a reserve him/herself, or alternatively, cash-out refinance assets shortly before the 2026 recognition date arrives.

  • Blake Christian
    July 12, 2019

    The working capital safe harbor is for a 31 month period, so the 2026 tax will extend beyond that period. In addition, the liability is not technically with the QOF, but with the taxpayer who realized the gain, so you will not be able to set up a reserve for the 2026 liability.

  • Matt Campbell
    July 12, 2019

    A reserve set aside would not be taxable within or outside the fund but would not reduce the original cap gain.