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What is involved in the process of creating an OZ fund and how long does it take?

I understand that if an investment is made in an OZ and the investment is held on to for more than 10 years, the capital gains tax is eliminated upon sale. However, if the funds came from the sale of another property, will the capital gains on the prior sale also be eliminated? For example, Property A was purchased for $1 million in 2000. Property A was sold for $2 million in 2019. Then the $1 million gain is invested in a QOF to purchase Property B in 2019 for $1 million. Then Property B is sold in 2030 for $2 million. In this scenario are capital gains tax completely eliminated for both Property A and Property B?


Answers
  • Valerie Grunduski
    November 25, 2019

    The tax benefits of a QOF investment are in three tiers: the deferral of invested capital gain; the partial exclusion of invested capital gain; the exclusion on gains related to appreciation after a 10-year hold. The gain on Property A (if a capital gain) would be subject to the first two benefits: deferral until filing your 2026 tax return and potential reduction for meeting 5- and 7-year holding periods. Tax on the remaining gain on Property A is still due on that 2026 return. Also, being able to eliminate paying gains tax on Property B requires having your QOF set up properly so that the sale of the property is equivalent to the sale of your investment in the QOF.

  • Erik Kodesch
    November 08, 2019

    Gains would be eliminated for Property B. Gains from Property A would be deferred until 2026 and partially eliminated (15% or 10% depending on whether QOF investment made in 2019 or 2020.)

  • Darci Congrove
    November 05, 2019

    No. The capital gain tax on the sale of property A is deferred until Dec. 31, 2026, at which time the tax on the original gain must be paid. This gain may be reduced by step-ups in basis for holding seven or five years. The seven-year basis step-up will expire as of Dec. 31, 2019, as an investment in a QOF in 2020 will not meet the seven-year timeline before the mandatory tax payment on Dec. 31, 2026. The five-year hold will permit a 10% step-up on the basis of Property A, which means that the taxpayer would pay tax on 90% of the original $1 million gain on property A. Property B, if held for 10 years or more, will not have any tax at the time of sale. The $1 million gain will be completely free of tax.

  • Kim Taylor
    November 05, 2019

    You should plan on 30 days to set up an OZF. Your corporate securities counsel will help you select an appropriate business structure, form your legal entities, and prepare the governing documents. They will also help you select an appropriate securities exemption and draft securities compliance documents such as a private placement memorandum and subscription agreement. Additionally, they will file securities notices with the SEC and state securities agencies.