How the Final Regulations on Qualified Opportunity Funds Come Out on Trust and Estate Related Issues

By Kevin Matz

On December 19, 2019, the U.S. Department of Treasury and the Internal Revenue Service (collectively, “the Treasury Department”) released long-awaited final regulations on qualified opportunity funds (“QOFs”) (the “final regulations”). The final regulations come on the heels of two tranches of proposed regulations, which generated more than 300 comment letters from organizations and other interested parties.  The American College of Trust and Estate Counsel (ACTEC) submitted two separate comment letters to the Treasury Department on trust and estate related issues, the second of which was dated June 27, 2019.  This article provides a scorecard on how the Treasury Department ultimately came out on trust and estate related issues that pertain to QOFs.

On December 19, 2019, the U.S. Department of Treasury and the Internal Revenue Service (collectively, “the Treasury Department”) released long-awaited final regulations on qualified opportunity funds (“QOFs”) (the “final regulations”):  https://www.irs.gov/pub/irs-drop/td-9889.pdf  The final regulations come on the heels of two tranches of proposed regulations, which generated more than 300 comment letters from organizations and other interested parties.[1]  The American College of Trust and Estate Counsel (ACTEC) submitted two separate comment letters to the Treasury Department on trust and estate related issues, the second of which was dated June 27, 2019 (the “ACTEC Comment Letter” or the “Comment Letter”):  https://www.actec.org/assets/1/6/Comments_on_Proposed_Regulations_on_Qualified_Opportunity_Funds_under_Code_Section_1400Z-2.pdf [2]  

Opportunity Zones

The 2017 Tax Act included in section 1400Z-2 a new tax incentive provision that is intended to promote investment in economically-distressed communities, referred to as “Opportunity Zones.”  Through this program, investors can achieve the following three significant tax benefits:

1.   The deferral of gain on the disposition of property to an unrelated person generally until the earlier of the date on which the subsequent investment is sold or exchanged, or December 31, 2026, so long as the gain is reinvested in a QOF within 180 days of the property’s disposition;

2.   The elimination of up to 15% of the gain that has been reinvested in a QOF provided that certain holding period requirements are met;[3] and

3.   The potential elimination of tax on gains associated with the appreciation in the value of a QOF, provided that the investment in the QOF is held for at least ten years.

An Opportunity Zone is an economically-distressed community where new investments, under certain conditions, may be eligible for preferential tax treatment.  Localities qualify as Opportunity Zones if they have been nominated for that designation by the state and that nomination has been certified by the Internal Revenue Service (IRS).  All Opportunity Zones were designated, as of June 14, 2018, and are available on the U.S. Department of Treasury website.  See https://www.cdfifund.gov/Pages/Opportunity-Zones.aspx

A QOF, in turn, is an investment vehicle that is established as either a domestic partnership or a domestic corporation for the purpose of investing in eligible property that is located in an Opportunity Zone and uses investor gains from prior investments as a funding mechanism.   

To become a QOF, the entity self-certifies itself.  The entity must meet certain requirements, in particular a general requirement that at least 90% of its assets be “qualified opportunity zone property” used within an Opportunity Zone, but no approval or action by the IRS is required.  To self-certify, the entity completes Form 8996, and then attaches that form to the entity’s timely-filed federal income tax return for the taxable year (taking into account extensions).[4]

Summary of ACTEC’s Positions

In its Comment Letter, ACTEC took the following five (5) primary positions:

1. Further consideration should be given concerning the income tax consequences resulting from the death of a taxpayer who has deferred gain through a timely reinvestment of gain in a QOF to provide relief for successors-in-interest

2. The Proposed Regulations should be revised to provide that a donor’s gift of an interest in a QOF generally should not be an event that causes inclusion of deferred gain

3.  Clarification should be provided concerning grantor trusts, including to confirm that a transaction with a grantor trust that is disregarded for income tax purposes pursuant to Rev. Rul. 85-13 should not be considered a sale or exchange of an interest in a QOF

4.  Further relief to extend the 180-day period for rollover of gain to a QOF should be granted to partners, S corporation shareholders and beneficiaries of estates and trusts because they may not receive a Schedule K-1 indicating capital gains until more than 180 days after the end of the taxable year

5.  Guidance is requested to clarify the availability of the step-up in basis upon death to the extent that the value of the QOZ investment at death exceeds the deferred gain amount

The Treasury Department agreed with ACTEC on its 3rd and 4th positions set forth above, but declined to adopt ACTEC’s 1st, 2nd and 5th positions in the final regulations.  The two positions for which the Treasury Department agreed with ACTEC, and adjusted its final regulations (i.e., the 3rd and 4th positions set forth above), are summarized below: 

  • Extended investment period for certain gains from entities that are reported on a Schedule K-1 — Partners in a partnership, shareholders of an S corporation, and beneficiaries of estates and non-grantor trusts now have the option to start the 180-day investment period on the due date of the entity’s tax return, not including any extensions.  This change addresses taxpayer concerns about potentially missing investment opportunities due to an owner of a business entity receiving a late Schedule K-1 (or other form) from the entity.[5]
  • Non-gift transactions with grantor trusts also will not constitute inclusion events – The Treasury Department has now clarified in the final regulations that a broad array of transactions between a grantor and that grantor’s grantor trust that involve QOFs will not constitute an inclusion event.  The proposed regulations had limited this exception solely to gifts to grantor trusts.  The final regulations expand the scope of this exception to inclusion event treatment to include other non-recognition transactions as well between a grantor and that grantor’s grantor trust, and as such will also embrace sales to grantor trusts, in-kind note payments from a grantor trust to the grantor, the grantor’s exercise of the power to substitute assets with a grantor trust, and distributions of QOF interests to the grantor from a grantor retained annuity trust (“GRAT”).[6] 

We now turn to review the Treasury Department’s disposition of ACTEC’s comments in greater detail.

1.  Income in Respect of a Decedent (“IRD”) Concepts under IRC Section 691 Apply Upon the Death of a Taxpayer Who Has Deferred Gain Through a Timely Reinvestment of Gain in a QOF

Section 1400Z-2(e)(3) provides that “[i]n the case of a decedent, amounts recognized under this section shall, if not properly includible in the gross income of the decedent, be includible in gross income as provided by section 691.”  This statutory provision raises questions concerning the appropriate treatment of the deferred gain where a person who has rolled over gain through a timely investment in a QOF dies prior to December 31, 2026 without having previously disposed of the QOF investment.

The final regulations resolved these questions consistent with section 691, which sets forth the rules that apply to a person’s receipt of income in respect of a decedent (“IRD”).  IRD refers to income earned by a decedent who was a cash basis taxpayer prior to his or her death, but that is not properly includible in  income until after the decedent’s death.  IRD is not reportable on the decedent’s final income tax return.  Rather, it is reportable by the recipient of the IRD item (e.g., by the decedent’s estate or some other person).[7]  One very significant aspect of IRD is that section 1014(c) denies a step-up in basis at death to items of IRD.[8] 

Following the approach taken by the proposed regulations, the final regulations state, as a general rule, that “a transfer of a qualifying investment by reason of the taxpayer’s death is not an inclusion event,”[9] and provides the following examples:

(A)  A transfer by reason of death to the deceased owner’s estate;

(B)  A distribution of a qualifying investment by the deceased owner’s estate;

(C)  A distribution of a qualifying investment by the deceased owner’s trust that is made by reason of the deceased owner’s death;

(D)  The passing of a jointly owned qualifying investment to the surviving co-owner by operation of law; and

(E)  Any other transfer of a qualifying investment at death by operation of law.[10]

The final regulations then specify that the following transfers are not considered transfers by reason of the taxpayer’s death, and thus are inclusion events, with the amount recognized to be includible in the gross income of the transferor as provided in section 691.

(A)  A sale, exchange or other disposition by the deceased taxpayer’s estate or trust, other than a distribution described in items (A) – (E) above.

(B)  Any disposition by the legatee, heir, or beneficiary who received the qualifying investment by reason of the taxpayer’s death; and

(C)  Any disposition by the surviving joint owner or other recipient who received the qualifying investment by operation of law on the taxpayer’s death.[11]

Of particular relevance, section 1400Z-2(b)(2) contains a special rule that caps the amount of the gain so as not to exceed the fair market value of the investment as of the date that the gain is included in income.  It provides as follows:

1400Z-2(b)(2) AMOUNT INCLUDIBLE.

1400Z-2(b)(2)(A) IN GENERAL.— The amount of gain included in gross income under subsection (a)(1)(A) shall be the excess of—

1400Z-2(b)(2)(A)(i) the lesser of the amount of gain excluded under paragraph (1) or the fair market value of the investment as determined as of the date described in paragraph (1), over

1400Z-2(b)(2)(A)(ii) the taxpayer’s basis in the investment.

In addition, the final regulations contain a special rule for determining the amount includible for partnerships and S corporations that should be carefully considered taking into account the facts and circumstances presented.  Specifically, Treas. Reg. §1.1400Z2(b)-1(e)(4) provides that, in the case of an inclusion event involving a qualifying investment in a QOF partnership or S corporation, or in the case of a qualifying investment in a QOF partnership or S corporation held on December 31, 2026, the amount of gain included in gross income is equal to the lesser of

i) The product of–

(A) The percentage of the qualifying investment that gave rise to the inclusion event; and

(B) The remaining deferred gain, less any basis adjustments pursuant to section 1400Z-2(b)(2)(B)(iii) and (iv); or

ii) The gain that would be recognized on a fully taxable disposition at fair market value of the qualifying investment that gave rise to the inclusion event.[12]

In its Comment Letter, ACTEC set forth its proposal to ameliorate certain harsh tax consequences that may befall a beneficiary who inherits a QOF interest but may lack the financial wherewithal to pay the tax come December 31, 2026.  ACTEC proposed that the better approach would be to allow the successor-in-interest to be able to continue to defer the gain under section 691 (including after December 31, 2026) until the time that the successor-in-interest disposes of its interest in the QOF.  Such disposition could be governed by the principles of section 691 that apply with respect to the disposition of IRD.  By adopting this rule, the successor-in-interest could be protected from inheriting a potentially significant tax liability without having the liquidity to pay for it.  ACTEC also suggested an alternative approach to permit the executor an election to treat death as an inclusion event, thereby making the decedent’s estate liable for the payment of the deferred tax.

The Treasury Department declined to adopt ACTEC’s proposal, however, asserting that such would be inconsistent with the statute, which requires that December 31, 2026 be the outside date for an inclusion event.[13]  The final regulations further clarify that the tax on the decedent’s deferred gain is the liability of the person in receipt of that interest from the decedent at the time of an inclusion event.[14] 

Accordingly, estate planners need to consider strategies to provide liquidity on this so-called “judgment day” of December 31, 2026 where the taxpayer dies prior to that date.  This may include life insurance – perhaps held through an irrevocable life insurance trust of which the person who inherits the QOF interest under the insured’s estate plan is a primary beneficiary.

2.  The Final Regulations Confirm that a Donor’s Gift of an Interest in a QOF Will Be an Inclusion Event for the Deferred Gain Unless the Gift is Made to a Grantor Trust

Section 1400Z-2(b)(1) provides for the deferral of gain that is invested in opportunity zone property until the earlier of “the date on which such investment is sold or exchanged, or December 31, 2026.”  (emphasis added)  A gift of an interest in a QOF is generally neither a sale nor an exchange.[15]  ACTEC accordingly requested that guidance be provided that a gift of an interest in a QOF should not be considered a sale or exchange for purposes of section 1400Z-2(b), provided that the gift is not otherwise treated by the tax law as a taxable disposition for income tax purposes.[16]

The second set of QOF Proposed Regulations took a different approach, however, and treated a gift (other than to a grantor trust) as an inclusion event, citing the legislative history as the basis for this conclusion.  The Treasury Department has retained that approach in the final regulations, which continue to provide that a taxpayer’s transfer of a qualifying investment by gift, whether outright or in trust, is an inclusion event, regardless of whether that transfer is a completed gift for Federal gift tax purposes, and regardless of the taxable or tax-exempt status of the donee of the gift.  The final regulations continue to provide an exception to this general rule in the case of grantor trusts,[17] as Treas. Reg. § 1.1400Z2(b)-1(c)(5)(i) provides that if the owner of a qualifying investment contributes it to a trust and, under the grantor trust rules, the owner of the investment is the deemed owner of the trust, the contribution is not an inclusion event.  In addition, Treas. Reg. § 1.1400Z2(b)-1(c)(5)(ii) addresses changes in grantor trust status, and states that a change in the status of a grantor trust, whether the termination of grantor trust status or the creation of grantor trust status, is an inclusion event but then provides an exception to inclusion event treatment where grantor trust status terminates as a result of the death of the owner of a qualifying investment with the provisions of Treas. Reg. § 1.1400Z2(b)-1(c)(4) applying to distributions or dispositions by the trust.

According to the preamble to both the Second Set of Proposed Regulations and the final regulations, the Treasury Department’s position that gifts (other than to grantor trusts) constitute an inclusion event is warranted in light of the legislative history – specifically, the conference report.  ACTEC’s Comment Letter carefully analyzed the conference report and concluded that there does not appear to be any indication of Congressional intent to give a meaning to the phrase “sale or exchange” contained in section 1400Z-2(b)(1) that is expressly contrary to its unambiguous language.  The Treasury Department, however, declined to adopt ACTEC’s position in the final regulations[18] – so this is an issue that may need to be resolved in the courts. 

The Treasury Department also declined ACTEC’s request to adopt a rule to prevent transactions between spouses for which the nonrecognition provisions of section 1041 apply from being treated as an inclusion event.[19]

3.  The Final Regulations Clarify that Transactions with Grantor Trusts Are Not Inclusion Events

The Treasury Department agreed with the changes and clarifications that ACTEC requested concerning grantor trusts, specifically with respect to the income tax consequences that would result from a transaction between a grantor and a grantor trust where Rev. Rul. 85-13[20] would otherwise cause it to be a non-recognition event for income tax purposes.

The grantor trust rules are set forth in sections 671 through 679.  These rules generally provide that if certain rights or powers are retained, the grantor (or other individual treated as the “owner” for income tax purposes) will be required to include all (or a portion) of the gains, losses, deductions and credits attributable to the trust on his or her own personal income tax return.  Consistent with the grantor trust rules, it should not matter whether the gain that is sought to be deferred, or the funds that are subsequently invested in the QOF, belong to the taxpayer or to such taxpayer’s grantor trust.  ACTEC requested clarification to this effect, and the Treasury Department agreed and made this requested adjustment in the final regulations.[21]

In addition, pursuant to Rev. Rul. 85-13, transactions between a grantor and such person’s grantor trust are disregarded for federal income tax purposes. 

The proposed regulations had provided that if the owner of a qualifying investment contributes it to a trust and, under the grantor trust rules, the owner of the investment is the deemed owner of the trust, the contribution is not an inclusion event.  The preamble to the proposed regulations suggested that the word “contributes” may have been intended to solely connote a gift, and not other non-gift transactions between a grantor and a grantor trust. 

In its Comment Letter, ACTEC noted that the scope of Rev. Rul. 85-13 extends well beyond gifts and embraces all transactions between the grantor and such grantor’s grantor trust during the grantor’s lifetime and, as such, could include (i) the creation of a grantor trust funded with a gift of a QOF interest, (ii) a sale of a QOF interest between the grantor or the grantor trust, (iii) the exercise of a so-called “swap power” described in section 675(4)(C) to reacquire the trust corpus by substituting other property of an equivalent value, where such power is exercisable in a nonfiduciary capacity without the approval or consent of any person in a fiduciary capacity, or (iv) a transfer by a grantor trust of a QOF interest to a grantor (for instance, in satisfaction of an annuity interest or an installment payment due under a promissory note).  Accordingly, a sale, swap or other non-gift transaction of an interest in a QOF between a grantor and such person’s grantor trust should not be considered a sale or exchange of an interest in a QOF, and therefore should not trigger the recognition of gain, and ACTEC’s Comment Letter requested that this be confirmed as well. 

The Treasury Department agreed with ACTEC on this, and clarified that none of these transactions (including transfers from the grantor trust to its deemed owner) will constitute inclusion events.[22]  The Treasury Department further clarified in the final regulations that transactions between a grantor and such person’s grantor trust does not start a new holding period for purposes of the basis adjustments that can result from holding an interest in a QOF for five or seven years, or for purposes of the potential elimination of tax on gains associated with the appreciation in the value of a QOF that has been held for at least ten years.[23]

ACTEC also commented that Prop. Reg. § 1.1400Z2(b)-1(c)(5)(ii), which addressed inclusion events related to grantor trusts, was too broad and could potentially be read to apply to a taxpayer that owned a QOF investment and was the owner of a grantor trust, regardless of whether the grantor trust itself held a QOF investment.  The Treasury Department agreed with this comment, and the final regulations clarify that this provision applies to a change in the status of a grantor trust that owns a qualifying investment in a QOF.[24]

4.   Relief is Granted to Provide Partners of a Partnership, Shareholders of an S Corporation, and Beneficiaries of Decedents’ Estates and Non-Grantor Trusts with the Option to Treat the 180-Day Period as Commencing Upon the Due Date of the Entity’s Tax Return, Not Including Any Extensions 

Section 1400Z-2(a)(2) provides that, to qualify for the tax benefits that can be derived through an investment in a QOF,  the taxpayer’s rollover of gain to the QOF must occur during the 180-day period beginning on the date of the sale or exchange that gives rise to such gain.  The final regulations followed the proposed regulations on this, and provide some relief to the above rule in the case of certain passthrough entities including with respect to beneficiaries of trusts and estates. 

  • First, the final regulations include special provisions by which gain recognized by a partnership may flow through to the partners and be reinvested by the partners in a QOF (except to the extent the partnership elects to rollover the gain itself).[25] 
  • Second, there is the potential for partners to have an increased period during which to reinvest gain in a QOF.   The partnership’s 180-day period begins on the date of its sale, but if the gain flows through to the partners, the partners’ 180-day period generally begins on the last day of the partnership’s taxable year.[26]

The proposed regulations stated that rules analogous to the partnership and partner guidance indicated above apply to other pass-through entities (including S corporations, decedents’ estates, and trusts) and to their shareholders and beneficiaries.[27]  In addition, the preamble to the proposed regulations requested comments concerning whether taxpayers would benefit from further clarification in the context of S corporations, decedents’ estates and trusts.

ACTEC took the Treasury Department up on its invitation, and in its Comment Letter expressed concern about the potential for an “information gap” to exist between the partnership, S corporation, executor and trustee, on the one hand, and the partner, S corporation shareholder, and beneficiary on the other hand.  The Schedule K-1 is the mechanism for a partnership, S corporation, estate or trust to report tax attributes – including capital gains – not only to the Internal Revenue Service, but also to the partner, S corporation shareholder or beneficiary, as the case may be.  If the tax return for the passthrough entity is placed on extension, there will be a substantial possibility that the Schedule K-1 will not be issued until more than 180 days after the end of the tax year, at which point the opportunity to roll over gain to a QOF will have been lost.[28] 

  • The Treasury Department agreed with ACTEC’ssuggestions.  As a result, the final regulations provide partners of a partnership, shareholders of an S corporation, and beneficiaries of decedents’ estates and non-grantor trusts with the option to treat the 180-Day period as commencing upon the due date of the entity’s tax return, not including any extensions.[29] 

5.  The Treasury Department Clarifies that a Step-Up in Basis under Section 1014 is Not Available to Adjust the Basis of an Inherited Qualifying Investment to its Fair Market Value as of the Deceased Owner’s Death

ACTEC also requested clarification in its Comment Letter concerning the availability of the step-up in basis upon death to the extent that the value of the QOZ investment at death exceeds the deferred gain amount.  As ACTEC pointed out, Section 1400Z-2(e)(3) provides that, “[i]n the case of a decedent, amounts recognized under this section shall, if not properly includible in the gross income of the decedent, be includible in gross income as provided by section 691.” (emphasis added)  According to ACTEC, the implication of this statutory provision is that to the extent a decedent’s investment in a QOF does not consist of “amounts recognized under this section,” such portion, upon the taxpayer’s death, should not constitute income in respect of a decedent (IRD) under section 691 (so as to result in a denial of a step-up in basis upon death under section 1014(c)) and should therefore be eligible to receive a step-up in basis upon death under section 1014(a).  This matter takes on additional practical complexity in light of section 1400Z-2(b)(2), which as discussed above, contains a special rule that caps the amount of the gain so as not to exceed the fair market value of the investment as of the date that the gain is included in income.[30]

The Treasury Department, however, declined to adopt ACTEC’s suggestion that there should be a partial step-up in basis upon death to the extent that the value of the QOZ investment at death exceeds the deferred gain amount.  In the view of the Treasury Department, section 1400Z-2(b)(2)(B) applies with regard to the recipient’s basis in the qualifying investment.  This section provides that the basis of the qualifying investment is zero, with specified increases for gain recognized at the time of an inclusion event and for qualifying investments held for at least five or seven years.  This provision governs without regard to section 1014.  Because a taxpayer’s basis in its qualifying investment is zero except as otherwise provided in section 1400Z-2(b)(2)(B) and section 1400Z-2(c) (which concerns qualifying investments held for at least 10 years), the Treasury Department determined that section 1014 does not apply to adjust the basis of an inherited qualifying investment to its fair market value as of the deceased owner’s death.[31]

6.  Additional Items

The following additional aspects of the final regulations are particularly relevant to estate planners:

A.  No Inclusion Event on Contributions of QOF Interests to Partnerships

Consistent with the proposed regulations, the final regulations provide that contributions of QOF interests to entities taxed as partnerships that are not taxable transactions under section 721(a) are not inclusion events.[32]

B.  Meanwhile, Contributions of QOF Interests to Corporations Are Inclusion Events

In contrast, contributions of QOF interests to entities taxed as C corporations or S corporations that would otherwise be tax-free under section 351 are inclusion events.[33]

C.  Transfers of Interests in Partnerships that Hold QOF Interests Are Inclusion Events

In addition, transfers of interests in partnerships that hold QOF interests (i.e., indirect interests in QOFs) are inclusion events[34] (unless they are to grantor trusts).  The final regulations provide that the inclusion event rules generally “apply to transactions involving any direct or indirect partner of the QOF to the extent of that partner’s share of any eligible gain of the QOF.”[35]  In addition, page 48 of the preamble to the final regulations notes that “[a]n inclusion event is a transaction that reduces or terminates the QOF investor’s direct (or, in the case of partnerships, indirect) qualifying investment for federal income tax purposes . . . .”[36]

D.  Meanwhile, Transfers of Interests in Corporations that Hold QOF Interests Are Not Inclusion Events

In contrast, transfers of interests in corporations that hold QOF interests are not inclusion events.  As noted above, the final regulations provide that the inclusion event rules generally apply to transactions involving any direct or indirect partner of the QOF.[37]  No similar rule applies to C corporations or S corporations.[38]

In the case of S corporations, the proposed regulations had included a special rule providing that an S corporation’s qualifying investment in a QOF would be treated as disposed of if there were a greater-than-25% aggregate change in ownership of the S corporation.  Following significant commentary on this proposed rule, the final regulations did not adopt this special 25% ownership change rule.  Rather, an S corporation investor (like a C corporation investor in a QOF C corporation) should not have an inclusion event for its qualifying investment solely as the result of a disposition of shares by one of the S corporation’s shareholders, regardless of the disposition’s magnitude. [39]

E.  QSST and ESBT Conversions

The final regulations confirm that neither a conversion from a qualified subchapter S trust (QSST) to an electing small business trust (ESBT), nor vice versa, is an inclusion event if the person who is both the deemed owner of the “grantor portion” of the ESBT holding the qualifying investment and the QSST beneficiary is the person taxable on the income from the qualifying investment both before and after the conversion.[40]  There would, however, be an inclusion event upon conversion if the qualifying investment is in the grantor portion of the ESBT and the ESBT’s deemed owner under the grantor trust rules is a nonresident alien.[41] 


[1]   The final regulations generally apply to taxable years beginning after the date that is sixty (60) days after the date of publication of the final regulations in the Federal Register (which the Treasury Department has set for January 13, 2020) – which, for calendar year taxpayers, will be to taxable years beginning on or after January 1, 2021.  However, until then, taxpayers generally may choose either (1) to apply the rules set forth in the final regulations, if applied in their entirety and in a consistent manner for all such taxable years, or (2) to rely on each section of the proposed QOF regulations, issued on October 29, 2018, and on May 1, 2019, but only if applied in their entirety and in a consistent manner for all such taxable years.   See Preamble to the final regulations (the “Preamble”) at 309-10.

[2]  ACTEC’s comments to the First Set of QOF Proposed Regulations is set forth at the following link: https://www.actec.org/assets/1/6/ACTEC-comments-to-Treasury-re-Qualified-Opportunity-Funds-2018-12-27.pdf

[3]   This is accomplished through basis adjustments.  Section 1400Z-2(b)(2)(B)(iii) provides that in the case of any investment in a QOF that is held for at least five years, the basis of such investment shall be increased by ten percent (10%) of the deferred gain.  In addition, section 1400Z-2(b)(2)(B)(iv) provides for an additional five percent (5%) increase in the basis of the QOF investment if it is held by the taxpayer for at least seven years.

[4]   The IRS Form 8996 and the instructions thereto are set forth at the following links: https://www.irs.gov/pub/irs-pdf/f8996.pdf and https://www.irs.gov/pub/irs-pdf/i8996.pdf.

[5]  The New York State Society of Certified Public Accountants (NYSSCPA) also requested this relief in its comment letter dated January 9, 2019 (the “NYSSCPA Comment Letter”).   https://www.nysscpa.org/docs/default-source/commentletter/nysscpa-comments-to-treasury—qualified-opportunity-funds-proposed-regs-1400z-2-final-19-01-09.pdf?sfvrsn=2

[6]  This was also requested in the NYSSCPA Comment Letter.

[7]  IRD can include, for example, the following: (i) income earned by an employee for services performed prior to his or her death but which is not received by the recipient until after the employee has died, (ii) rents earned by the decedent prior to death but not paid until after the decedent’s death, (iii) an employee’s interest in a qualified retirement plan, and (iv) a person’s interest in an individual retirement account (“IRA”).

[8]   Since items of IRD are subject to both income and estate taxes, the recipient is allowed an income tax deduction for the proportionate share of the estate tax (and generation-skipping transfer (“GST”) tax) attributable to the IRD item.  (See IRC § 691(c)) This deduction mitigates, to some extent, the burden of double taxation.

[9]  Treas. Reg. § 1.1400Z2(b)-1(c)(4)(i).

[10]  Treas. Reg. § 1.1400Z2(b)-1(c)(4)(i)(A)-(E).

[11]  Treas. Reg. § 1.1400Z2(b)-1(c)(4)(ii).

[12]  Treas. Reg. §1.1400Z2(b)-1(e)(4). 

[13]  Preamble at 50.

[14]  Treas. Reg. § 1.1400Z2(b)-1(c)(4)(iii).

[15]  Section 102.

[16]  An exception to this general rule could apply, for example, if the donor’s interest in the QOF is encumbered by debt in excess of basis.  See Treas. Reg. § 1.1001-1(e)(1).

[17]   Treas. Reg. § 1.1400Z2(b)-1(c)(5).

[18]  See Preamble at 95-96; Treas. Reg. § 1.1400Z2(b)-1(c)(3)(i).   

[19]  See Preamble at 98; Treas. Reg. § 1.1400Z2(b)-1(c)(3)(ii).  Section 1041 generally provides that no gain or loss shall be recognized on a transfer of property from an individual to (or in trust for the benefit of) (1) a spouse or (2) a former spouse (in the case of a former spouse, where such transfer is incident to divorce).  Under section 1041(c), a transfer of property is considered incident to divorce if such transfer (1) occurs within one year after the date on which the marriage ceases, or (2) is related to the cessation of the marriage.   

[20]  See Rev. Rul. 85-13, 1985-1 C.B. 184.

[21]  See Preamble at 52-53; Treas. Reg. § 1.1400Z2(a)-1(c)(9).

[22]   See Preamble at 94-95; Treas. Reg. § 1.1400Z2(b)-1(c)(5)(i).

[23]  See Preamble at 94; Treas. Reg. § 1.1400Z2(b)-1(d)(1)(iii).

[24]   See Preamble at 95; Treas. Reg.  § 1.1400Z2(b)-1(c)(5)(ii).

[25]  Treas. Reg. §1.1400Z2(a)-1(c)(8).

[26]  Partners may instead elect to use the partnership’s 180-day period if they so desire (e.g., if the desired investment is already lined up).  See Treas. Reg.§1.1400Z2(a)-1(c)(8)(iii)(B).

[27]  Prop. Reg. §1.1400Z2(a)-1(c)(3).

[28]   This information gap problem can be especially pronounced in the case of certain estates and trusts.  Under section 663(b), a fiduciary is permitted to elect to treat a distribution made in the first 65 days of the tax year as having occurred on the last day of the preceding tax year.  Such a distribution could involve capital gains that, as a result of the section 663(b) election, may be treated by the estate or trust as having been distributed to the beneficiary on the last day of the preceding tax year.  The beneficiary would not become aware of this in the ordinary course until it receives the Schedule K-1 reporting such distributed gains.  As noted above, this may potentially occur more than 180 days after the end of the estate’s or trust’s tax year if the Form 1041 fiduciary income tax return is on extension.

[29]  See Preamble at 42; Treas. Reg. §1.1400Z2(a)-1(c)(8)(iii)(B)(2).

[30]  Section 1400Z-2(b)(2) provides as follows:

1400Z-2(b)(2) AMOUNT INCLUDIBLE.—
1400Z-2(b)(2)(A) IN GENERAL.— The amount of gain included in gross income under subsection (a)(1)(A) shall be the excess of—

1400Z-2(b)(2)(A)(i) — the lesser of the amount of gain excluded under paragraph (1) or the fair market value of the investment as determined as of the date described in paragraph (1), over
1400Z-2(b)(2)(A)(ii) — the taxpayer’s basis in the investment.

[31]   See Preamble at 102-03; Treas. Reg. § 1.1400Z2(b)-1(g)(6).

[32]   See Treas. Reg. § 1.1400Z2(b)-1(c)(6)(ii)(B) (“[A] contribution by a QOF owner (contributing partner), of its qualifying QOF stock, qualifying QOF partnership interest, or direct or indirect partnership interest in a qualifying investment to a partnership (transferee partnership) to the extent the transaction is governed by section 721(a) is not an inclusion event, provided the interest transfer does not cause a partnership termination of a QOF partnership, or the direct or indirect owner of a QOF, under section 708(b)(1).” (emphasis added)

[33]  See Preamble at 48.

[34]  This did not change from the proposed regulations.

[35]  Treas. Reg. § 1.1400Z2(b)-1(c)(6)(i) (emphasis added).

[36]  Preamble at 48 (emphasis added).

[37]  See Treas. Reg. § 1.1400Z2(b)-1(c)(6)(i).

[38]  See Preamble at 86; see also Preamble at 48 (“[a]n inclusion event is a transaction that reduces or terminates the QOF investor’s direct (or, in the case of partnerships, indirect) qualifying investment for federal income tax purposes . . . .”  (emphasis added)

[39]  See Preamble at 86.

[40]  See Treas. Reg. §§ 1.1400Z2(b)-1(c)(7)(i); 1.1400Z2(b)-1(c)(5)(iii).

[41]  See Preamble at  92.

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