On June 4, 2020, the IRS released guidance relating to Qualified Opportunity Funds (QOFs) and their investors relating to the ongoing COVID-19 pandemic. This guidance was a welcome communication as it laid out many taxpayer friendly provisions. The biggest and most impactful provision is regarding a possible extension of time to successfully invest in a QOF and defer capital gains.
Notice 2020-39 states that if a taxpayer was required to make an investment in a QOF to successfully defer capital gains and the 180th day of their investment period fell between April 1, 2020 and December 31, 2020, the taxpayer now has until December 31, 2020 to make that investment. This has a significant impact for taxpayers investing in QOF’s and adds an interesting dimension of tax planning to year-end discussions. With this current notice any taxpayer that had recognized a capital gain from October 4, 2019 onward now has the ability to defer making an investment decision in a QOF until year-end, along with the corresponding tax liability that will be deferred. This could give taxpayers a “last bite of the apple” to defer 2019 income taxes after the filing deadline and take advantage of the deferral mechanism of a QOF through December 31, 2020.
For example, let’s say a taxpayer has a 2019 $2MM tax liability. Of that tax liability amount $500K is from a $2.5MM capital gain and the taxpayer pays all liabilities by July 15, 2020. Further, let us assume that the capital gain was incurred via ownership in a flow-through entity and the K-1 was issued to the taxpayer. Under this relief the taxpayer would have the ability to extend their decision to invest in a QOF until December 31, 2020, when typically there is only an 180 day window for a taxpayer to successfully invest. Even if the taxpayer filed timely on October 15 (assuming a timely filed extension), capital commitment to the QOF could occur between October 16 and December 31, 2020 and still be eligible for the deferral of capital gains tax. The one additional factor in this scenario is that an amended return would need to be filed in order to claim the refund of deferred tax. This opens the doors for clients to bring this change into consideration when going into Q4 planning.
Notice 2020-39 also granted relief to the QOFs themselves. From April 1, 2020 through December 31, 2020 the funds’ clock is suspended for purposes of the 30-month period during which property may be substantially improved. This allows extra time for the funds to infuse the necessary capital into QOF property to meet necessary testing requirements. In addition, funds’ 90% of assets test that is required semi-annually received a reprieve. A fund’s lack of ability to meet that test due to COVID-19 is deemed to meet the reasonable cause under 1400Z-2(f)(3) and the fund will not lose its status as a qualifying investment or designation as a QOF. This comes as huge relief to QOFs that might have experienced supply chain interruptions and or difficulties in accessing the necessary labor workforce due to the varied Shelter-At -Home orders that were enacted by governors across the country.
Thus, Notice 2020-39 gives a break not only to investors, but to the actual funds themselves and allows for the restoration of operations and plans that were put into place. The extension of the time allotted to invest in QOFs also may be viewed as an attempt by the Treasury to give extra tax motivation to fuel capital investments in a potentially uncertain financial time. We will continue to monitor additional information provided by the Treasury and disseminate as quickly as possible. Should you have any questions in the interim, please reach out to your closest HBK team representative.