October 2, 2019
IRS releases draft Form 8997 for reporting qualified opportunity zone fund investments
On September 25, 2019, the IRS released draft Form 8997, Initial and Annual Statement of Qualified Opportunity Fund (QOF) Investments, which investors in qualified opportunity zone funds (QOFs) must file to report QOF investments held at the beginning and end of the current tax year, current tax year capital gains deferred by investing in QOFs, as well as QOF investments disposed of during the current tax year.
Eligible taxpayers — including individuals, C corporations, regulated investment companies (RICs), real estate investment trusts (REITs), partnerships, S corporations, trusts, and estates — holding a QOF investment at any time during the tax year must file Form 8997.
Definition of qualified opportunity zones
The Tax Cuts and Jobs Act (TCJA) created qualified opportunity zones by adding IRC Section 1400Z-1 and IRC Section 1400Z-2 to encourage investment in economically-distressed areas by giving tax incentives to taxpayers who invest and hold on to investments in qualified opportunity zones through QOFs. (See Tax Alert 2019-1534 for EY's latest information on opportunity zones.)
IRC Section 1400Z-1 allows certain economically-distressed areas to be designated as qualified opportunity zones.
IRC Section 1400Z-2 provides benefits for investment in QOFs. A QOF is a corporation or partnership that holds at least 90% of its assets in qualified opportunity zone property. Investors in QOFs must make an IRC Section 1400Z-2(a) election to defer eligible gain. The investment interest must be an equity interest and may include preferred stock or a partnership interest with allocations. In general, the investment must have been made within 180 days after the deferred gain was realized.
Investors can generally defer tax on eligible gains invested in a QOF until the earlier of the date on which the investment in a QOF is sold or exchanged, or December 31, 2026. If the QOF investment is held for longer than five years by the end of the deferral period, 10% of the deferred gain is excluded; a 15% exclusion applies if the investment is held for more than seven years by the end of the deferral period. If the investment is held for at least 10 years, the investor is eligible for an increase in basis of the QOF investment equal to its fair market value on the date that the QOF investment is sold or exchanged, thus excluding 100% of the gain that would have been realized from disposing of the appreciated QOF.
What must be reported
The draft 2019 Form 8997 requires taxpayers to report for each QOF investment:
Taxpayers holding a QOF investment at any point during the tax year must file Form 8997. This requirement for QOF investors is new and in addition to the requirement that QOF investors make IRC Section 1400Z-2(a) elections to defer eligible gains invested into QOFs using Form 8949. The Form 8997 requirement for QOF investors is also separate from the requirement that QOFs self-certify and annually report compliance with the IRC Section 1400Z-2(d) 90% investment requirement using Form 8996.
QOF investors should consult with their tax advisors and preparers regarding compliance with the reporting requirements related to their QOF investments. Additionally, QOFs may want to inform their investors of this new requirement. We expect that the IRS will continue providing guidance on opportunity zones, which will likely include finalizing a version of draft Form 8997, as well as providing additional reporting requirements for QOF investors and/or QOFs.